Companies which undertake research and development ("R&D") activities can typically benefit from enhanced corporation tax reliefs under the UK's R&D schemes.
There are two main schemes for claiming relief, the availability of which depends on whether the company claiming the relief is a small or medium-sized enterprise ("SME") or a large company.
Both schemes provide enhanced tax relief set off against taxable profits for qualifying R&D expenditure. These enhanced reliefs can reduce a company's taxable profits or increase a company's losses. Under the scheme applicable to SMEs (the "SME Scheme"), it is also possible for a company to surrender a loss arising from qualifying R&D expenditure in exchange for a cash credit from HM Revenue & Customs ("HMRC"). There are proposals to extend this ability to surrender a loss for cash to larger companies.
Qualifying for either scheme can, therefore, provide significant tax benefits for companies which are eligible.
In considering eligibility under the R&D tax relief scheme, consideration needs to be given to:
- what activities will constitute R&D;
- whether the company falls within the SME or large company category;
- whether the expenditure incurred by the company qualifies for enhanced reliefs; and
- the amount of the enhanced reliefs available.
Activities Constituting R&D
For enhanced tax reliefs to be available under the R&D schemes, the activity conducted by the relevant Company must constitute "qualifying R&D". The definition of "R&D" for these purposes will follow its meaning for accounting purposes. Consequently, "research and development is distinguished from non-research based activity by the presence or absence of an appreciable element of innovation. If the activity departs from the routine and breaks new ground it should normally be included; if it follows an established pattern it should normally be excluded".
Guidelines issued by the Government stipulate that the R&D activities must relate to a project which seeks an advance in science or technology. R&D reliefs can only be claimed in respect of expenditure on activities within a project (or sub-project) which directly contribute to achieving the advance in science or technology through resolution of scientific or technological uncertainty. "Science" for these purposes means physical or materials science such as engineering, physics and chemistry. "Science" would not include, for example, social sciences or mathematics, although mathematical techniques can be used in qualifying sciences.
For the project to represent an 'advance in science or technology', it must relate to an advance in the global state of knowledge or capability of science or technology, not just the knowledge of the company undertaking the R&D. In general, the activities must address some uncertainty in science or technology. The Guidelines state that "scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice is not readily available or deducible by a competent professional working in the field".
Classifying an activity as qualifying R&D can often be a difficult process and it may be necessary to seek specialist advice.
Classification of companies as SMEs or Large Companies
If a claimant company with R&D expenditure qualifies as an SME, it may be able to benefit from enhanced reliefs under the SME Scheme.
A company will be an "SME" if it has both:
- fewer than 250 employees and either or both of: (i) an annual turnover not exceeding €50 million; and (ii) a period-end balance sheet total not exceeding €43 million; and
- less than 25% of its capital or voting rights owned by one or more companies that are not small or medium-sized.
A company will be considered to be a "larger SME" but may still be able to obtain SME relief if it has fewer than 500 employees and either or both of: (i) an annual turnover not exceeding €100 million; and (ii) a period-end balance sheet total not exceeding €86 million.
If the company is connected to or linked with other enterprises (for example, it is part of a larger group), the statistics of those other enterprises may need to be included when testing whether or not the company is an SME.
A "large company" is one that does not fall within the definition of an SME (including the definition of "larger SME"). Companies which exceed or fall below the larger SME limits for the first time are generally given a year of grace by HMRC. Therefore, companies will not typically change status unless they exceed or fall below the relevant thresholds for two successive years, in which case they would change their status with effect from the second year. This grace period will not apply in the case of an SME being taken over by a large enterprise.
When looking at qualifying expenditure for enhanced reliefs, it is necessary to consider the SME Scheme and the Large Company Scheme separately.
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