Many companies in the waste and recycling sector could be missing out on the R&D tax credits they are entitled to, writes Geoff Bennett
We often wonder why so few companies claim research and development (R&D) tax credits. Based on our experience of helping some 300 SME clients over 11 years, we have found that many companies and their accountants simply do not recognise when they do R&D. Because of this, less than 0.5% of SMEs actually claim R&D tax credits.
Many companies do not appreciate the full scope of what constitutes R&D. This can lead to no claim or low claims. Some accountants do not recognise R&D, often because their clients do not, or they have snippets of information which lead to wrong conclusions.
Some accountants have had difficulties with HM Revenue & Customs (HMRC) relating to claims in the early days of R&D tax credits and see it as a problem area that is best avoided. Some feel that an R&D tax credit claim will lead to enquiries into broader aspects of client affairs by HMRC.
In general, companies are too modest and see R&D as something that is only for scientists. A smooth, full potential claim requires good knowledge of the guidelines and how HMRC deal with claims, and some companies feel they just do not have the time to go into it.
With around only 9,960 SME claims in the year to April 2012, according to the latest HMRC Statistics, and about 30,000 UK accountancy firms who have many aspects of tax to deal with, it is unreasonable to expect them to have a very high level of expertise in R&D tax credits.
What constitutes R&D is not discussed within companies. Many believe a ‘world first’ has to be developed to qualify, which is not correct.
We have come across reactions such as “if it is a Government scheme, the qualifying process will be too much hassle to make the effort worthwhile”. Or accountants have commented “you are engineers, not scientists, so you would not qualify” or “you only develop web sites so you would not qualify”.
Clients we have helped to claim credits include an engineering company that had developed an advanced solution for its customers and taken on all the development risks, and a business services company that did a scientific study identifing factors influencing performance in its industry and then developed the technology to improve it.
In the past year, we have dealt with more than 140 companies which had not previously made claims for R&D tax credit.
In the area of R&D tax, you will hear people talk about the aim of ‘advancing science’, but we have never met a company which sets out to do this. More typically, a company will want to adapt science or technology, or develop the capability of science or technology to do something practical, such as make a product, create a service, develop a manufacturing or operational process or create a material.
Where the resulting research and development also requires them to resolve technological uncertainties, this work is R&D. Where consumables are used in the process, these could qualify as direct R&D expenditure. Where there are indirect R&D costs they may also qualify.
The word ‘science’ continues to be used in a broad sense of all the reliable knowledge about a topic. In this sense, every industry and every company has its own ‘science’. Where a company adapts or develops that science in a way which is not “readily deducible by a competent professional working in the field”, that work could be R&D.
What happens in practice is that competent professionals working for a company will have an idea to create a new and innovative product, service, process or material based on their current understanding of the related ‘science’ and utilise or create technologies to deliver the end result.
The claims process
The claims process is part of the normal treatment of providing the necessary annual accounts information to HMRC, and the qualifying expenditure should be shown as an adjustment to the profit figure on which tax is calculated.
Only the qualifying figure is needed for tax purposes. But you should maintain a record of how that figure has been calculated, and be prepared to show back-up documentation such as payroll and invoicing information.
As instructed by guidelines on the HMRC website you should:
- Understand the guidelines and interpret them in order to see how they apply in your industry and your company. This is open to misunderstanding.
- Identify possible R&D projects, understand the R&D content through identifying the possible areas of scientific and technological advances or capability/advances. Understand where R&D begins and ends.
- Identify the scientific and technological uncertainties which were encountered in the projects in order to achieve the advances sought. Only work directly associated with resolving those uncertainties is qualifying R&D.
- Create a document which describes those advances and uncertainties and when and how they were resolved. This document should be written in layman’s terms.
- Calculate the expenditure incurred in doing the R&D in terms of direct labour, sub contracted labour and directly related consumable costs. See HMRC web site for details.
- Provide the correct qualifying costs to whoever handles your Corporation Tax returns.
- Answer any questions which HMRC want to ask in relation to technical qualification and costs.
Figures published by HMRC in August 2013 show that in the year 2011/12 around 9,960 SMEs claimed £400m, making the average SME claim worth about £40,000. From 1 April 2012 the rate at which qualifying R&D expenditure is treated for corporation tax purposes increased from 200% to 225%.
In very rough terms, companies will normally be able to recover about 25% of their qualifying R&D spend in either tax credits (cash) or corporation tax relief. On the basis of last year’s figures, if the same claims were repeated in this financial year the average SME claim would be around £50,000.
The Dyson report on innovation recognised the importance of the R&D tax credit scheme in encouraging companies to invest in R&D, stating: “Of the various tax instruments available to the Government, R&D tax credits have the advantage that they seek to help companies that are themselves prepared to invest in R&D. Government does not need to choose sectors or companies, with the result that R&D can be encouraged in the widest possible range of sectors, taking advantage of businesses’ own insights into likely breakthroughs.”
With an estimated 4.5 million SMEs in the UK, it is clear that fewer than 1% claimed R&D tax credits in 2011/12. Is this an accurate reflection of the R&D work actually done by SMEs?
Around 21,000 SMEs have claimed R&D tax credits since the scheme started in 2000. Does this mean a lot of SMEs have stopped doing R&D or have many just stopped claiming tax credits on the R&D they do?
At current rates, an SME with £100,000 of qualifying R&D expenditure would be able to reduce its corporation tax bill by £25,000 or, if it was loss making, it could receive a credit in cash of close to that amount. These sums can make a significant impact on R&D budgets.
Effective R&D can have a huge impact on corporate success and the bottom line. One client explained to me that his company would need to generate sales of about £1m in order to have the same bottom line impact that his first R&D tax credit payment had made. Think about that!
Geoff Bennett is an advisor at Randdtax (www.randdtax.co.uk)