Receiving outside investment from investors can be an exciting time in your company’s development. Getting access to that much-needed capital from an Angel Investor, Venture Capital firm, or Private Equity group can help you get to the next level. However, you might get a shock once the celebrations die down and you begin to consider your next R&D Tax Credit claim.
While equity financing will not prevent you from qualifying for R&D Tax Credits, it could mean that you miss out on a significant amount of R&D funding. The exact amount you lose out on is determined by HMRC’s view of your financial relationships with your investors.
How HMRC classes you and your investor
HMRC has established three different categories to identify your financial connection with your investor.
- Autonomous enterprises
- Linked enterprises
- Partner enterprises
If you classify as an autonomous enterprise, you can relax, you won’t be affected by your connection with your investor, and you’ll be able to claim the total maximum for your R&D claim.
However, suppose your financial connection with your investors is defined as a linked or partner enterprise. In that case, you’ll likely have to claim R&D Tax Credits through the RDEC scheme, which provides considerably less funding than the SME scheme.
We’ll now go through how HMRC classifies each enterprise to assist you in determining where you fit.
If you do not have an outside investor who owns 25% or more of your company’s capital or voting rights, you and your investor are essentially an autonomous enterprise.
To add, even if you have several investors, each with a stake of under 25%, you and your investor will remain as an autonomous enterprise, provided the investors are not linked. If the investors are linked individuals, the enterprise may be considered a linked or partnered enterprise.
How can individual investors be linked?
Individual investors are linked if they share a family connection or are required to vote in unison. Similarly, if two or more investors jointly own 50% or more of your business and 50% or more of another company in the same market or ‘adjacent market,’ you may not be an autonomous enterprise.
It can sometimes be challenging to identify if your investors are linked. For more information, you can go to HMRC’s Corporate Intangibles Research and Development Manual.
Alternatively, you can get in touch with one of our R&D experts today.
Exceptions to the rule
There are some exceptions to the rule. Even if the 25% threshold is reached or surpassed by the below investors, you and your investor can still be classified as an autonomous enterprise:
- public investment corporations and VCs,
- individuals or groups of individuals with a regular venture capital investment activity who invest equity capital in unquoted businesses (‘business angels’), provided the total investment of those business angels in the same enterprise is less than €1.25 million,
- universities or non-profit research centers,
- institutional investors, including regional development funds,
- autonomous local authorities with an annual budget of less than €10 million and fewer than 5,000 inhabitants.
A business can keep its autonomous status while having one or more investors listed above. However, each investor must not have a stake of more than 50%, and they must not be linked to each other.
HMRC will classify your business as a linked enterprise if your investor can exercise control over your business’s affairs. They have three ways to decipher this. Your investor:
- Has a majority, i.e. owns more than 50% of your shares and your company’s voting rights.
- Has the power to appoint or remove the management, administrative or supervisory body from your company.
- Has the ability to exercise a “dominant influence” over your company.
It’s not just a company that you can be linked to. An individual investor who works in the same or ‘adjacent’ industry to you and owns more than 50% of your shares will make you and your investor a ‘linked enterprise.’ This means that you would be ‘linked’ to any other company your investor owns 50% or more of.
What does this mean for your R&D tax credit claim?
If your company is part of a ‘linked enterprise’, you will need to include your investor’s employee headcount, revenue, balance sheet, and any other company your investor is ‘linked’ to.
This is important because HMRC uses the company size test to determine whether you’re eligible for the SME Scheme or the RDEC Scheme. For instance, to claim under the SME Scheme, a business should have 500 employees or less, a turnover of less than €100 million per year, and a balance sheet of less than €86m, any business with a bigger company size must claim through the RDEC Scheme.
In most cases, SMEs will claim through the SME Scheme, which allows you to recover 33% of your development costs. However, if you are a larger business, you will claim through the RDEC Scheme, which only lets you claim up to 10% of your costs.
Therefore, the scheme you claim through is entirely dependent on your investor’s employee count and turnover. Being ‘linked’ to your investor could therefore bump you up to the RDEC scheme.
You can also be regarded as an SME if your combined company size falls within the SME scheme limit.
A partner enterprise is one where a larger business owns between 25%-50% of your SME. This is not a ‘linked enterprise’ because your investor does not have a majority share.
What does this mean for your R&D tax credit claim?
If you are partnered with another company, their assets, balance sheet, and employee count will proportionately contribute to your own. As a result, the amount you contribute is determined by how much of your business your partner owns.
For example, if your SME, which has 60 employees and a balance sheet of €20m, is 33.33% owned by a company with 1500 employees and a balance sheet of €259m, your employee count would be 500 + 60 and €86m + €20m of their balance sheet. This would take your employee count to 560 and balance sheet to €106m, which classifies you as a large company.
Alternatively, if you were 33.33% owned by a company with 500 employees and a balance sheet of €150m, your employee count would be 167 employees and a balance sheet of €70m, which keeps you within the SME scheme limits.
Even if you were to be classified as a large company, there are expectations to the rule outlined in the autonomous enterprise section.