RDEC scheme explained
The Research and Development Expenditure Credit commonly known as the RDEC Scheme is a UK government tax incentive that aims to foster innovation amongst the UK’s larger businesses.
Introduced in 2013, it allows large companies and some smaller companies to claim R&D tax relief “above the line” as taxable income rather than as a below-the-line benefit. This represents a significant difference to the SME R&D scheme.
The RDEC scheme replaced the previous Large Company scheme, which didn’t offer this above-the-line accounting treatment.
If you’re unsure whether you should claim with the RDEC or SME scheme then first have a read of our guide on which scheme is suitable for your company.
Who can make an RDEC claim?
Any UK company with qualifying R&D projects can, in theory, make an RDEC claim. If you’re unsure if your activity counts as R&D then it’s worth reading our R&D Eligiblity Guide.
If you’re undertaking R&D then you next need to decide on whether you can claim through the more generous SME scheme. The SME scheme delivers back 33%, whereas the RDEC scheme effectively delivers 11%, so when possible it’s preferable to apply using the SME scheme. The question to ask is therefore, who who must use the RDEC scheme rather than the SME scheme?
UK companies which have 500 employees or more, and either more than €100 million turnover or €86 million gross assets need to claim through the RDEC scheme rather than the SME scheme. In addition to larger companies, three types of small companies must also use the RDEC scheme rather than the SME scheme for all, or some, of their R&D tax credit relief.
Firstly, small companies that have received notified state aid may need to claim either partly or fully through the RDEC scheme rather than the SME scheme. How much of their R&D expenditure would be claimable through the RDEC scheme or the SME scheme will depend on the nature of the grant, and how many projects they are claiming against.
Before claiming a grant, you should fully consider the impact the grant will have on your ability to later claim R&D tax credits. Typically grants will pre-fund an R&D project, whereas R&D tax credits provide funding after the R&D project has started. However taking a grant before the project may mean you need to claim via the RDEC scheme rather than the SME scheme, effectively reducing your subsidised funding for the project by up to 22%.
Secondly, SMEs whose ownership is partly held by a large company may also need to claim through the RDEC scheme. If a large company owns between 25-50% of the voting or share capital in the business then they will be classified as a “partner enterprise”. In that case the equivalent % of the partner enterprise’s workforce, balance sheet and gross assets must be taken into account when considering the size of the claimant’s company. For example, if your SME is 33.33% owned by a company with 1500 employees then your employee count would be 500 + your company’s headcount.
If a large company owns more than 50% of the voting rights or share capital of your company, or it satisfies other tests of control outlined by HMRC here, then it will be classed as a “linked enterprise”. In the case of a linked enterprise, its total workforce, balance sheet or gross assets will apply to your company’s profile when deciding which scheme to apply for. For a detailed discussion of whether you might have a linked or partner enterprise, then we recommend using the EU criteria for SMEs (which HMRC have applied), or getting in touch with one of our team.
Thirdly, if as an SME you are carrying out R&D on behalf of another company as a subcontractor then you will need to claim through the RDEC scheme rather than claiming SME relief. This is to prevent excessive subsidisation of the same R&D projects by multiple companies.
How much can you claim with RDEC?
As of 1st April 2020, companies can receive 13% credit returned on their total qualifying R&D expenditure. However, it’s worth noting that the RDEC scheme credit is subject to corporation tax at 19%, so companies receive approximately 11p back for every £1 spent.
Here’s an example RDEC calculation: if a company had £1,000,000 worth of R&D spend occurring after 1st April 2020, they would receive 13% above the line credit (£130,000), which will be taxed at the 19% Corporation Tax rate, so the credit they receive would total £105,300.
Companies either receive the credit as a cash payment or a reduction on their corporation tax bill depending on their financial position. Loss-making companies will receive a cash credit, and profit-making companies will receive the reduction.
The increase in the RDEC rate from 12% to 13% in the 2020 spring budget is a welcome boost to innovation in the UK. It’s important to note however that the rate increase only applies to the spend taking place after the 1st April 2020. This may mean that your most recent claim will be subject to two rates of RDEC relief as the qualifying spend may cover the period both before and after the change.
Accounting treatment for the RDEC scheme
In 2013, the government changed the accounting treatment of the RDEC scheme so that the credit now appears “above the line”.
The motivation for the change was that it allows the departments that carry out the innovation in larger businesses to show the credit as income when calculating their accounting profit before tax, rather than it ending up in the broader company income statement. This helps to ensure that those making the decisions to conduct R&D are clearly remunerated.
While that was the stated intention, the broader benefits are also significant. By placing the credit above the line, the visible income of the company is positively impacted. This increases the appeal of businesses in the eyes of investors and the public markets. It has become a significant factor for multinationals in deciding to locate their R&D activities in the UK.
Qualifying costs for the RDEC scheme
In general, the information available on qualifying costs for the R&D tax credit scheme will apply to the RDEC regime. However there is one significant difference: in the RDEC regime you are unable to claim for subcontracted R&D, except where the subcontractors are either: “an individual, a partnership (each member of which is an individual), or a qualifying body”.
A qualifying body is “a [UK] charity, an institution of higher education such as a university, a scientific research organisation or a health service body.” (HMRC CTA09/S1142). The most common qualifying bodies we see claimed for are UK universities and NHS hospitals. The government also maintains a list of overseas bodies which qualify as eligible as a “prescribed” or “qualifying bodies” for RDEC claims.
While this gives reasonable scope to claim for some subcontractor arrangements, the most significant exclusion from this list, however, is limited companies. In our experience, the majority of subcontractor costs we file against for the SME R&D tax credit are for limited companies, so having limited companies excluded from potential subcontractor costs is a significant difference when applying through the RDEC scheme.
It’s also worth noting that the costs for Externally Provided Workers (EPW’s) are claimable under RDEC. This is where the difference between subcontractors and EPW’s becomes quite critical. EPW’s are effectively workers hired under your own company’s direction, whereas subcontractors are hired under their own direction as experts in their field. Additionally, there must be 3 parties involved in an EPW arrangement (e.g. your business, a staffing agency and the EPW).
So as an example, an EPW might be an agency worker hired to provide administrative assistance to your R&D team, whereas a subcontractor might be a specialist engineering firm employed to conduct independent research on a technical roadblock your team has reached.
Submitting an RDEC claim
When submitting an RDEC claim there are seven steps that you need to complete before the submission happens.
To help explain these steps we’ve provided example company financials below:
- £2m accounting profit before R&D costs
- £400,000 R&D costs
- £70,000 PAYE & NIC costs relating to R&D
- £200,000 corporate tax loss
- No other outstanding tax liabilities
- RDEC rate is assumed to be at 13%
The company will need to then undergo the following seven steps to calculate its RDEC credit:
1. Offset existing corporation tax. Firstly, you’ll need to offset any existing corporation tax liabilities. If you have a credit remainder then that carries on to step 2.
Example: R&D Costs of £400,000 x 13% = £52,000. No company tax liability so all of the £52,000 carries forward to Step 2.
2. Apply the notional tax rate. In order to ensure that both profit and loss-making companies receive the same net benefit, you’ll need to apply a “notional tax rate” of 19% to the balance regardless of your financial position.
Example: £52,000 RDEC credit – 19% = £42,120 RDEC credit carried forward to Step 3. £9,880 carried forward to future accounting periods, which reduces future corporation tax liabilities.
3. Check the credit against the R&D PAYE/NIC costs. HMRC cap the payment of the credit to the total value of the PAYE and NIC contributions for the workers involved in this RDEC claim. Any amounts in excess of the PAYE/NIC cap will be carried over to next year’s claim period,
Example: PAYE & NIC Costs of £70,000, so £42,120 credit passes to to Step 4.
4. Honour corporation tax liabilities. At this stage you must honour any corporation tax liabilities held from previous accounting periods. Those will then offset the credit amount due here.
Example: No corporation tax liabilities from previous accounting periods held. £42,120 carried on to Step 5.
5. Surrendering the credit for group relief. The amount taken from step 4 can be transferred to another group company to offset against their tax liability. This is optional. You can still receive your credit even if other companies in your group have outstanding tax liabilities.
Example. No group relief opted for. £42,120 carried on to Step 6.
6. Honour other tax liabilities. Now you’ll need to deduct any other tax liabilities held from previous accounting periods, eg unpaid VAT or PAYE.
Example: No additional liabilities held. £42,120 carried on to Step 7.
7. Credit paid after HMRC tests. If your company is a “going concern” and is not subject to an HMRC enquiry on its tax return, then the credit will be paid out in full.
Example. £42,120 paid out as cash credit.
This process can become quite complex for some companies, especially if they have liabilities or credits from prior accounting periods. At EmpowerRD we offer consultations at late stages of the RDEC claim process if needed. So get in touch with our team and we’ll be happy to advise on your specific case.
How EmpowerRD manage RDEC claims
At EmpowerRD we’ve built out a platform which makes the entire process of creating and managing an RDEC claim submission significantly easier than working with a traditional advisor, accountant or managing the claim in-house.
Our platform allows for teams across your business to easily contribute either costs or narrative data to the claim. The progress in their contributions can be tracked by the claim co-ordinator and there are intelligent guides and prompts to ensure that the technical contributions are easily drafted and refined. This significantly speeds up the process of compiling a claim and ensures that the disruption to the tech team is kept to a minimum.
In addition to the benefits of our platform, you will be allocated a claim manager who will guide you and your team through the claims process, be on-call for any queries you have about the claim and help you to compile your claim report. Before submission, our team of ex-HMRC inspectors and ex “big 4” accounting specialists will check your claim to ensure it passes our submission standards. Should you wish, we’ll also submit the claim for you and deal with any HMRC queries for no extra cost.
We are also able to provide a fully-managed service in addition to the typical EmpowerRD claim treatment. With our fully-managed service, our team will calculate your claim, draft your narratives and manage the process of submitting. Speak to one of our advisors to understand what type of service would be most suitable for your claim.
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