How to make an SME R&D tax credits claim

The small to medium-sized enterprises (SME) R&D tax relief is commonly known as the SME R&D tax credits scheme or the SME R&D tax relief scheme. It is a UK government tax incentive that promotes innovation amongst the UK’s small to medium-sized businesses.

This guide will cover everything you need to know about the SME R&D tax relief scheme, including how it works, who is eligible, and how to apply for it.

 

SME R&D tax relief is one of the two schemes, the SME and RDEC scheme (short for the Research and Development Expenditure Credit).

The SME R&D tax relief scheme changed on 1 April 2023

For accounting periods beginning April 2023, the SME Scheme relief returns up to 33.35% of small to medium-sized businesses’ development costs, and the credit is not subject to corporation tax. You can recoup the R&D tax relief as a cash payment and/or Corporation Tax reduction.

For accounting periods from April 2023, the SME R&D tax relief scheme is less generous, with the SME scheme’s enhancement rate decreasing from 130% to 86% and the SME tax credit rate reducing from 14.5% to 10%. Again, the credit is not subject to corporation tax. You can recoup the R&D tax relief as a cash payment and/or Corporation Tax reduction.

It was also announced in the Spring Budget 2023 that R&D-intensive SMEs would not be as affected by the decreases and would receive a higher relief rate. Therefore, from April 2023, the SME scheme relief will return up to 27% of R&D costs for R&D-Intensive SMEs.

Please note that most companies will be submitting their claims for the 2022 financial period, so the changes discussed here are unlikely to have an impact on your upcoming claim. However, staying informed about these reforms is crucial for planning ahead and making informed decisions. For a clear understanding of the new SME rates, head straight to our Guide on SME R&D tax credit changes.

Where did R&D tax credits come from?

In 2000, the UK Labour Government started the R&D tax credit scheme to support innovation and growth for small to medium-sized UK businesses.  

The government set up the scheme to offer SMEs who engage in R&D a reduction in Corporation Tax and/or payable credit.

The most crucial factor determining whether your business qualifies for SME R&D tax credits is the size of your business.

HMRC has set a criterion to determine whether you qualify as a small to medium-sized company.

The company size test

If your business has fewer than 500 staff and a turnover of under €100m or a balance sheet total under €86m, then you can likely claim through the SME Scheme.  If your company exceeds those limits, then you should claim using the RDEC scheme. Note that the limits are in euros because the HMRC rules have been adapted from European-wide rules.

 

 

 

 

Three types of SMEs must claim tax relief through the RDEC Scheme.

Subcontracting SMEs  

If you were subcontracted to perform R&D for a larger company, you would have to claim through the RDEC Scheme. This is because the cost of the subcontracted activity will contribute to the contracting company’s R&D expenditure. HMRC apply this condition to stop excessive subsidisation of the same activity. 

     

SMEs owned by big companies

linked and partner enterprises

Partner Enterprises

If a larger business owns your SME, you may need to claim through the RDEC Scheme. If your SME is 25-50% owned by a larger company, they are classified as a “partner enterprise,” and their assets, balance sheet and employee count will proportionately contribute to your own. For example, if your SME is 33.33% owned by a company with 1500 employees, your employee count would be 500 + your company’s headcount. 

Linked Enterprises

Alternatively, if your SME is more than 50% owned by a large company, then the total size of that business will apply to your calculation. The business will be classified as a “linked enterprise.” In this case, the entire total of their assets, balance sheet and employee count will apply to your company’s profile when choosing which scheme. If you don’t know whether you are a partner or a linked enterprise, consult the EU criteria for SMEs (to which HMRC has applied) or get in touch with one of our team members.

Grant Recipient

If your grant counts as ‘notified state aid’, you may need to claim it entirely or partly through the RDEC Scheme. Most government-backed grants will qualify as notified state aid, although there are some exceptions.

Additionally, the proportion of qualifying expenditure that needs to be claimed through the RDEC scheme will depend on three things; the number of projects, the financial backing of those projects, and the nature of the way the grant is received. Find out more in our guide to grants and R&D relief.

Dividing up your claim between the two schemes can be difficult. If you require help dividing your claim between the two schemes or don’t know which scheme you should apply for, get in touch with one of our advisors. 

The research and development (R&D) tax credit scheme can benefit up to 33.35% of development costs. However, the cash benefit of an R&D Claim varies depending on your business’s Corporation Tax position and whether you’re breaking even, making a profit or loss-making.

For all SME Claims, HMRC enhances your R&D expenditure up to 130% of its value. So if your business spent £100k on R&D, you would receive £130k. Once enhanced by HMRC, it’s your firm’s financial position that determines how much you receive back. 

Your R&D credit as a company that is breaking even

When you break even, your enhanced R&D expenditure has a rate of relief of 14.5% applied. So break-even companies, therefore, receive 18.85% of their R&D expenditure.

If you are a loss-making SME, Once you finish your tax credit claim, HMRC calculates your R&D credit by combining your enhanced R&D expenditure and trading loss, with the same 14.5% applied. 

For that reason, the greater your loss, the more R&D credit you will be due as a % of your R&D expenditure. Note: Your total credit cannot surpass 33.35% of your R&D expenditure.

If you are a profit-making company, once you’ve finished your tax credit claim, HMRC deducts the value of your enhanced R&D expenditure from your taxable profits. This enhanced deduction makes your R&D tax credit the difference between your corporation tax bill before and after the R&D credit is applied. 

If the enhanced R&D expenditure is higher than your taxable profit, the enhanced R&D expenditure becomes a trading loss, and a loss-making calculation applies. See in the calculation below:

The minimum you’ll receive is 18.85% (the break-even rate), and the maximum cap for profitable companies is set at 25%.

 

Break Even SME

When your company breaks even, your R&D enhanced expenditure will now have a 10% tax relief applied instead of 14.5%, resulting in an 8.6% relief rate available instead of the 18.85% that was in effect before April 2023.

Breaking even calculation

Total qualifying R&D Expenditure (TQE): £1,000,000

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

R&D enhanced expenditure x New SME tax credit rate = Tax Credit Claim Value

£860,000 x 10% = £86,000

Tax Relief Value = £86,000 (8.6% of relief)

Loss-making SME

HMRC calculates your R&D tax credit when you’re a loss-making company by combining the enhanced R&D expenditure and trading loss. The new 10% tax credit rate is applied instead of 14.5%, resulting in an 18.6% relief rate available instead of the old 33.35% before April 2023.

Loss-making calculation

Total qualifying R&D Expenditure (TQE): £1,000,000

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

Maximum surrenderable loss (186%)

(£1,000,000 + £860,000) x 10% = £186,000

Tax Relief Value: £186,000 (18.6% of relief)

Profit-making SME

To calculate the R&D tax relief as a profit-making company, first, deduct your increased R&D expenditure from your taxable profits. Then multiply that figure by the corporation tax rate to get your revised corporation tax bill. The money you save is calculated by subtracting the reduced corporate taxes bill from what it would typically be without the deduction. See the calculation below.

Financial position

Total Qualifying R&D Expenditure (TQE): £1,000,000

Profit: £1,500,000

New Corporation Tax = Profit x 25%

1,500,000 x 25% = £375,000

R&D credit calculation

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

New taxable profit = Profit – R&D enhanced expenditure

£1,500,000 – £860,000 = £640,000

New corporation tax = New taxable profit x 25%

£640,000 x 25% = £160,000

Tax savings

Corporation tax – Reduced corporation tax

Total tax saving: £375,000 – £160,000

Total tax saving: £215,000 (21.5% of relief)

Note: Starting from 1 April, companies generating over £250,000 in profits will pay 25% corporation tax. Businesses seeing profits between £50,000 and £250,000 will be subject to a graduated rate ranging from the current 19% up to the new 25%.

A profit-making company can receive a relief rate ranging from 16.34% to 21.5%. The company’s profit margin determines the rate, which determines its corresponding corporation tax band.

What if the R&D enhanced expenditure is higher than your taxable profit?

If the R&D enhanced expenditure is higher than your taxable profit, the R&D enhanced expenditure becomes a trading loss, and a loss-making calculation applies. However, the new 10% tax credit rate must be applied instead of the old 14.5%.

From April 2023, the SME scheme will become less generous. However, there is a silver lining for R&D-intensive SMEs. The government has announced its plans to roll out a higher rate of relief in the Spring Budget, benefiting innovative and R&D-led SMEs.

What is an R&D-intensive SME?

An R&D-intensive SME is a company with qualifying R&D expenditure that is at least 40% of its total expenditure.

How much will an R&D-intensive SME receive?

An R&D-intensive SME will be able to claim a higher payable R&D tax credit rate of 14.5% (rather than the reduced 10%).

This means that loss-making R&D-intensive SMEs will receive a cash credit of £27 for every £100 spent on R&D expenditure instead of the reduced rate of £18.60 available to non-R&D-intensive SMEs.

How will this be delivered?

As part of the existing SME scheme, companies will be able to indicate if they are claiming as R&D-intensive using a new digital ‘Additional Information’ form. The introduction of this form is set to take effect on or after 1 August 2023.

The research and development tax credit can be claimed for an accounting period that ends up to 2 years before the claim is submitted. So, for example, if you find out about the R&D tax credit scheme in July 2023, and you have a year-end of July 31st, you will be able to claim all the R&D expenditure dating back to your financial period from August 1st 2020 – July 31st 2021. 

For this reason, it’s a good idea to ensure that you’re claiming for all your historic costs when you first claim from the scheme.

Once you’ve found out that your activities qualify for R&D, you need to know which costs can be claimed.

Identifying R&D qualifying costs can be challenging but the main ones are below: 

Eligible R&D expenditure

Staff Costs: Staff costs that qualify include:

• Salaries
• Class 1 National Insurance contributions
• Pension contributions
• Business expenses
• Bonuses (where attributable to R&D) 

Subcontractor Costs: Under the SME Scheme, the amount you can claim for a subcontractor depends on whether they are connected or unconnected. 

• When unconnected, you can claim 65% of the payment made to subcontractors.
• When connected you can claim 100% of the R&D payment made to the subcontractor.

Externally provided R&D staff: These are costs paid to a third party who are involved with the R&D project.

Consumable items: Items that are directly employed and consumed in the R&D projects can also qualify.  

Software licence fees: You can claim for software directly used in the R&D project

Clinical trials volunteer costs: Clinical trials are essential within the pharmaceutical industry. 

To get more in-depth information and find more qualifying costs, we recommend reading our qualifying costs guide.

There are usually six steps to submitting an SME claim:

1. Which project should I claim for?

It’s first best to choose which projects you will be claiming for. HMRC likes you to break up your development work into a series of projects. Each project must meet HMRC’s guidelines to make it eligible for R&D tax credits.

2. Which scheme should I apply for?

As outlined above, there are two schemes you can apply for SME and RDEC. The scheme you apply for depends on the size, finances and other factors relating to your business.  

3. What is my claim size?

To calculate tax credit claims, you should add up the eligibility costs and qualifying expenditures. And if you are claiming for SME, make sure you enhance your total expenditure by 130%

4. Write your technical narrative

From August 2023, the technical narrative will be submitted through HMRC’s new Additional Information Form. This is your chance to explain the scientific or technological advances you’re trying to make and the scientific or technological uncertainty you tried to overcome when working on your project. This will now be mandatory from August 2023.

5. Complete your CT600

You then need to put your financial calculations into your CT600

6. File your Claim

You then combine the Additional Information Form and CT600 and file your claim and wait for the payable tax credits or tax reliefs.

We’re here to help. Hundreds of SMEs have trusted EmpowerRD’s R&D platform and specialists to help them build optimised, compliant R&D tax claims. Please get in touch with one of our experts today if you have any further questions.