R&D tax credits for SMEs
The small to medium-sized enterprises (SME) R&D tax relief is commonly known as the SME Scheme. The SME Scheme 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 Scheme, including how it works, who is eligible, and how to apply for it.
What is SME R&D tax relief?
The SME R&D tax relief is one of two schemes: the SME and RDEC schemes (short for the Research and Development Expenditure Credit).
Available to all small to medium-sized businesses, the SME Scheme relief returns up to 33.35% of a business’s 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.
The RDEC scheme returns 13% gross and 10.53% net of your qualifying R&D expenditure. The main reason businesses need to claim through the RDEC scheme is their size.
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.
Who qualifies for SME R&D tax credits?
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.
SME exceptions that should apply for the RDEC Scheme
Three types of SMEs must apply through the RDEC Scheme.
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
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.
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.
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.
Before claiming for a grant, it’s worth considering the impact a grant will have on your capacity to claim R&D tax credits later. In most cases, grants will pre-fund future R&D activities, whereas R&D tax credits provide funding after the R&D project has started.
However, taking a grant before the project could potentially mean you’d have to claim through the RDEC Scheme. Claiming through the RDEC Scheme instead of the SME Scheme will effectively reduce your subsidised funding for the project by up to 22%. That’s because the SME scheme returns up to 33% of your spend, whereas the RDEC scheme returns approximately 11% net.
How much will my business receive from the SME Scheme?
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.
Your R&D credit as a company that is loss-making
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.
Your R&D credit as a company that is profit-making
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%.
How far back can you claim R&D tax credits?
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 2021, 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 2018 – July 31st 2019.
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.
Qualifying costs for the SME 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:
- Class 1 National Insurance contributions
- Pension contributions
- Business expenses
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.
Submitting an SME claim
There is 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 expenditure. And if you are claiming for SME, make sure you enhance your total expenditure by 130%
4. Write your technical narrative
The technical narrative is 2-5 A4 pages long and is your chance to explain your development work and any challenges you faced to HMRC. It’s not mandatory but is helpful for HMRC.
5. Complete your CT600
You then need to put your financial calculations into your CT600
6. File your Claim
You then combine your technical narrative and CT600 and file your claim.
How EmpowerRD manage SME Claims
At EmpowerRD, our intelligent online platform makes the entire process of creating an SME claim significantly more efficient than working the traditional way: with an accountant, traditional advisor or managing the claim in-house.
Our platform allows for multiple users to contribute either cost or technical information to the claim process. The EmpowerRD’s narrative writing team and the claim coordinator can then easily track each contribution ensuring the claim is built quickly and efficiently.
We also have intelligent guides and prompts to help the tech team draft and refine the technical narrative. This assistance significantly speeds up the process, guaranteeing minimum disruption to your team’s time. It usually takes a company less than a week when claiming with EmpowerRD; it’s taken hours in some cases. This is drastically faster than traditional advisors, who typically take between 2 to 3 months.
How to choose an R&D tax credit advisor
Know which questions to ask before deciding on your next advisor.
Guide to R&D advance funding
R&D Advance Funding can give you access to up to 80% of your future R&D tax credits up to 9 months before receiving the payment from HMRC.
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How to make an RDEC claim
The complete guide to compiling and submitting an RDEC claim. Includes an explanation of the differences between the two schemes.
Guide to government funding
A breakdown of the different types of government funding available to innovative businesses in the UK. Includes Coronavirus response funding.