A crucial part of R&D tax planning reaches beyond qualifying expenditure to how the benefit is ultimately passed on to the claimant.
There are actually a number of factors that inform what type of benefit the client receives, including the client’s preference, the financial position of the company and whether they’re claiming under the SME scheme or Research and Development Expenditure Credit (RDEC) for larger companies.
There are three main benefit options, spanning cash payments, Corporation Tax reductions and the carrying forward, or back, of an enhanced loss. It can also be a combination of these things.
The main difference between the SME scheme and RDEC, is that the SME scheme primarily reduces a company’s taxable profits. RDEC, however, is visible ‘above the line’ as income in the accounts. The credit itself is taxable income and ultimately reduces a company’s corporation tax liability or, in certain circumstances, can be paid as a cash credit.
Here, we’ll look at the different options under the SME scheme and then RDEC.
Under the SME scheme, there are five ways to receive the benefit, and the determining factor is primarily whether the company is profit or loss making. After that, client preference can come into play in certain circumstances. The five possibilities are:
1. A tax rebate
R&D tax relief can be claimed for the previous two accounting periods and, if a company claims for a period in which corporation tax has already been paid, the company tax return is amended and HMRC will issue a repayment, complete with interest.
2. A Corporation Tax saving
If, however, a claim is made in the same year that a company files the relevant corporation tax return, and it has a Corporation Tax liability yet to be paid, then the relief will first fall in the form of a reduction in Corporation Tax.
3. Loss reliefs
If a client is loss-making (before or because of the R&D tax relief claim), then several loss relief options are available. They can:
Carry this back to the previous year, if the previous year was in profit.
Carry this forward to offset against future trading profits from the same trade, if a future year is in profit. There is no time limit to carrying the loss forward.
Surrender the loss for group relief (where applicable).
Carrying a loss forward will deliver greater relief than a cash credit if the firm will be profitable in the future (see below) but some companies will prefer to receive the cash without delay.
In this year’s Budget, the one-year carry back rule was extended temporarily to three years.
4. A cash credit
If a company is loss-making, it can choose to receive a cash payment and surrender its R&D enhanced losses. This can be an attractive option as it can give a much-needed boost to cash flow. However, the cash credit is at a reduced rate of 14.5% compared to the current rate of Corporation Tax of 19%.
5. A combination
If the client’s position switches from profit to loss as a result of an R&D tax credit claim, it could:
Recover the Corporation Tax already paid.
Make a Corporation Tax saving as well as utilise the resulting losses by carrying these backwards or forwards.
Make a Corporation Tax saving as well as claim a cash credit in return for surrendering those losses.
A final complication now exists with the proposed rise in the Corporation Tax rate in April 2023 to 25% with, as yet, no announcement that the 14.5% credit rate will also increase accordingly; this could sway the decision between cash and losses going forward.
Research and Development Expenditure Credit (RDEC)
If claiming R&D tax relief under RDEC, the benefit is realised differently. Unlike the SME scheme, profit and loss-making companies are treated exactly the same way when it comes to their benefit. This means the 13% credit (RDEC tax credits are worth 13% of qualifying expenditure) will be taxable, and only paid out net of tax.
There are seven steps (below) that must be followed in strict order when calculating RDEC claims, and these will determine exactly how the credit is received. The aim of these is to ensure that the credit offsets outstanding tax owed before any cash is paid out.
1. Discharge any liability to Corporation Tax for the accounting period
The gross RDEC rate (13%) is offset against the firm’s Corporation Tax liability for the period to which the R&D tax credit claim relates.
2. Adjustment to reduce to net of tax amount
To ensure that only the net amount of the credit is payable in cash, if the amount remaining after step 1 exceeds the net value of the credit (gross credit less Corporation Tax), the balance is withheld and carried forward to use in future periods.
3. Limit to PAYE/NIC of R&D staff
The payment of the cash credit is subject to a cap based on the PAYE and NIC paid to HMRC relating to the employees included in the claim. Amounts in excess of the cap can be carried forward for use in future periods.
4. Discharge Corporation Tax liability for other accounting periods
Before the credit is paid in cash, HMRC may offset it against any outstanding Corporation Tax owed for any other accounting periods.
5. Elect whether to surrender for group relief
It’s possible to surrender up to the credit amount available at this step (as well as any amount restricted at step 2) to a group company to offset its tax liability. However, you don’t have to do this — the firm can still receive a cash payment even if other companies in its group have tax liabilities.
6. Discharge any other liabilities of your company with HMRC.
Any amounts remaining at this step will be offset by HMRC against other taxes if there are amounts outstanding. For example, overdue PAYE or VAT liabilities.
7. Cash credit payable to company
Finally, the company is eligible for a cash credit.
As you can see, the benefit depends upon numerous factors and it is impossible to tell a client what their claim will be worth without making a detailed assessment.
Byline by Grant Quigley, research and development tax manager at business tax consultancy Catax