Research and development tax credits can be a valuable tax break for small companies. Profitable companies can reduce their tax bills by around a quarter of eligible costs. For loss-making companies the tax break can be even more valuable, with a payable credit worth a third of qualifying R&D costs.
Are you eligible for R&D tax credits?
To be eligible for tax credits, your business must trade as a UK limited company. Businesses that use other structures (for example, self-employment or partnerships) are not eligible.
The company must also qualify as a small or medium-sized enterprise (SME). This means that you must have fewer than 500 employees. You must also have either turnover below €100 million, or total assets below €86 million.
Special rules apply if your company is part of a larger group or has partnerships with other companies involving more than 25% of voting rights or capital. If so, a proportion of their employees, turnover and assets may need to be included in determining whether you qualify as an SME.
If you are a subcontractor to a large company you may be eligible to claim (less generous) research and development expenditure credits (RDEC).
Tax credits and grants
If your R&D project is also receiving grant support, this can affect your eligibility for tax credits. You may be able to claim the SME tax credit, RDEC or a mix of the two:
- You can claim the SME tax credit for any eligible expenditure which is not subsidised by the grant.
- Where costs are subsidised by the grant, you cannot claim the SME tax credit. But you can claim RDEC on eligible costs.
What R&D costs can you claim?
Only some research and development activity is eligible for tax relief. The R&D must aim to make a scientific or technical advance. It must also need to overcome scientific / technological uncertainty - you cannot already know how you will achieve your goal or whether it is possible.
Typically, commercial research and development will involve a mix of both eligible and non-eligible activities. Commercial activities, such as market research, production and distribution do not qualify. But a project to solve new technical challenges, for example as you develop a prototype, may well qualify.
Provided that a research and development project falls within the definition, most of the costs are normally eligible for tax relief. You can find more detail in our overview of research and development tax relief or by checking the government's detailed definition of research and development for tax purposes.
Research and development examples
Qualifying research and development is not restricted to particular industries.
Examples of projects that might qualify for R&D tax relief include:
- developing a new process, such as a safer manufacturing technique
- creating the prototype for an improved, more energy-efficient machine
- working out innovative computer code using new techniques (but not simply writing code following an established pattern)
- researching new pharmaceuticals or plant strains
- designing new ways of using different materials in construction
But projects that do not aim to make a scientific or technological advance are unlikely to qualify - even if they are new innovations for your business. For example:
- improving the visual design of a product
- reverse-engineering a competitor's product
- installing an existing software solution, or getting IT consultants to build a new website using ordinary web technologies
- scaling up from a prototype to mass production (unless that involves making another new scientific or technological advance)
- getting protection (eg patents or trademarks) for your intellectual property
Research and development tax credit calculation
Since 1 April 2015, the SME tax credit has been 230% of eligible costs. A lower rate of 186% applies for costs incurred from 1 April 2023 onwards. You set this 'enhanced expenditure' against your taxable income. How much this is worth to you depends on whether your company is profitable or loss-making.
For a profitable company, with £100,000 of eligible costs:
- Enhanced expenditure = £100,000 x 230% = £230,000
- Normal allowable expenses (without R&D tax credit) = £100,000
- Increase in tax deductions = £230,000 - £100,000 = £130,000
- Reduction in tax payable = £130,000 x 19% (corporation tax rate) = £24,700
- Value of tax credit as percentage of eligible costs = 24.7%
If your company is loss-making, you can surrender the loss relating to your eligible costs for a 14.5% payable tax credit:
- Eligible costs = £100,000
- Enhanced expenditure = £230,000
- Payable credit = £230,000 x 14.5% = £33,350
- Credit value as percentage of eligible costs = 33.35%
For expenditure from 1 April 2023, the tax credit falls from 14.5% to 10%. Loss-making companies that qualify as R&D intensive (spending more than 40% of their total costs on R&D) can claim a higher rate.
Payable tax credits are generally capped at £20,000 plus three times the company’s total PAYE and National Insurance contributions liability, but companies involved in creating intellectual property are usually exempt from the cap. Any payable tax credit you receive is not taxable.
Any payable tax credit you receive is not taxable.
Alternatively, a loss-making company can carry back the extra loss to set against the previous year's profits, or carry it forward to set against future profits. Ask your accountant or tax credits adviser which is the best option in your circumstances.
How to claim R&D tax credits
You claim tax credits as part of your corporation tax return, or by amending a corporation tax return you have already filed. You can do this up to two years after the end of the company's accounting period.
The biggest challenge is knowing what qualifies as eligible research and development and what costs you can claim. If you are an SME making your first claim, you can apply to HM Revenue & Customs for Advance Assurance:
- You complete the Advance Assurance form. This includes basic information about the company and details of your research and development.
- HMRC contact you to ask about your research and development. This is normally just a phone call but can involve a meeting if necessary.
- HMRC make a decision. If you are given Advance Assurance, you are guaranteed that your claims for the first three years will be accepted, as long as they are in line with what was discussed.
- You claim R & D tax credits through your corporation tax return. HMRC may contact you to check that you are doing what you said in your Advance Assurance application.
For accounting periods beginning on or after 1 April 2023, companies that want to start claiming research tax relief must give HMRC notice within six months of the end of the accounting period. From 1 August 2023, you are also required to provide additional information with your claim, describing the R&D and giving details of the costs.
Whether you are applying for Advance Assurance or working out what to include in your corporation tax return, you have the option of using a tax credit consultant. As well as helping you identify and calculate eligible expenditure, a consultant can help you prepare an explanation of what R&D you do and why it qualifies for tax credits.
A tax credit consultant will typically charge a percentage of the value of the claim. Before choosing a consultant, you should compare fees across multiple advisers, check their track record and whether charges apply even if a tax credit claim is unsuccessful.
You can find more guidance and examples by downloading HMRC's guide Making R&D easier for small companies.