Are R&D Tax Credits tax free? Tip’s for FD’s…

Enhanced tax relief for Research and Development or R&D Tax Credits as it is more commonly known, remains a valuable cornerstone of the UK tax code designed to encourage innovation. Many companies are already claiming and with good advice will have a general knowledge how the scheme works. As with all areas of tax it is worth taking time to gain an appreciation of the finer details often left to the accountant to sort out. Chris Williams of ThirdRock explains the basic accounting treatment and tips for proactive FD’s. 

Whether a tax benefit or tax credit is taxable in a company’s hands will depend on which scheme the claim is made.

1.     Research Development Expenditure Credit (RDEC)

The RDEC scheme is a taxable credit available to large companies in the UK that incur costs related to R&D activities and to SMEs that are ineligible for the SME R&D scheme due to grants or subsidies or have been subcontracted to do R&D work by a large company.

 Under the RDEC scheme, the benefit is delivered as a taxable ‘above the line’ credit in the main body of the company’s Profit and Loss (P&L) account. Qualifying R&D expenditure is eligible for a 13 per cent tax credit, effectively received as a taxable grant. At current Corporation Tax rates this results in a 10.53 benefit of the qualifying R&D expenditure, after tax.

 Tip for FD’s... A valid R&D tax claim under the RDEC scheme is broadly another taxable income stream and should be treated as such. An early review of the companies qualifying R&D projects and relevant expenditure is desirable and specific provisions maybe made in the financial statements and cash flow forecasts. An understanding whether a potential project may qualify for R&D Tax Credits may influence a board decision for project sanction.

 2.     SME R&D Scheme

The SME R&D Scheme allows companies to claim a notional 130% enhancement on top of 100% qualifying expenditure incurred (230% in total). The enhanced tax relief maybe used to reduce the company profits subject to Corporation Tax, currently at 19% or by surrender of company losses in exchange for a payable tax credit at 14.5%. The company can surrender the lower of the enhanced tax relief or the taxable losses for the period so a tax credit can be worth as much as 33.35% for each £1 of eligible R&D expenditure.

 The SME R&D Scheme further differs from the RDEC Scheme as the enhanced tax relief and benefit (however realised) is treated in the company accounts as an adjustment via the company’s tax account and does not interfere with the P&L.

Tip for FD’s... A valid R&D tax claim under the SME Scheme is effectively a tax-free adjustment to the company’s tax account and will serve to strengthen the balance sheet. An early review to quantify the company’s claim is desirable so that a specific provision may be made in the balance sheet prior to filing at Companies House.

 What is clear after dwelling on the accounting treatment of any R&D tax claim is that it is always beneficial for companies to review their projects as early as possible. ThirdRock take a holistic approach to R&D tax claims and advocate that companies adopt an ongoing R&D in-year working document for projects and cost analysis with regular reviews by a qualified R&D tax advisor.