There’s a misconception about R&D Tax Credits that they are only worthwhile if your company is profitable. Not only that is not true, but the scheme is actually more favourable for loss-making SMEs, which can get 33% of their expenditure cash-back, instead of 26% off their tax return.
Let’s review the process of claiming R&D Credits to better understand how effective the scheme is in each case scenario.
You start from calculating your qualifying expense, which is the costs of any qualifying R&D activity.
Then, you “enhance” your expense – meaning that you artificially increase your R&D expense for the year, therefore reducing your taxable profit.
How this benefits profitable companies is quite obvious: if their taxable profit decreases, they’ll pay less taxes. Their profit might even turn into a loss after the R&D expense is enhanced. Such loss can be “surrendered”, meaning that it can be exchanged with cash in turn for not being carried over to future years.
1: The government is planning to reintroduce a cap on the amount of cash that can be claimed through the “surrender” mechanism. This, according to the latest Budget, is expected to be at 300% of a company’s PAYE and NI contribution. This is bad news for loss-making company mainly employing subcontractors, as they won’t be able to surrender much of their loss.
2: The loss that can be surrendered is not cumulative with loss carried forward from earlier years. If you are profitable and you don’t want to lose the loss you carried from the previous year, you will have to apply R&D credits first, and then use part of the carried loss to reduce your profit to zero – but won’t have any loss to surrender! Instead, you’ll have the remaining loss to carry forward for the next year.
3: Because of a loophole in the scheme, HMRC ended up penalising companies the closest they are to breaking even. The “surrender” mechanism relies on you surrendering your enhanced expenditure, but you can only do so with an actual loss.
So if your loss is equal or greater than your qualifying expenditure, your relief will typically be 33.35% of your R&D expense.
On the other hand, if your profit is greater or equal to your enhancement, it will benefit from a reduction of 130% of the original R&D expense.
Anything between these two scenarios results in a lower benefit for the company, as either the surrendered loss is not big enough to obtain the same amount of cash compared to the R&D expense, or the profit is not enough for the company to use all of the enhancement.
Companies that spend for their R&D activities should always claim Tax Credits, especially if they are loss-making. But be careful with these clauses, as your relief could be much lower than you anticipated.