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Enhancement Once the qualifying R&D Expenditure has been calculated, the next thing is to calculate the enhancement.

R&D Tax Credits for SMEs work by “enhancing” part of the R&D expenditure. What this means is that instead of 100% (the normal amount) being deducted from the turnover to calculate the profit, a higher percentage is deducted.

This means that if, for example, you had £200k of turnover, and £100k of expenditure, all of which was R&D, and therefore your initial position was £100k of profit (which would lead to £20k of Corporation Tax at 20%), if the expenditure was enhanced by 50%, you would deduct another £50k, leading to only £50k of profit and only £10k of Corporation Tax - i.e. a £10k reduction in your tax payable.

The situation is somewhat different if you’re making a tax loss, or if the enhancement takes you into a tax loss, but we’ll get to this in the next section. In this section we’re just calculating the enhancement.

The rate of enhancement depends on the period that you’re looking at. HMRC keeps adjusting this rate, so it is always worth checking what rate actually applies to the period you’re looking at. At the moment, these are the rates since 2007 (ignore the surrender rate for now, we’ll cover it later):

Unless your accounting period exactly matches the tax year, you will have to calculate a prorated enhancement (and surrender) rate for the period. This can be done very simply by prorating based on the months at each period. For example, for an accounting period from October 1st to September 30th, there would be 6 months (October - March) at one rate and another 6 months at the next one. If the period was October 1st 2014 to September 30th 2015, the prorating would be 6 months at 225% and 6 months at 230%, so a prorated enhancement rate of (6 x 225% + 6 x 230%)/12 = 227.5%.

The Enhancement Rate includes both the Qualifying Expenditure and the Enhancement. So if there is a £100k Qualifying Expenditure enhanced at 230%, the actual Enhancement is £130k. The whole £230k sum is referred to as the Enhanced Expenditure. It’s worth paying attention to these terms, as a common mistake can be to use one amount when you were meant to use another.

If, before the R&D claim, the company was showing a tax profit (e.g. £100k), and the enhancement is smaller than that profit (thus not taking the company into a loss), then you’re done with the calculations at this point. Please move on to the CT600 preparation step.

If, however, the company was in a loss before the claim, or if the company is taken into a loss by the application of the enhancement, please proceed to the next section.

Surrender

No, not the white flag type of surrender!

Surrender, in this context, refers to giving up part or all of the loss that’s been generated by the enhancement, in order to get cash right now.

For most businesses, cash in the hand is worth more than cash in the future. However, for years, the R&D Tax Credits scheme only allowed businesses to recover cash if they were profitable (and therefore had taxes to offset). The businesses that most need the help are, of course, those which are not profitable. So, a number of years ago, HMRC introduced the ability for a business that is loss-making and that files for R&D Tax Credits to surrender the loss they’ve generated in exchange for cash on hand.

The way the process works is that if, after the claim has been applied, there is any loss, then part or all of that loss may be surrendered at the “surrender rate” in the table in the previous section.

There are a few restrictions:

The loss that can actually be surrendered is limited by two factors:

The loss that is actually present after the claim is applied: so if the company started with a £50k profit and the enhancement was £75k, the loss after the claim would be £25k, and that is the maximum that could be surrendered.

The “enhanced expenditure” amount. So if the loss was £1m, the R&D expenditure was £100k, and the enhancement for that year was £125k (at 225%), the enhanced expenditure would be £225k, the total loss after claim would be £1.125m, and the part of this that would be surrenderable would be £225k.

It is also worth noting that this cannot be stacked up with loss carried forward from previous years. The R&D Tax Credit is applied before any loss carried forward. So if you started at £100k of profit, and had an enhancement of £150k (so after claim you are at a £50k loss), but also had some loss from previous years of £200k, you could not use that £200k to get yourself to a £250k loss and thereby increase the amount you can surrender.

At GrantTree, we deal with a lot of different companies with a lot of different approaches when it comes to filing their accounts and where/when R&D Tax Credits should be included. During the 5 years we have been up and running, we have identified the best practice to make sure a claim gets through HMRC’s labyrinths as smoothly as possible: submitting the R&D Tax Credits claim as an amendment to the original accounts. Let’s dig a little deeper into exactly why we do this and how it benefits those filing a claim.

The background:

You will already know that an R&D claim is split into the financial and the technical sections. Within the financial section at the end of your calculations, the figure needs to be inputted into a document called a CT600 (the form which, along with your Corporation Tax computations) makes up your Tax Return).

Our discovery - everybody loves a shortcut:

When an R&D claim is being processed, what we have found is that speed is of the essence. You probably don’t want to be waiting for months on end to receive your R&D claim and the way we have identified as the quickest way to get round this is crucial: do everything exactly as you have always done it. Compile and file your accounts and tax return (CT600 and computations) without the R&D amount - just carry on as normal. Once your accounts and tax return have been filed, create an amendment to your CT600 and computations which you can then re-file with HMRC.

How it works:

When a CT600 is submitted, it ordinarily goes to HMRC’s general office. The people that work there are much less familiar with R&D claims, and in our experience, are much more likely to question the inclusion of R&D figures in the CT600. We’ve found this out the hard way by going through enquiries, where HMRC can do any of the following: call for more information, write a letter asking us to expand on what was included in the CT600 and claim, or organise a face to face enquiry. All three of these types of enquiries hold up the claim being accepted. It could be an extra month, but some enquiries have in the past gone on for over a year.

By filing your CT600 in the usual way without the R&D figures and then compiling an amendment to file directly with the relevant R&D unit, it means that the amended CT600 and computation go directly to the relevant HMRC R&D specialist. They know the R&D Tax Credit scheme inside out so will be much more likely to understand your claim and ensure it gets processed in the quickest possible way. Think of them like a butcher to Tesco - Tesco may sell meat, but the butcher really knows their stuff and will be able to understand and interpret your needs more effectively.

“But isn’t that a bit dodgy? I don’t want to submit an incorrect tax return.”

Submitting without the R&D figure in the original tax return is not ‘incorrect’. It reflects the tax position at the point of filing. The amendment is purely an update to reflect the new tax position after the claim has been submitted. It allows you to bypass the legislative quagmire of HMRC and the best bit is: you can carry on doing everything as normal in terms of filing your original accounts. The only thing that needs to change is that after you have filed your accounts and tax return, you need to amend your CT600 to include the R&D figure you are claiming for and then submit this along with the claim document to the relevant R&D unit.

Well, there you have it. Our bona-fide shortcut to make sure that your application is seen by the appropriate channels at HMRC and that you can receive your claim money as quickly as possible.

This year, following the Innovate UK re-organisation, we have been advising current and prospective clients more often than before that an application to the European Commission (EC) SME Instrument mechanism is a worthwhile exercise. Although some know a little, many know nothing about this potentially lucrative source of support. What is it, how do you apply and how can it help innovators innovate?

Is it affected by Brexit?

Firstly before digging deeper, let’s address the Brexit issue. As with all funding for UK companies through European Comission mechanisms, the advice from the Commission is short and sweet. As long as the UK is legally a member of the EU, UK based companies can apply for funding without prejudice. The UK is a member of the EU until the end of the process that is triggered by the invoking of Article 50 of the Lisbon Treaty. With 6 SME Instrument deadlines set from now until October 2017, there’s plenty of time to plan a submission.

What is the SME Instrument?

The SME Instrument is the H2020 Work Programme designed to support innovation in Europe’s SMEs. Unlike much of the rest of the H2020 framework, applications can be made by single companies or in collaboration. It is a three phase funding programme, which companies can enter at either phase one or two. Phase three is a range of commercialisation support only for successful phase two projects. The yearly budget is around €92m across phases one and two.

Phase one, while optional, is a great place to start. It’s a short-ish 10 page application for a 3-6 month project that will result in a roughly 20 page feasibility study report at the end. The scope of what can be undertaken is fairly forgiving and will support; risk assessment, market study, user involvement, Intellectual Property (IP) management, innovation strategy development, partner search or feasibility of concept work. You could receive a lump sum of €50k which would cover 70% of your project costs.

Phase two is designed to support innovation activities such as demonstration, testing, prototyping, piloting, scaling-up, miniaturisation, design, market replication and the like aiming to bring an innovation idea (product, process, service etc.) to industrial readiness and maturity for market introduction. Projects lasting up to 24 months and costing between €0.5m and €2.5m are considered and the EC will cover 70% of project costs. The final report of a phase one project is an excellent basis for the much more in-depth 30 page application for this phase.

For successful applicants the EC offers up to 15 days of business coaching, three days for phase one and 12 for phase 2, designed to support business and operational development and to help foster pan-european cooperation and collaboration.

There are 13 topic areas which the mechanism supports, ranging from nanotechnology to agri-tech, although there is an Open Disruptive Innovation topic a topic dedicated to supporting new business models for inclusive, innovative and reflective societies that are agnostic to your sector focus.

Of course with SMEs from 43 countries eligible to submit an application, it is very competitive; over 2014/15, only 8% of phase one applicants were successful and 6% of phase two.

Four main categories

Let’s say you’ve identified a project (perhaps the only project your company is undertaking) and you’re trying to figure out what costs to include in the project. How do you do that?

The first thing to note is that HMRC defines only 4 categories of qualifying costs:

Direct labour: that is, employees paid directly by the company (e.g. on the payroll, in the UK or elsewhere) to work on the project.

External staff: staff hired from an external staff provider, but otherwise similar to employees - i.e. directly employed on the project.

Subcontracted R&D: parts of the project that have been extracted and parcelled out to a subcontractor, typically with a specification for what needs to be delivered and a subcontractor agreement or contract.

R&D Consumables: things that were consumed in the R&D.

The first 3 sections are relatively straightforward, though it’s worth noting that external staff that’s provided by a connected party can count as direct labour. A connected party is another company that is “connected” to the claiming company. (link to connected and partner enterprise)

Exceptions:

Of course, this wouldn’t be fun without exceptions!

Even though HMRC will happily declare, that these are the only 4 categories of costs that qualify, and use that to reject various costs that you want to include, their own web page states otherwise.

Additional costs that are explicitly states as qualifying are:

payments to clinical trial volunteers (of relatively little relevance to startups)

software licences

utilities (power, fuel - but not data or telecommunications costs!)

In practice there are some other costs that will qualify as well, even though they are not listed here, and may be rejected by some R&D units.

As for why heating and lighting qualify for R&D relief, but data costs do not, I leave that up to the reader to divine.

Let’s talk numbers:

Employees

The process for adding the costs up for employees is very straightforward:

For each employee, calculate the “total emolument” for the employee - that’s the cost of their gross salary, Employer’s NIC, pension, and bonuses that are R&D related.

Multiply that number by the percentage of R&D involvement the employee had.

Add up all the resulting numbers: this is the qualifying R&D expenditure for employees.

Example:

Subcontractors

As mentioned earlier, subcontracted projects either count as a whole or not at all, and are apportioned at 65%. The process is fairly similar, except that there are no arbitrary percentages, and the table ends up looking fairly similar:

Externally Provided Workers

EPWs are halfway between subcontractors and permanent staff. Unless they were hired purely to perform R&D, they will often have a percentage apportionment for their time. This percentage further needs to be multiplied by 65% to arrive at the final apportionment. Again, if the EPW charges VAT, that should not be counted as part of their cost.

Remember that costs do not include VAT.

Note that if a subcontractor did more than one project for the claiming company, only the projects that were part of an R&D project should be included here.

R&D Consumables and Software Licences

There are various ways to calculate these, but we find that they generally fall into two categories: apportioned expenses, and wholly R&D expenses.

Things like “Light and Heat” are typically apportioned based on the R&D percentage of the company’s total activity. This R&D percentage is basically calculated by adding up the percentages of all the people using the service/consumable, and dividing it by the total number of people. So, for example, if you had 5 people in the office with R&D involvements of 10%, 30%, 30%, 40% and 80% respectively, you would apportion 10%+30%+30%+40%+80%/500% = 38% of the Light and Heat costs to R&D.

This method of calculation should be applied to things like Light and Heat, which are accepted by HMRC as acceptable R&D consumables, but which are shared between other people.

The other method applies to consumables and software licences that are wholly consumed by the R&D process. In those cases, the entire consumable cost is included, at a rate of 100%.

Sample CT600:

It is essential to know exactly how and where to put your R&D claim figure in a tax return, otherwise it will impact on your entire claim document, often resulting in an HMRC enquiry to get to the bottom of why they perceive your calculations as incorrect. Obviously, this is not ideal since HMRC enquiries can be long and painful, and cost a lot of effort to resolve..

Before you begin: the first amendment

When you file a claim, you need to submit the claim document with both technical and financial sections, plus the tax return, which consists of a CT600 and tax computations. In the 5 years we have been operating, we have identified that the best way to ensure your claim speeds through HMRC without an enquiry is to file your accounts and tax return as normal (without the R&D claim amount) and then file an amended tax return (link to R&D Tax Credits: filing with an amendment versus filing with the original tax return) directly with an HMRC specialist R&D unit which includes the R&D claim amount. The reason for this is that it ensures that the claim is seen by a specialist who knows about R&D Tax Credits. In our experience, when the claim is submitted to the central tax office, it occasionally gets picked up by an HMRC inspector who is not familiar with R&D Tax Credits. If that happens, they see it as an opportunity to learn R&D Tax Credits (at your cost!), and not only are they guaranteed to have questions (thus causing delays), but those are likely to be fairly nonsensical questions that an experienced R&D inspector would never ask.

This article will outline the steps necessary to include your R&D claim figure and is written with the assumption that you are using this process of filing an amendment and that you are working from your already-filed CT600.

The starting line: which software to use

We cannot provide comprehensive documentation for how to do this in all the numerous software packages that can be used to create a CT600. Internally, we use something called TaxFiler. It should be relatively easy to adapt the instructions to another software package, so long as the system supports R&D Tax Credits claims and your tax computations are not too complex. As usual, if your tax computations are too complex to do this easily, we recommend that you use a specialist or at least get your accountant involved. It’s important to get this right, as HMRC can apply penalties if mistakes are made.

Once the CT600 has been set up in TaxFiler, the following steps are necessary to add in the R&D Tax Credits claim:

Adjust Trading Profits

First, before adding the R&D section, you should go into your existing “Trading Profits” section and add the R&D Expenditure there. After you’ve created your CT600 and set it up to reflect your pre-claim tax computations, go into Data Input and click on the Trading Profits section.

Within Trading Profits, click on the “Adjustments to trade profit” tab and then scroll down to the “Enhanced Research & Development expenditure” section and click on Edit:

Finally, set the correct enhanced expenditure and enhancement amount:

Add “Research & Development Tax Credit” section

Go back to the Data Input section and Add a new section for Research and Development Tax Credit:

And similarly set the second tab data. Many sections are auto-calculated but you can override the calculations in some cases (particularly if there are rounding issues).

That’s it! Your CT600 is now correctly amended. Don’t forget to attach the tax computations and the Technical Narrative (including the calculations table explaining how you arrived at the total R&D figure) when emailing the specialist unit, or else, once again, you risk delays and extra scrutiny.

Hopefully this article has provided you with enough information about how and why we file an amendment this way, and how to do it yourself. We find it helps claims get to where they need to be and get back to you again in the fastest possible way.

2016 has been a year of turbulence, both politically and socially. While it feels like it’s probably worth waiting for at least the next thing to happen before commenting, we feel that there’s sufficient information and insight available to offer a sensible analysis of how all our Innovation funding clients, partners and friends might navigate the immediate future.

After Theresa May was sworn in as the UK’s new Prime Minister on the 13th July, a swingeing cabinet reshuffle not only changed the makeup of the Conservative front bench, but also rearranged some key government departments.

Greg Clark replaces Sajid Javid as Business and Energy Secretary in a new department stripped of its oversight of Further and Higher Education which after a 9 year absence returns to be within the policy remit of Justine Greening’s Department of Education, but with additional policy responsibility for Energy and Industrial Strategy.

UK Innovation Funding

The restructuring has been broadly welcomed although there is currently no evidence to suggest how the “comprehensive industrial strategy” that the new department is charged with delivering will impact on general government support for innovation and R&D.

We will have to wait to understand the impact of the restructure on Innovate UK’s future. There had been rumours for some time concerning a possible merger between Innovate UK and Research UK and  the recent Higher Education and Research Bill does indeed pave the way for this to happen, although there are calls for the bill to scrapped and it is unclear how it might be implemented needing cross department coordination. Innovate UK is seemingly preparing for change and alongside the new grant funding framework they are piloting a few new funding models over the year, the first contract-based opportunity is live now.

Innovate UK funding will continue to exist and will continue to be competitive. We strongly recommend allowing plenty of time to prepare an application, especially with the new collaboration requirements for projects over £100k in the sector-specific competitions.

EU Innovation funding

And so. The elephant in the room. UK business’ access to European Commission H2020 funding. We are confident that it is business as usual until we hear otherwise. The European Commission issued a clear statement on 4th July confirming that until the UK legally leaves the EU, businesses are able to participate and receive funding from H2020 actions.

Of course we have no ability to predict when exactly the UK will no longer legally be part of Europe, but we will at least have 2 years’ notice. The H2020 work programme and budget is updated every two years with the 2018-2020 work programme currently in development. It’s either optimistic or encouraging, but the UK has been submitting consultations for the final H2020 work programme as recently as 5th July. This framework indicates UK companies will be welcomed as applicants until at least March 2018.

We have heard rumours and anecdotal evidence of European funding being pulled or put on hold and understand the concern around the issue. Our own research indicates many reports are not making a distinction between ERDF, part of the ESIF, ERC and H2020.

ERDF and the other ESIF funding mechanisms are for long-term infrastructure support. It’s therefore not surprising projects are being put on hold until the withdrawal process is clarified as many upcoming funding agreements are for projects lasting 3 years or over. ERC funding is similarly suffering from frequently being long-term in its scope. With funding sought for multi year projects, it is not surprising that consortia are not keen on including UK researchers who may be unable to participate for the whole project.

Whilst the Brexit vote has temporarily rattled the UK’s tech industry, the dust is now settling and we begin to look to the future to figure out what form post-Brexit may take. Here we explore the past and future relationship between the EU and the UK’s R&D Tax Credits scheme.  

What does the EU have to do with R&D Tax Credits? 

A peculiar aspect of R&D tax relief is that there are two different schemes running in parallel: one is the RDEC (Research and Development Credit), formerly known as the Large Companies Scheme, and the other is the SME scheme, which is far more lucrative than the RDEC scheme. The EU regulates the SME scheme, which operates under what is known as the State Aid rules.

State Aid regulations are imposed on national governments to ensure fairness in competition for companies across the EU, and financial support as generous as the one provided by the SME scheme requires approval from the European Commission in a process known as ‘notifying’ the State Aid. Other schemes such as the SEIS and funding from Innovate UK also fall within notified State Aid. In short, these regulations define the characteristic requirements of a SME and prevent projects from receiving financial assistance from multiple sources in an unfairly advantageous manner. This is the reason why the interaction between grants and R&D Tax Credits can be complicated if you are claiming R&D Tax Credits yourself and why it is important to ascertain whether the grants fall within State Aid or other rules pertaining to subsidised expenditure. However, receiving a grant does not prevent a company from being eligible for R&D Tax Credits. As previously mentioned, R&D Tax Credits consist of two schemes; while the SME scheme is subject to State Aid rules, a company who has received a State Aid grant would still be eligible for the RDEC scheme. 

Would we lose R&D Tax Credits when we Brexit? 

Honestly, it’s not possible to say with absolute certainty how the R&D tax relief will change. In the past decade, the government has demonstrated that it is supportive of innovation and its determination is reflected in its increasingly generous R&D tax relief schemes. We have already seen the lift of the cap on payable tax credits in April 2012 when companies began receiving more than they paid into HMRC (prior to April 2012, the amount payable was restricted by the company’s corporation tax and PAYE contributions), and the incremental increases of the enhancement rates (from 150% before 2008, to 175% in 2011, to 200% in 2012 and the current 230%) and the surrender rates (from 11% in 2012 to the current 14.5%). 

Philip Hammond, the new Chancellor, has confirmed that there would be no emergency budget on 14 July, and he has hinted that there may be a spending surge to counter Brexit shock. We won’t know for certain whether corporate tax will be cut to 15% or what any of the tax schemes will be until the Autumn Statement, but it is unlikely that the R&D tax relief schemes would be scrapped and if the Chancellor’s statement holds true, then it is probable that changes to the schemes will be more generous than previous years. Could Brexit lead to a greater amount of R&D Tax Credits available under new domestic rules? 

Here’s a thought experiment with the UK outside of the EU: could Brexit lead to a greater amount of R&D Tax Credits available because the schemes are no longer subject to EU regulations? 

Yes it could. The EU imposes regulations on the SME scheme to ensure a level playing field for European businesses by restraining the subsidies national governments can provide.This is called “State Aid” regulation. So it is technically possible that once the UK is outside of the EU, the UK will be free to offer companies all the money it wishes. For example, it could technically allow companies to claim Tax Credits on expenditure for which a grant has also been awarded. 

However, we don’t think that will be the case because there are many other areas where there’s been clear interest in removing EU red tape (e.g. VAT), and State Aid regulations would likely be of very low priority to the Brexit government. Furthermore, removal of the EU State Aid regulations without replacing it with similar regulations would likely lead to abuse of the schemes. So far, these EU regulations have been effective in preventing the unfair advantage of “double dipping”, and if the UK were to remove the EU red tape, it is probable that similar domestic regulations would need to be put in place in the hopes that they could achieve the same result. So there’s little incentive for the government to make that a priority in the first few post-Brexit years. 

What can we do in this uncertainty? 

Whilst we’re trying to be optimistic about Brexit, there is little doubt that London has been shaken by the outcome of the referendum. We have heard stories of investors pulling out of funding rounds and companies putting recruitment efforts on hold. A lot of the detail about the next steps is up in the air, so for now it is a waiting game until we see which way the wind is blowing for Britain’s tech hub future. 

If you checked out our previous post, you will understand the importance of being autonomous in your R&D claim. However, sometimes your company (or you!) are a linked or partner enterprise and this is particularly important as it can affect whether your company is deemed an SME and your eligibility for the R&D Tax Credits scheme.

Linked Enterprise:

In short, your company is considered to be linked to the owner of your shares if one of the following is true:

the other company owns more than 50% of the voting rights,

they can appoint or remove a majority of your management team,

they can exert a “dominant influence” over your company,

they can indirectly achieve the above via agreements with other shareholders.

Basically, if they control your company, you are “linked”.

Alongside this, it is possible that you can be linked through an individual as well, providing you are both in the same industry. A good example of this is if you were running a small SME airline and Richard Branson personally owns 51% of your company, you are also linked to any other companies which he owns 51% or more of (ie potentially Virgin Airlines).

This is particularly important as your numbers would then be aggregated with the others, meaning your company would likely not fit in under the SME scheme and the R&D Tax Credits become a less attractive option. This would also apply if you were linked to a VC fund which manages, say, more than €50m.  

Partner Enterprise:

There is another case to consider - if you are not autonomous, but the other company is not considered linked. For example, if PartnerCo owns 30% of your business, you’re a partner of PartnerCo, but they don’t control you, so you’re not linked.

So what happens then? Well, you may have a chance to still fall under the SME R&D Tax Credits scheme. To figure it out, multiply the shareholding by the turnover, balance and staff count of the other company. For example, if you were 30% owned by PartnerCo back when they only had €10m of balance, they would only add €3m to your own balance, for the purpose of figuring out whether you’re an SME. So if you had €1m of balance, adding the two together would result in €4m, well under the SME limit.

If you had €1m of balance, and 30% owned by PartnerCo when they were worth €100m, your balance aggregate would be €31m - so you would still be an SME, even though PartnerCo would not be.

Finally, if you were 30% owned by PartnerCo when they had €1b of balance, your aggregate would be €301m, so you would not be an SME.

It works in reverse too!

As a final thought, it’s worth pointing out that this works both ways. If your company owns more than 25% of a large company, you are considered in aggregate with that company, so even if you have zero turnover, you will still not be considered an SME.

In this latter case, you would still count as autonomous, however, because Sequoia is a venture company. HMRC explicitly allows up to 50% ownership by:

public investment corporations and VCs,

individuals or groups of individuals with a regular venture capital investment activity who invest equity capital in unquoted businesses (‘business angels’), provided the total investment of those business angels in the same enterprise is less than €1.25 million,

universities or non-profit research centres,

institutional investors, including regional development funds,

autonomous local authorities with an annual budget of less than €10 million and fewer than 5,000 inhabitants