Connected companies

What do ‘connected companies’ mean in the R&D tax credit claim?

Connected Companies

How having connected companies impact SMEs R&D Tax Credit Claim



When filing an R&D tax relief claim, there is a specific guideline of the type of costs that qualify. If you want to learn more about the type of costs that are eligible to be included in your R&D claim, you can read our article here.


If an SME claiming R&D tax relief has a connection with the subcontractors and/or externally provided workers, specific rules apply.



What is a connected company?


There are several ways where companies can be deemed connected.


  • Family relationships (civil partner, spouse, relative etc)
  • Common ownership and control


How does having a connected company impact a company’s R&D tax claim?


If an SME hires unconnected subcontractors or EPWs for its R&D activities then they can claim 65% of the costs as tax relief. If the subcontractors or EPWs only work part-time on the R&D activities within the company, appropriate apportionment must be made.


However, if a connection is identified, then the claim value is generally less than 65%. The expectation is that the invoice or cash exchange will not be at market rates, thus no profit margin. Although it is important to look into the actual costs incurred by the subcontractor, not just the amount paid to them by the claimant company. This measure is put in place to stop companies artificially inflating their invoices to increase the value of the R&D tax claim.


Some claimant companies and subcontractor / EPW providers can also elect to be connected, which in certain scenarios can maximise the claim. Practically speaking, this will require knowledge of the profit margin and base costs of the subcontractor/EPW as it is generally only beneficial if the profit margin is less than 35%. Any election applies to all payments under the same contract or arrangement and is usually made as part of the claims process.


We recognise that these calculations and the understanding of the specific rules when claiming R&D tax relief can get complicated. That’s why in our R&D tax solution Novel we have a specific section that helps ascertain whether you are a connected company. Depending on what you add, it’ll tell you the correct next steps. You can try Novel today and get your first month FREE.

costs

What costs qualify for SME R&D tax relief?

costs

For a business to successfully claim R&D tax relief benefits, it needs to understand what are the qualifying costs. HMRC has a specific guideline of the type of costs that are eligible and not eligible for the R&D tax credit.


Depending on whether a company is loss-making or profitable, a small or medium-sized enterprise (SME) can receive between 14.5% and 33% of its R&D cost back as cash or tax credit. Overall, direct and externally provided staff, subcontracted R&D, consumables, energy costs, software, trials, prototyping and independent research may all qualify for R&D tax relief. Costs that are not eligible are production and distribution of goods and services, marketing, payments for the use and creation of patents/trademarks, cost of land and hosting, as well as capital expenditure.


It is important to keep in mind that there are some exceptions to each of the categories. For example, although capital expenditure is generally not eligible, the cost of acquiring capital equipment may benefit from a separate category under Capital Allowances. Therefore, if you are unsure of what to include in your R&D tax credit application, it is best to speak to an R&D tax credit specialist.



Eligible R&D expenditure

  • Direct R&D staff costs
  • Subcontracted R&D
  • Externally provided R&D staff
  • Consumable items
  • Software directly used in the R&D activity
  • Utilities
  • Clinical trial volunteers

Scroll to learn more about the eligible costs.



Some helpful links:



Time-Based Costs


Staff Costs


For staff that are directly and actively engaged in the R&D project, the claim can include employees salaries, wages, class 1 NIC and pension fund contributions. If the staff is only working partially on the project, then appropriate allocations will be needed, in which the number of hours dedicated to the R&D project carefully tracked. Redundancy payments cannot be claimed as a staff cost.


staffing cost

Subcontractor Costs


Subcontractor R&D has different rules depending on whether the company is an SME or a Large Company. Generally, you cannot claim R&D expenditure subcontracted to other persons as a Large Company but as an SME you can claim up to 65% of the payments made to the staff provider.


Externally Provided R&D Staff


EPWs are temporary workers sourced from an external agency that is directly and actively engaged in the R&D project. These people are not employees or subcontractors. Businesses can claim up to 65% of the costs paid out to the external agency for the EPWs services. Special rules apply if the company and staff provider are connected or elected to be connected, click here to learn more. If the EPWs carry out both R&D and non-R&D work, appropriate apportionment should be applied.


costs

Material-Based Costs


Consumables


A business can claim for the cost of items that are directly employed and/or consumed during qualifying R&D activity. This includes materials and a proportion of water, fuel and power consumed during the R&D process. The type of consumables that qualify as a cost for R&D tax relief tends to be different in each sector. For example, this could include materials used for modelling or prototypes, where there is generally no intention to sell.


Utilities


Consumable items employed indirectly are not qualifying expenditure. For example, the power used in the training facility would be included to the extent that the facility was providing training directly to support the R&D activity. If the facility provides power to be used both for R&D and other activities, then it would either need to be separately metered or a suitable apportionment would need to be calculated. Any material that is consumed or transformed in the process of R&D activity can be claimed, but not those that will make up the finished or saleable product. At the moment, you cannot claim costs for rent, telecoms or data storage.


Software


Business can claim the cost of software that is directly used for the R&D activity, if the software is only used partially for R&D, then appropriate apportionment should be made. It can be as simple as Microsoft Office or could be specialist software specific for the R&D activity. For example, software used by the HR department for routine work relating to the R&D staff can be included, however, software used to train HR would not be included.


Other Costs


Clinical Trial Volunteers


Pharmaceutical companies and research organisations often make payments to volunteers taking part in clinical trials. These are usually eligible costs for the R&D tax credit.



Try Novel


Hopefully, the above guide was helpful in explaining some of the eligible costs for the R&D tax credit. However, we understand that sometimes it can get tricky, especially when correct apportionments need to be made. This is why in our R&D tax relief software Novel the cost section is developed in a way where all the apportionments will be done automatically for you. This way you can rest assured that you are claiming the correct costs. Try Novel today with a free one-month trial.

tax credit

All you need to know about RDEC vs SME R&D Tax Credit, and what’s the difference?


A company that is undertaking innovative research and development work may be eligible to claim R&D Tax Credit under one of two schemes



Research and Development (R&D) tax credit is a valuable government tax initiative that is designed to encourage and reward companies investing in R&D projects that will help further knowledge in a given field. There are two types of tax credit schemes that a company can claim, either the SME R&D relief or RDEC.


This article will explore the key features of the two schemes, how to find out whether you qualify and what type of costs are eligible. It further describes why companies should utilise these tax incentives and how Novel can help your company claim for the R&D tax credit if you are an SME.


tax credit

When does R&D take place?


To claim benefits on an R&D project, HMRC has specific criteria that need to be met:


  • For tax purposes, R&D takes place when a project seeks to achieve an advance in science or technology.
  • The solution that the R&D project aims to find should not be easily worked out by a competent professional in the field. This means that there needs to be an aspect of uncertainty.

When exploring the topic of R&D tax relief, you will hear the word ‘innovation’ thrown arround but how do you know when your business is being innovative?


Where is the line between innovation and everyday improvements


It is time to dispel the innovation misconception. Usually, we associate innovation with something globally significant but innovation comes in many forms. From the seemingly mundane to world-changing discoveries.


What do we mean by this statement? Many businesses are innovating when they are improving existing systems or creating solutions to new problems. This is why certain businesses may be undertaking innovative research and development that you wouldn’t associate with traditional ‘R&D’ heavy industries like pharmaceuticals or biotech. To see examples of R&D projects within particular fields, click here and choose from the available industries.


But world of caution. To be clear, we are not saying finding a workaround to an issue is automatically innovative but rather than innovation can happen in any sector. Let’s use the famous NASA Space Race story as an example to illustrate this point.


NASA spent millions to develop a pen that could write in space, whereas the Soviet Union used a pencil. Although a simplified version, it’s enough to illustrate a key distinction between innovation and improvement. Developing a space-friendly pen is innovative, whereas just using a pencil (although solves the problem) is just an improvement.


With this in mind back to the initial question. Is what I am doing innovative and what is innovation in the eyes of HMRC? It can be tricky to understand whether your business is innovative and would qualify for R&D tax relief in the UK. Although the scheme is inclusive and any sector can be eligible, there are specific guidelines on what activities HMRC considers as ‘qualifying’ for R&D tax relief.


When businesses try to understand whether their work qualifies, a common mistake is that they consider it from a commercial perspective rather than from an innovative one. While something can be commercially innovative, it may not be innovative from the perspective of R&D tax relief because it doesn’t aim to solve a technological or scientific uncertainty. To learn more about this topic, visit the blog post below to learn more about how to distinguish a qualifying R&D project from a project that is commercially innovative.


Alternatively, Novel, our R&D tax relief software, can also help you understand whether your projects would qualify for relief. You can sign up for 1 month free to test the system by clicking here.


Types of R&D Relief


Depending on the size of your company and if the project has been subcontracted or not, you may qualify for either one of the two R&D reliefs.


Small and medium-sized enterprises (SME) R&D Relief


  • Must be a limited company based in the UK that has been trading for at least a year.
  • Less than 500 staff
  • A turnover of under £85 million a year.


Research and Development Expenditure Credit (RDEC)


  • Companies that do not meet the above SME criteria are classified as ‘large companies’.
  • Although this scheme is created for large companies, it can be claimed by SMEs that have been subcontracted to do R&D work by a large company.
  • In circumstances where an SME has received some source of grant funding or subsidy, it cannot claim under the SME R&D scheme and needs to apply through the RDEC scheme.



What are the benefits of making an R&D Tax Credit claim?


From experience and the statistics published by the government, we know that many businesses miss out on claiming the R&D tax credit. The two main reasons why companies miss out is because some don’t know about the scheme, and many don’t think they qualify.


However, with a chance to get a tax credit of up to 230% and the ability to bring a claim two years from the start of a qualifying R&D project, this is something your company shouldn’t miss!


The benefit comes in the form of a CT liability reduction and/or a direct payout from HMRC. There are two ways of getting a payout. One is by a refund, this is used if the CT liability has already been paid for the year in question. Any refund awarded then can be used to offset against other imminent tax bills such as PAYE.


The other is by surrendering losses for a cash credit. This type of payout is, in fact, the most generous as the scheme is designed to help loss-making companies that are in the product development phase with minimal to no sales.


The main benefits of a successful claim are:


  • Rebate on Corporate Tax
  • Payable Tax Credit


SME R&D Relief Benefits


Profitable SMEs can subtract an extra 130% of their eligible R&D expenditure from their taxable profit, including the normal 100%, making the total available rate of relief 230%, with cashback available to loss-making SMEs of 33.35% on qualifying expenditure. This means that tax-paying companies can claim £26 back for every £100 spend on R&D, while loss-making companies can claim £33.35.



Research and Development Expenditure Credit (RDEC) Benefits


The RDEC is a tax credit. This means, that if we take the current RDEC tax credit of 13%, which was increased in the Spring 2020 Budget from 12% and offset it with the current tax rate of 19%, the case benefit increases to 10.53% from 9.72%.


If the business is not paying tax because its loss-making, or it is using up losses brought forward, a cash credit of 10.53p per £1 spend is available. However, this cash credit is limited to the amount of PAYE and NIC paid by the company in a given period.



Grants, subsidies and RDEC


Government grants and subsidies are not the same as an R&D tax credit, but it is a type of innovation funding by the government. There is a common misconception that if an SME received grant funding, it cannot claim R&D tax benefits. However, that is not exactly correct. SMEs that received a grant tend to be restricted from claiming under the traditional SME R&D scheme, which is more generous, but they can, nonetheless, claim under the RDEC. The main difference is the rate of relief that an SME can benefit from.


Depending on the way a grant is structured, it will have an impact on what type of R&D tax credit benefits you can claim, so we advise having an R&D specialist look into that for you before you consider that you are not qualified. There are also some grants that are not classified as state aid, such as de minimis State Aid, which means an SME would be eligible to claim under the SME R&D tax credit scheme for any extra costs not subsidised by the grant. With the chance to save up to £33 back for every £100 spend on R&D, it’s worth finding out more.



tax relief construction


Qualifying Costs


SME R&D Tax Credit Claim


  • Staffing costs, including wages, class 1 NIC and pension contributions.
  • Consumable or transformable materials, such as equipment, utilities and more.
  • Subcontracted R&D staff.
  • Externally provided workers.

To learn more about qualifying costs for SME R&D tax credit, click here.



RDEC


  • Staff costs, including wages, class 1 NIC and pension contribution.
  • You can claim 65% of the relevant payment made to an external agency if they provide staff for the project.
  • Consumables or transformable materials.
  • Payments to qualifying bodies, such as a university, charity or scientific research organisation, may qualify.

    Not qualifying costs


    • Production and/or distribution of goods and services
    • Marketing
    • Capital expenditure
    • Cost of land
    • Cost of patents and trademarks
    • Rent


    What is the difference between the SME R&D and the RDEC tax credit scheme?


    In summary, the SME R&D tax credit scheme and the RDEC scheme are both UK government R&D tax credit initiatives that address different types of companies. What qualifies as R&D project is the same for both schemes, the main differences are in terms of their eligibility criteria, the amount of tax credit a company receives and what are the qualifying costs.


    SMERDEC
    230% rate enhanced deduction13% of expenditure – CT rate (April onwards) 
    12% of Expenditure – CT rate (Jan 2018 to April 2020) 
    Can claim tax credit of the lesser of either the surrendered loss or the enhanced R&D expenditure at 14.5%  Can claim credit under certain conditions 
    Can claim subcontractor expenses  Only claim in house, unless subcontracted to qualifying bodies, individuals, or partnerships of individuals 
    Can’t claim contributions to independent research  Can claim contributions to independent research 
    Claim can be reduced if the R&D project is subsidised or a grant is received in respect of it.  No reduction for grant or subsidy 

    How Novel can help


    We believe governments all over the world should support innovation. Currently, in the UK the support is available through the R&D tax scheme but it’s difficult to get hold of, so we help. We knew that the best way to get more people to claim R&D tax relief is to develop an automated solution that will guide and educate businesses about the relief, and help them correctly claim.


    Novel was created to help businesses claim under the SME R&D scheme and at the moment doesn’t support RDEC claims. However, we are planning on allowing for RDEC claims through our platform so stay tuned. Try Novel today and get 1 month free.