HMRC Research and Development

1. HMRC Research and Development Alan Dickinson & Andy Bostock Manchester Specialist Unit

2. Agenda – R&D Tax Relief • Why was it introduced • General Conditions • How the relief works • What is research & development for tax purposes? • What expenditure qualifies • The treatment of grants and subsidies • Recent developments – consultation process. • How to make a claim • Practicalities of claiming and a worked example • Help and further information

3. Some background The R&D tax relief schemes are part of a challenging Government goal to raise levels of R&D investment as a whole to 2.5% of GDP by 2014.

4. Some background Two R&D schemes introduced to encourage UK innovation. • The first, for small and medium companies. This is a Notified State Aid. • The second provides relief for large companies and is not notified.

5. Nearly 9,000 claims now made each year… Source: HMRC National Statistics based on CT returns.

6. …for almost £980 million of support Source: HMRC National Statistics based on CT returns.

7. General conditions • Only available for companies. • R&D expenditure must be relevant to the company’s trade. • Minimum £10k p/a spend on qualifying costs. (This condition will not apply to expenditure incurred after 1 April 2012) • Excludes capital expenditure (on which 100% Research & Development Allowances are available).

8. How the relief works • R&D tax credits – company tax relief which gives an increased deduction for qualifying R&D expenditure. • The increased deduction reduces the taxable profits and hence the amount of corporation tax payable. • Loss making small or medium companies can in certain circumstances surrender the R&D losses arising as a result of the increased deduction in return for a payable credit. (more on that later!)

9. How the relief works • The level of relief available depends upon which R&D relief scheme a company falls within. • The small or medium company (SME) scheme allows for an enhanced deduction of 175% of the company’s qualifying expenditure. (This has been increased to 200% from 1 April 2011.) • The large company scheme allows for an enhanced deduction of 130% of the company’s qualifying expenditure. (Previously 125% before 1 April 2008.)

10. SME or Large Pre 1 August 2008 Post 1 August 2008 • The extended post 1 August 2008 definition is for R&D Tax Relief purposes only. < 250 Employees < 500 Employees and and Annual turnover notexceeding €50m Annual turnover notexceeding €100m or or Balance sheet totalling no more than €43m Balance sheet totalling no more than €86m

11. So what is R&D for tax purposes? • The DTI guidelines explain what is meant by R&D for a variety of tax purposes. • Tax definition differs from Commercial definition. • R&D takes place when a project seeks to achieve an advance in science or technology. • Activities which directly contribute to achieving the advance through the resolution of scientific or technological uncertainty are R&D.

12. So what is R&D for tax purposes? • A scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, or how to achieve it in practice, is not readily available or deducible by a competent professional working in the field. • Uncertainties that can be readily resolved by a competent professional working in the field are not scientific or technological uncertainties. • Must be an advance in knowledge or capability in the field – not just the company’s own state of knowledge or capability.

13. Possible commercial project time line – defining R&D for tax purposes

14. Examples of qualifying & non-qualifying projects • An individual • Has a an idea to produce an innovative food container which will greatly improve shelf life and reduce waste costs, by also being bio-degradable. • Embarks on R&D in relation to the materials used to achieve this. (It is accepted this is uncertain to the competent professional and represents a scientific and technological advance). • He introduces capital into the business and draws no salary to keep the costs down and fund the R&D. • Does not qualify for R&D relief as not incorporated. • Also, the strategy of paying no salary reduces what is usually the largest R&D allowable cost, were he incorporated.

15. Examples of qualifying & non-qualifying projects • A software company which designs computer games, writes a new story line for an X-Box / PS3 game. • No matter now inventive the story line is that in itself is not R&D. • However the changes in the code, language and object interaction required to achieve the response speeds needed to run the game on a desktop games console was ground breaking in the software field and was qualifying R&D. • The qualifying costs related to the activities during this period of uncertainty and which were directly related to resolving the code problems. This qualifying period ceased when these issues were resolved.

16. Examples of qualifying & non-qualifying projects • Other local industry sectors which may more obviously qualify include: • Life & health sciences including pharmaceuticals and new drugs. • Agrifood – reduced salt content versus shelf life & taste and foods with positive health benefits. • Advanced materials – including the development of new materials, the use of new materials in existing processes to significantly improve efficiency or performance. • Advanced engineering – e.g. the automotive industry weight & energy efficiencies. • Focus on the advance being achieved and not the industry or product aspiration, specification or design. • Involve the people actually doing the work in the considerations / decisions.

17. Qualifying R&D expenditure • Is expenditure on: • Staffing costs (CIRD83000/83200) • Consumable items (82300/82400) • Software (CIRD82500) • Externally provided workers (Relief on 65%) (CIRD84000/84100) • Subcontracted R&D (Relief on 65%) (CIRD84200/84250) • Contributions to independent research (Large Scheme) (CIRD82200)

18. Some other conditions • The amount of payable credit (SME Scheme only) claimable is up to 14% of the surrendered R&D loss (16% prior to 1 August 2008). • This is limited to the company’s PAYE and NIC liabilities payable for payment periods ending in that accounting period and where: • Accounts are prepared on a going concern basis • Finance Act 2010 abolished the Intellectual property (IP) condition in the SME scheme for expenditure in accounting periods ending on or after 9 December 2009. • Special treatment for grants & subsidies.

19. Grants & Subsidies (Main Principles) • SME Scheme • Grants & subsidies are deducted and R&D claim made on net allowable expenditure. • If grants are Notified, no claim possible under the SME scheme, but may still claim under large scheme. • Large Company Scheme • Grants & subsidies not deducted and R&D claim made on gross allowable expenditure.

20. Grants & Subsidies • SME Co Ltd receives a grant for R&D work. What are the implications? • 1. If grant is a notified state aid: • No relief available under SME scheme. • But could still get relief under large company scheme, i.e. @ 30% on • gross costs. • 2. If grant is not a notified state aid: • Grant deducted and relief on net costs @ 75% under SME scheme • (plus) • Amount of grant not allowable under SME scheme, may be allowable • under large scheme @ 30%. • N.B. The grant receipt is taxed under the normal taxing provisions.

21. Grants – practical examples • A Ltd a SME spends £100k on qualifying R&D with a £40k subsidy which is a notified state aid ( to include ‘Grant for R&D’ etc) • R&D Costs £100,000 • Less funding £40,000 • Net project cost £60,000 • No Claim Under SME scheme BUT can claim under large scheme • R&D tax relief £100,000 @ 30% = £30,000 • Tax saved enhanced exp £30,000 @ 28% = £8,400 • Plus accounts deduction £100,000 @ 28% = £28,000

22. Grants – practical examples • A Ltd a SME spends £100k on qualifying R&D with a £40k subsidy which is not a notified state aid: • R&D Costs £100,000 • Less funding £40,000 • Net project cost £60,000 • R&D SME tax relief £60,000 @ 75% = £45,000Plus • R&D Large tax relief £40,000 @ 30% = £12,000 • Tax saved enhanced exp £57,000 @ 28% = £15,960 • Plus accounts deduction £100,000 @ 28% = £28,000

23. Recent developments • November 2010 – Consultation on Corporate Tax Reform including R&D Tax Credits and Patent Box published. • March 2011 - Budget proposals. • April 2011 – Finance Act 2011 changes operative • June 2011 – Treasury response to Consultation. • June 2011 – Further period of consultation announced. • September 2011 – 2nd consultation period ends. • October 2011 – Assurance Pilot commences. • April 2012 – Further budget changes introduced.

24. How R&D Relief is claimed • In full company tax return at end of accounting period. • The tax relief will benefit the company on its usual corporation tax payment date for the accounting period. • The SME Scheme payable tax credit is normally paid within 28 days of receipt of the claim by the appropriate R&D Specialist Unit.

25. Practicalities of claiming • No specific form/standard. • Outline of project. • Outline of the uncertainty to be resolved. • Details of the allowable costs on direct resolution. • Call HMRC in early. • Sampling. • Backdated claims possible (within the anniversary of the filing date).

26. A SME practical example

27. Help in making a claim • HMRC website athmrc.gov.uk/ct/forms-rates/claims/randd.htm • The HMRC Corporate Intangibles and Research & Development (CIRD) Manual at: www.hmrc.gov.uk/manuals/cirdmanual/index.htm • The R&D Specialist Units • And finally…

28. Questions