For many companies, research and development (R&D) tax relief can be vital to allow businesses to reinvest funds into innovation activities for growth. However, calculating the potential benefits companies may be entitled to through the R&D tax credit schemes can be confusing.
With the upcoming changes to corporation tax (CT) rates, as well as the changes to the tax deduction and tax credit for the SME R&D tax schemes and the increase in the Research and Development Expenditure Credit (RDEC) rate coming into effect from April 2023, the calculations are only likely to get further complicated. As a result, it is essential that companies understand these changes as R&D tax relief claims could look different to previous years which may lead to entitled benefits being overlooked or missed.
Understanding the R&D tax relief calculations
In order to understand the changes to the R&D tax relief scheme, two calculations are provided below, both based on a company having a qualifying expenditure (QE) of £100,000 in the accounting year. The below example assumes a September 2023 accounting year-end to highlight how the changes affect the calculation for a claim spanning the changes in April 2023.
Example 1: Based on a profit-making company
Considering the September year-end, it is important to start by determining the period of time that the company has both before and after April 2023 due to the rate changes in both CT and the R&D tax scheme. This is done based on the number of days, but for simplicity the example uses whole months. So, in this example, it will be six months before the changes (October-March) and six months after (April-September).
First the uplift will need to be calculated. The uplift is the extra tax deduction claimed through the scheme and is subtracted from the profit figure in the tax return. This gives a lower profit figure on which the company will pay CT.
Uplift rates
- Before 1 April 2023 – 130%
- From 1 April 2023 – 86%
The below example assumes that the R&D expenditure is split evenly throughout the year.
| |
Before R&D |
After R&D |
Based on £100,000 qualifying expenditure |
| Tax adjusted profit |
£200,000 |
£200,000 |
This is the profit figure taken from the company’s accounts, adjusted for tax purposes. |
| R&D uplift |
|
(£108,000) |
The R&D tax relief scheme allows an extra deduction of the qualifying expenditure amount to be made. In this example it is calculated as £50,000 expenditure at 130% deduction (first six months) and £50,000 at 86% deduction (second six months). |
| Adjusted profit/(loss) |
£200,000 |
£92,000 |
This is how the R&D uplift has reduced the company’s profit figure. |
| Corporation tax due |
£43,625 |
£19,055 |
This is the effect of the R&D tax relief on the company’s corporation tax liability. |
| Tax saving |
|
£24,570 |
The tax saved as a result of the R&D claim. |
For the corporation tax calculations, the example uses a single company with no associated companies which would affect the calculation.
As the example is for a September 2023 accounting year-end, it uses six months on the rates applicable prior to the change in April 2023, and six months on the rates after April 2023. For other companies the numbers of months will adjust depending on the year-end.
Before R&D claim
£200,000 tax adjusted profit:
- 6/12 months prior to April = £100,000 x CT rate of 19% = £19,000
- Plus 6/12 months after April = £100,000 x CT rate calculated as per note 2 below = £24,625
A total CT figure of £43,625.
Note 1: CT rate to 31 March 2023 19%.
Note 2: 19% CT rate applies to the first £50,000 of profits, then between £50,001 and £250,000 is an effective marginal rate of 26.5% and 25% above £250,000 – the lower and upper profit limits will be proportionately reduced to reflect the fact that only six months of the accounting period falls in the financial year-ended 31 March 2024 (FY 2023).
After R&D claim
£92,000 tax adjusted profit:
- 6/12 months prior to April = £46,000 x CT rate of 19% = £8,740
- Plus 6/12 months after April = £46,000 x CT using rates in note 2 above = £10,315
A total CT figure of £19,055.
Example 2: Based on a loss-making company
Again, this example is based on a QE of £100,000. If the company is loss making, the R&D uplift will increase its tax-deductible loss. The company can decide to carry the loss forward for tax savings against future profits or HMRC will pay them a cash tax credit for the amount of loss being cashed in. Any remaining tax loss will be carried forward to the next accounting year.
| |
Before R&D |
After R&D |
Based on £100,000 qualifying expenditure |
| Tax adjusted profit/(loss) |
(£200,000) |
(£200,000) |
This is the loss figure taken from the company’s accounts, adjusted for tax purposes. |
| R&D uplift |
|
(£108,000) |
The R&D tax relief scheme allows an extra deduction of the qualifying expenditure amount to be made. In this example it is calculated as:
£50,000 expenditure at 130% deduction and £50,000 at 86% deduction.
|
| Adjusted profit/(loss) |
(£200,000) |
(£308,000) |
This is how the R&D uplift has increased the company’s loss figure for tax purposes (£200,000) + (£108,000) = (£308,000). |
| Amount cashed in for tax credit |
|
(£208,000) |
HMRC will allow the company to cash in the R&D uplift amount and the original expenditure (subject to sufficient losses in the year) for a tax credit payment. The tax credit in this example is £25,975 *see calculation below table.
Original QE of £100,000 + £108,000 R&D uplift = £208,000 of losses surrendered for tax credit.
|
| Loss carried forward |
(£200,000) |
(£100,000) |
Remaining balance carried forward to next accounting year. |
In the example below, the company would receive a tax credit of £25,975. However, thought should be given to which option to take, as carrying the loss forward to reduce CT in future accounting years could be more beneficial. This is because the cash tax credit from April 2023 is 10% of the loss that is cashed in whereas if those losses are used against future profits, the tax relief could be between 19% and 25% depending on the company’s level of profits.
The tax credit in the example was calculated as follows:
£50,000 QE – prior to April 2023
£50,000 x uplift 130% = £65,000. The original QE of £50,000 plus the uplift of £65,000 can be cashed in for a tax credit of 14.5% = £16,675
Plus
£50,000 QE after April 2023
£50,000 x uplift of 86% = £43,000. The original QE of £50,000 and the uplift of £43,000 can be cashed in for a tax credit of 10% = £9,300
R&D expenditure credit
The R&D expenditure credit (RDEC) calculation is the same for both the profit and loss-making companies. The RDEC benefit is treated as ‘above the line’ income in companies’ accounts so the benefit is subject to tax at companies’ marginal rates. The only difference is that for profit-making companies it reduces the CT payment, and for loss-making companies with no tax liability it is a cash payment from HMRC.
The RDEC payment is calculated by multiplying the QE by the RDEC rate for the claim period.
- RDEC rate before April 2023: 13%
- RDEC rate from April 2023: 20%
For this example, the QE is increased to £200,000, again for a company with a September year-end.
£200,000 time apportioned before April and from April.
QE of £100,000 applicable to RDEC rate of 13% (before April 2023)
£100,000 QE, RDEC rate before April 2023 of 13% will apply (£100,000 x 13% = £13,000)
£13,000 less CT rate of 19% (£13,000 x 19% = £2,470 deduction is applicable)
The deduction is then made from the RDEC credit (£13,000 - £2,470 = £10,530 RDEC credit)
QE of £100,000 applicable to RDEC rate of 20% (after April 2023)
£100,000 QE, RDEC rate from April 2023 of 20% will apply (£100,000 x 20% = £20,000)
£20,000 less CT rate of 25% (£20,000 x 25% = £5,000 deduction is applicable)
The deduction is then made from RDEC credit (£20,000 - £5,000 = £15,000 RDEC Credit)
A total payment of £25,530 – which will either be paid to the company, or a reduced CT payment will be due.
Understanding the R&D tax credit scheme is essential to avoid missing benefits
As a result of the calculation changes, companies will need to consider their options on how to utilise the benefit from the SME scheme as the reduced tax credit could make this the least tax-efficient option. It is important to consider factors such as the company’s current financial situation and whether they need the cash that the scheme can create. If they are likely to go from loss-making to profit-making in the following years, carrying forward the loss would reduce any CT payments. With the increase in CT rates, carrying forward the loss could well become the preferred option for companies.
Therefore, careful consideration needs to be exercised when assessing all the options available to determine which would best suit individual needs. As part of this assessment, it is critical that companies speak to a tax specialist to ensure they are aware of all their options to make an informed decision.