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R&D tax credits for SMEs

Research and Development (R&D) tax credits are a form of tax relief available to companies (upon meeting certain conditions) designed by the UK government to encourage companies to invest in R&D.

Graham Samuel-Gibbon

Graham Samuel-Gibbon


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The latest government report on R&D statistics (which is from September 2018) shows that there was almost £25bn of R&D expenditure for the year 2016-2017. This correlates to almost 40,000 R&D tax credit claims for the year, representing approximately £3.5bn in tax relief.

If you are an SME (a company with fewer than 500 staff and a turnover of under €100m or a balance sheet total under €86m) with qualifying R&D expenditure then, put simply, your company may be eligible for R&D tax credits which will either reduce your company's liability to corporation tax or, if your company is in a loss position, generate a cash payment to the company upon surrender of those losses.

Either way, the R&D tax credit will give your company an enhanced deduction for corporation tax purposes, thereby reducing your tax bill, or your company will receive a cash payment that the company could then re-invest back into its business. Often tech startups involved in R&D will find they are burning through cash during the early stages of development and generating losses. The R&D tax credit scheme incentivises companies to incur such costs, by enabling them to surrender those losses in exchange for a cash credit which in turn helps with the cash flow issues facing most start-ups.

In practical terms, the R&D tax relief for SMEs allows your company to deduct an extra 130% of qualifying costs from yearly profit (as well as the normal 100% deduction) totalling a 230% deduction, or claim a tax credit cash payment (where the company is loss making) to the tune of 14.5% of the surrenderable loss. Evidently, these R&D tax credits can be very valuable to the company. As such, SMEs need to keep abreast of any changes to the company (in terms of staff headcount, turnover and gross assets) which could affect the company's status for R&D tax credit purposes (especially to ensure that it does not lose its SME status and thereby lose its eligibility for the R&D cash credit), as well as being clear as to the extent to which the R&D being undertaken qualifies for credit.

Generally, where at a relevant balance sheet date, a business goes over or falls below the staff headcount or financial thresholds to qualify as an SME, HMRC accepts that this will not result in a change of status from SME to large company, or vice versa, until the position is repeated for the second consecutive year. However, careful consideration of SME status is required when it comes to M&A activity involving the company and, in particular, when an SME is acquired by a large company or group as this concession is not available.

Acquisition of an SME by a large company or group deems the SME company to be a large company in the period of acquisition for the purposes of the R&D tax credits scheme. This change in status applies for the whole period in which acquisition takes place (ie not just from the date of acquisition). The upshot of this is that the SME, which was once entitled to R&D tax relief, is no longer eligible to claim this cash credit under the SME regime, despite the fact that it would have been entitled to do so when it was an SME during that part of the accounting period before acquisition took place. This is because the acquired SME has become a large company for R&D purposes and the regime applying to large companies (known as the R&D expenditure credit scheme) differs to that of the SME regime.

The existence of R&D tax credits and their quantum require expert consideration in circumstances where an SME is involved in M&A activity. If a large company is to acquire the SME, the parties to the transaction need to appreciate that any R&D tax credit the vendor may have factored into pricing may no longer be available following an acquisition. Buyers should therefore not expect to pay for any R&D tax credits in circumstances where those tax credits will be lost on acquisition into the buyer's group. Timing of the acquisition can often be a relevant factor for the parties to the transaction. Acquisition 11 months into an accounting period could mean that sizeable R&D tax credits are lost due to the change in SME status.

The parties might, in those circumstances, agree to complete at a later date when a new accounting period has begun, thereby availing the company of its R&D tax credit for the previous accounting period. Of course, the parties will then need to agree how this potentially valuable asset is factored into pricing. Similarly, if the company's status for R&D tax purposes will not change as a result of its acquisition (ie it is acquired by another SME), then the parties to the transaction will need to consider how the tax credit will be apportioned and/or factored into pricing.

R&D tax credits can be especially valuable to SMEs. If you are unsure as to whether the regime applies to your circumstances, HMRC offers an advance assurance scheme which allows the company to ask HMRC whether or not it qualifies.

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