The UK government incentivises innovation as fuel for the economy’s long-term growth and as a method for tackling societal problems. The UK strives to be a significant player within the global innovation landscape, and R&D tax credits are a way to encourage and reward the companies undertaking this scientific and technological innovation.
R&D tax credits for Large Companies are accessed through the UK’s Research & Development Expenditure Credit (RDEC) scheme. This reduces the company’s tax liability or is received as a cash benefit depending on the company’s financial position.
The current benefit is 20% pre-tax, so for every £1 of qualifying expenditure, you receive 20p back. This extra cash can be reinvested in further R&D activities, hiring new talent, and ultimately growing your business.
The UK government has committed to spending £22 billion to incentivise UK R&D by 2025; Large Companies are often instrumental in developing innovative technologies and consistently investing in improving products and processes. As such, Large Companies stand to benefit significantly from government investment in innovation.
What is RDEC?
Research & Development Expenditure Credit (RDEC) is the R&D tax scheme for Large Companies (and some SMEs, see below). The Large Company scheme was established in 2002 and has become progressively more generous since then. It is the complementary scheme to the SME R&D tax scheme for which small and medium-sized businesses are eligible; these co-exist to target the differing needs of UK companies conducting R&D projects.
The RDEC R&D tax credit scheme benefit arrives in the form of a reduced corporate tax bill or, in some circumstances, a payable cash credit. It is an above-the-line credit, which is visible as income in the company’s Profit and Loss Statement (P&L). This could also have a positive impact on R&D investment decisions. It is subject to 25% corporate tax, making the net benefit roughly 15%. The RDEC scheme, unlike the Large Company scheme it replaced, rewards loss-making companies with a cash benefit.
How does the RDEC scheme work?
The scope of R&D for tax purposes is broader than you may generally consider. If your company spends money on innovation for business, at least a portion of these costs will likely be eligible. Large companies often incur significant expenses on incremental product or process improvements that can sometimes be overlooked as just ‘business as usual activities.
The criteria for R&D in tax terms are:
- Seeking an advance in a field of science or technology.
- This advance can take the form of developing something completely new, appreciably improving an existing process or product, or duplicating it with a different method, material or from a competitor who has kept it as a trade secret.
- Attempting to overcome scientific or technological uncertainty whilst seeking your advance; something your knowledgeable employees could not solve without investigating.
- This uncertainty could be due to various challenges such as infrastructural limitations, architectural challenges, cost constraints, industry-related trends, etc.
- Failure is part and parcel of R&D, so the project doesn’t have to be successful to be eligible.
The definition of R&D used by the government is deliberately broad as it needs to cover all industry sectors. It covers everything from construction and engineering, IT and technology, food and beverage, manufacturing, and life sciences. The scope of projects and activities that qualify is extensive – from new product development and product/process improvement to internal projects such as sustainability improvements. Often, work that feels routine can meet all the criteria for R&D.
There are several cost categories for qualifying activities you can claim for, including staff time, software licenses, consumables, and materials. To claim under the RDEC scheme, you must first assess activities and costs to determine which qualify.
What is the RDEC rate?
The RDEC scheme was introduced for Large companies in 2013, gradually replacing the Large Company scheme introduced in 2002. It has become more generous since its introduction. From 1st January 2018, the RDEC rate was 12%, rose to 13% on 1st April 2020, and as of 1st April 2023 the RDEC rate is 20%.
The benefit is accounted for within the P&L, so it increases EBIT earnings and enhances financial standing. The realisation of the benefit is ‘above the line’ and means it is subject to 25% corporation tax, so the effective RDEC rate is 15%.
So, 15p back on every £1 of qualifying expenditure (QE) can be claimed back – equating to a gross benefit of £150,000 for £1 million of QE. According to HMRC’s annual Research and Development Tax Credits Statistics, large companies’ average claim in 2018-19 was over £335,000.
The benefit is used to offset against the company’s corporation tax liabilities or as a cash benefit if it exceeds the total tax owed to HMRC, which is often the case in loss-making companies. The rate is the same depending on for-profit and loss-making companies, though the method for receiving the benefit is different.
How to make an RDEC claim
The first step to making an RDEC claim is to ensure that the company, and expected claimable costs, are eligible for the RDEC scheme. The projects or activities that you believe represent the company’s R&D need to be checked against the criteria of R&D for tax purposes, along with investigating other aspects of the company’s daily running.
For example, work that feels ‘routine’ in your engineering or design departments may qualify as R&D. The costs of staffing, materials etc., associated with these qualifying activities need to be collected and collated to generate a total qualifying expenditure.
Evidence of technological advances and uncertainties faced during this R&D activity can be written up and submitted to strengthen the claim. The total qualifying expenditure multiplied by 20% gives you the benefit. This figure is submitted within your tax calculation alongside any supporting documents, such as technical reports. For large claims (‘Large Company’ scheme claims tend to be larger), you must submit substantial evidence to ensure that HMRC can readily determine the claim’s legitimacy.
Once submitted, HMRC will review the claim then either accept it, ask questions, or open a formal inquiry. There are seven steps to determine how you will receive the RDEC credit, which allows you to offset any tax owed to HMRC.
There are complexities to qualifying costs, including the relationship between the company and external workers involved in R&D and ensuring you identify all your qualifying activities. A specialist advisor can navigate the process accurately and typically leads to a more significant claim, with well-supported evidence understood by HMRC reviewers – all without taking up too much of your precious time!
Who can claim?
The RDEC tax scheme targets Large companies that undertake qualifying R&D activities. The definition of a large co for tax purposes in the UK is a company with:
- More than 500 staff across all connected companies
- Either more than €100 million turnover OR more than €86 million in gross assets.
To be eligible, you must be liable for UK corporate tax, and the expenditure you want to claim must be revenue in nature. The RDEC scheme does not allow you to claim for the cost of subcontracted-out R&D.
Some SMEs can also claim under the RDEC scheme if:
- R&D is subsided
- State Aid has been applied for or received for the R&D project
- A large company subcontracted the R&D
You can claim R&D tax relief for your last two completed accounting periods. After two accounting periods, the R&D undertaken can no longer be back claimed, so there’s no time like the present to begin the process of your R&D tax claim.
What does RDEC stand for?
RDEC stands for Research and Development Expenditure Credit.
When was RDEC introduced?
The RDEC scheme was introduced in April 2013 as a replacement for the large company scheme, which officially ended on 1st April 2016. The previous scheme allowed for the augmentation of R&D expenses, often leading to a decrease in taxable profit or an increase in tax loss.
However, claiming R&D tax credits did not result in an immediate cash benefit unless the loss could be applied against other profits. This included profits or losses carried forward from a previous period or from another company within the same group.
To address this issue, the RDEC scheme introduced an above-the-line credit, with the possibility for this to be payable for loss-making companies that meet specific requirements. This meant that companies that do not have taxable profits can still benefit from R&D tax credits by receiving a cash credit.
How is RDEC calculated?
Companies that qualify for the RDEC scheme can claim 20% of their qualifying expenditure minus corporation tax (which equates to 25%). For example, if your qualifying expenditure was £600,000, this is how you would calculate your benefit:
£600,000 x 20% = £120,000
£120,000 – 25% = £90,000 (the benefit you’ll receive)
Is RDEC taxable?
Yes, your credit amount is taxable to corporation tax, which means 25% will be deducted from the final credit amount you receive.
Is RDEC a government grant?
The RDEC scheme provides a tax credit to businesses that invest in qualifying R&D activities, which means it is not classified as a government grant.
It is worth noting that if a business receives a government grant to fund some or all of its R&D projects, that business can still claim R&D tax credits under the RDEC scheme. If the business falls under the definition of an SME, it cannot claim under the SME scheme, however, it should still be able to claim through the RDEC scheme.