UK: innovation incentives overview

Innovation incentive schemes in the UK currently comprise of:

• Research and Development tax reliefs

Over the last few years, R&D tax relief has undergone significant reform resulting in multiple schemes currently ‘applicable’ to qualifying companies in the UK:

Accounting periods commencing before 1 April 2024

• SME (Small to Medium-sized Enterprise regime) – “enhanced-deduction” credit
• SME regime for research intensive businesses – enhanced credit available for qualifying companies
• RDEC (Research and Development Expenditure Credit)

Accounting periods commencing on or after 1 April 2024

• MRDEC (Merged Research and Development Expenditure Credit) for all companies that are not classified as research intensive SMEs
• ERIS (Enhanced R&D Intensive Support) – enhanced support available for qualifying businesses / loss making SMEs
• RDA – Research and Development Allowances
• Patent Box
• Various types of grant funding

Are there specific industries that qualify or are there reliefs that require a particular industry focus?

R&D tax relief is available across all industries and sectors as long as the company is subject to corporation tax in the UK.

Do you have to apply for incentives prior to conducting the research or claiming the benefit?

Yes – SME, RDEC and MRDEC schemes: for accounting periods beginning on / after 1 April 2023, new applicants (or those companies that have not submitted an R&D claim within the ‘relevant’ period) need to submit a claim notification form to HMRC within six months of the end of the accounting period to which the R&D claim relates.

Are there specific documentation or reporting requirements for claiming incentives?

Yes - all R&D claims need to be submitted alongside the corporation tax submission. Since 8 August 2023, applicants also need to file an additional information form, via the HM Revenue & Customs online portal, before they submit their corporation tax return, including R&D claim. 

For accounting periods commencing before 1 April 2024

SME regime

• Profitable companies

For qualifying expenditure incurred up to 31 March 2023 a 130% enhancement is applied to the qualifying costs, reducing profits / Corporation tax payable providing a net benefit of 24.7%.

For qualifying expenditure incurred after 1 April 2023 an 86% enhancement is applied to the qualifying costs, reducing profits / Corporation tax payable providing a net benefit of 21.5%.

• Loss-making companies

For qualifying expenditure incurred up to 31 March 2023 a 130% enhancement is applied to the qualifying costs. The company can surrender the full R&D expenditure amount (230%) for a payable cash credit at 14.5% providing a net benefit of 33.4%.

For qualifying expenditure incurred after 1 April 2023 an 86% enhancement is applied to the qualifying costs. The company can surrender the full R&D expenditure amount (186%) for a payable cash credit at 10% providing a net benefit of 18.6%.

Qualifying Research-Intensive SMEs will be able to receive a cash credit at 14.5% providing a net benefit of 27%.

RDEC regime

• Profitable and Loss-making companies

For qualifying expenditure incurred up to 31 March 2023 companies receive an RDEC credit of 13% which is subject to Corporate Tax at 19% providing a net benefit of 10.5%.

For qualifying expenditure incurred after 1 April 2023 companies receive an RDEC credit of 20% which is subject to Corporate Tax at 25% providing a net benefit of 15%.

For Accounting periods commencing on / after 1 April 2024

MRDEC

• Profitable and Loss-making companies

Companies will receive an MRDEC credit @ 20% of the qualifying expenditure. The credit is taxable at the notional rate of Corporation Tax applicable (currently 25% for profit making company and 19% for loss making company) providing a net benefit of up to 16.2%.

ERIS

• Loss-making SME companies

Qualifying loss-making research-intensive SMEs will be able to claim a credit calculated in the same way as the SME scheme pre-1 April 2024 providing a net benefit of 27%.

Within two years of the end of the relevant accounting period, subject to Claim Notification and Additional Information forms being filed as noted above.

Applicants must be subject to UK corporation tax.

For Accounting periods commencing before 1 April 2024

To qualify as an SME: <500 employees, including connected group/companies, and either turnover <€100 million or gross balance sheet assets <€86 million.

SME R&D Intensive scheme: applicants must qualify as an SME and have at least 40% of their total expenditure relating to qualifying R&D activities.

Certain qualifying R&D expenditure of qualifying SMEs can only be claimed under RDEC.

Companies that do not qualify as SMEs can only apply for the RDEC scheme.

For Accounting periods commencing on or after 1 April 2024

The MRDEC Scheme is available to qualifying Companies of all sizes though those meeting the ERIS criteria outlined below can claim the enhanced ERIS loss relief. 

Enhanced R&D Intensive Support: applicants must qualify as an SME, be loss-making and have at least 30% of their total expenditure relating to qualifying R&D activities.

What are the criteria that define activities that qualify as R&D, and who determines the criteria?

Current DSIT guidelines are the same as the previous guidelines (previously referred to as the BEIS (Business, Energy, and Industrial Strategy Guidelines)) with the addition of 'pure mathematics' as a qualifying R&D activity.

Do the R&D activities have to be performed within the country to qualify? If not, is there a distinction made between the country where the claimant company is resident, EU countries, and non-EU countries?

For Accounting periods commencing before 1 April 2024

No.

For Accounting periods commencing on or after 1 April 2024

The Merged Scheme has brought in limits to the R&D activities that take place offshore. Broadly, contracted-out R&D activity will have to be physically located in the UK for the costs to be included in R&D tax relief claims. While all qualifying Externally Provided Worker (EPW) payments will need to be subject to UK PAYE and Class 1 NICs – this includes UK companies who currently claim R&D costs paid to overseas group companies for connected EPWs.

There are a few exceptional circumstances where oversees activities will be allowed:

• Where it is unreasonable to undertake the R&D in the UK due to geographical, environmental, or social factors;
• Where legal or regulatory requirements require the activity to take place in a specific territory, or;
• In the case of certain SME businesses registered in Northern Ireland (subject to certain conditions being satisfied).

Does the intellectual property need to reside in the country granting the incentives or in the company claiming the incentives?

No.

Does the tax authority have to review the resultant developments to allow a deduction or credit?

No.

For Accounting periods commencing before 1 April 2024

Varies slightly by SME / Large R&D regime, but includes staff costs, externally provided workers, sub-contracted costs, consumables, payments to qualifying bodies (e.g. universities), payments to subjects of clinical trials, data and cloud computing costs (from 1 April 2023).

R&D costs in general need to be P&L costs to be qualifying. There are specific criteria for revenue costs capitalised in Intangible Fixed Assets (normally software costs) that can be treated as expensed when incurred provided a CTA09 s1308 election is made.

For Accounting periods commencing on or after 1 April 2024

The Merged Scheme has aligned the rules on qualifying costs for all claimant Companies while removing contributions to independent research (for example, that done by universities).

Qualifying expenditure includes: staff costs, externally provided workers, sub-contracted costs, consumables, payments to subjects of clinical trials, data and cloud computing costs.

R&D costs in general need to be P&L costs to be qualifying. There are specific criteria for revenue costs capitalised in Intangible Fixed Assets (normally software costs) that can be treated as expensed when incurred provided a CTA09 s1308 election is made.

Are the incentives temporary or permanent?

Claims need to be made for each period in question and are reviewed by HMRC. Subject to HMRC approval, and once the relevant enquiry window has passed (provided no discovery assessments can be raised) the R&D incentives are permanent.

How is the benefit obtained?

Subject to various requirements, claimants can choose to receive the benefit either as a reduction in corporation tax, carried forward losses, or a cash credit.

Are the incentives incremental in nature or volume-based?

Within each particular claim regime for the UK, the amount of benefit is calculated on a fixed percentage of qualifying expenditure incurred / identified in relation to qualifying activities. However, there can be limits on the amount claimed depending on qualifying criteria.  These criteria have changed over time.

Are there general rules for estimating the value of the incentives?

No, the value of incentives is directly linked to the value of qualifying R&D expenditure.

• Consider whether a claim notification is required
• Determine qualifying projects
• Obtain details of the associated expenditure
• Prepare a detailed R&D report identifying the R&D projects and qualifying expenditure
• Complete any other regulatory requirements (e.g. Additional Information Form)
• Submit the final R&D report / claim to HMRC along with the submission or amendment of a CT return.

Is there a cap on the maximum level of benefit that can be received per year, per company, or for all the qualifying taxpayers together?

For expenditure incurred in an accounting period commencing on or after 1 April 2024 there is no longer a cap on the amount that can be claimed per R&D project for SMEs.  There can be a restriction on the amount of cash that can claimed as a repayment. This is based on the claimant’s income tax and national insurance paid on its employees’ earnings in that accounting period.

For accounting periods commencing before 1 April 2024 there is a limit of €7.5 million on the total amount of funding which can go to any one R&D project for SME business claimants. Any amounts above this limit will need to be made under the RDEC / MRDEC regime.

Are tax credits refundable?

Yes, if an enquiry is raised and the claim is disallowed by HMRC.

Can surplus incentives be carried back or forward and used in years other than the origination years?

Yes, extra losses can be carried backwards or forwards (subject to certain criteria) to be offset against profits. If the claimant company is part of a group, the losses can also be Group relieved (subject to certain criteria).

Are there any other types of limitations?

For Accounting periods commencing before 1 April 2024

If a company already receives a subsidy from elsewhere (i.e., by obtaining grant funding), it may limit its ability to claim under the SME regime, but it can still claim under RDEC regime.

For Accounting periods commencing on or after 1 April 2024

No.

Are the R&D costs deductible when deriving taxable income?

No.