Paul Webb – Tax partner at accountancy RJP.

Research and development (R&D) tax relief is about offsetting the costs incurred on R&D by either reducing your corporation tax bill, or receiving cash rebates if you are a loss-making small and medium-sized enterprise (SME).

The majority of companies who claim R&D relief are hi-tech businesses – software developers, specialist manufacturers or biotech companies – although many other types of company may indeed qualify for relief.

In the past, tax relief available through the R&D tax credit system has always been criticised for being hard to access and of limited value to smaller firms and start-ups that are unprofitable. But changes introduced this year will make a real difference to business owners and this could become a very useful means of financing innovation.

New tax credits rules in 2011

SMEs can now obtain tax relief of 200 per cent on qualifying expenditure for research and development.

Essentially companies receive a further 100 per cent deduction on qualifying expenditure, meaning corporation tax savings of up to 40p for every £1 spent (for companies paying at the small companies tax rate).

If a company does not make a profit but has made an investment in R&D, which is the most common situation for a start-up, they are entitled to a 14 per cent cash rebate. Currently this is capped at the same level as the total tax paid out for PAYE and National Insurance Contributions (NIC) but will change from next year.

Tax credits in the future

From 1 April 2012, the tax relief will rise to 225 per cent. Most significantly, the rebate on corporation tax payments will no longer be capped at the same level as total tax paid out for PAYE and NIC, which means companies will receive the full rebate regardless of their PAYE and employer’s NIC payments.  

In the past, because so many start-ups have few employees but need to invest heavily in R&D, this scheme was often of limited value.

In some cases a business would have spent more on R&D than their wage bills, making the scheme effectively redundant from a tax relief point of view.

But now, for smaller firms or entrepreneurs with a bright idea for a high tech start-up, the improvements to the R&D tax credit system could be a very useful and economical source of finance as banks continue to be cautious about lending.

Projects that could be eligible for R&D tax relief include: internal development of a new web-based Customer Relationship Management system; development of an internal bespoke time recording and billing system; the translation of software into foreign languages; and development of iPad and iPhone applications.

Tax refunds claimable could amount to tens of thousands of pounds and with the relief now at 200 per cent of qualifying costs increasing to 225 per cent in 2012, it is more valuable than ever.

Presently staff costs, consumable stores, sub-contractor costs, externally provided worker costs, software costs and water, fuel and power costs could all be claimable.

As a policy, this improvement to the R&D tax credits system is estimated to be costing the treasury around £20 million in the first year, rising to £105 million in 2014. That’s quite a lot of money, however they obviously place a great deal of importance on the UK’s ability to generate value through intellectual property and innovation.

Positioning the country as a centre of R&D excellence represents good long-term thinking and is vital for the economy’s future prospects in the face of competition from advancing countries such as China and India.

Business owners would be wise to ensure they do not miss out on this opportunity.