A business in loss doesn’t necessarily mean that it’s failing. Startups, for instance, often experience a spending deficit to get off the ground and fund long-term investments. Data published by the ONS in August 2020 revealed almost 16% of UK businesses were experiencing costs greater than turnover, a further 13% said they were breaking even, and nearly 27% weren’t sure of their financial position.
Many businesses believe R&D tax relief is reserved only for profitable companies and so miss out on the benefits. In truth, the SME tax relief scheme aims to support loss-making businesses by granting R&D tax credits as a cash injection.
HMRC provides R&D tax credits in exchange for the business surrendering its losses. However, surrendering losses carries an opportunity cost that might not always be in your client’s best financial interest. As your client’s accountant, it pays to be aware of their expected financial needs to get the most out of their R&D.
How losses are useful for UK businesses
Losses can be financially valuable thanks to the extended loss carry back rules for businesses.
The Finance Act 2021 provides a temporary two-year extension to the timeframe outlined in these rules. It applies to accounting periods that end between 1 April 2020 and 31 March 2022.
Thus, carry back rules have broadly been extended from one previous year to three previous years. Companies can use any unused balance of the losses from an accounting period, as long as the business remains in the same trade for 12 months. If an accounting period doesn’t fit neatly within this period, the profit that can be offset is apportioned accordingly.
Losses are also flexible in how they’re utilised as they can be brought forward to future accounting periods. Trading losses carried forward can be offset against subsequent trading profits or the total profits of an accounting period. However, if the business’s profits exceed £5m, there are limitations to the amount that can be offset. If this is the case, no more than 50% of these profits can be covered by carried-forward losses.
Related: The myths around R&D Tax Credit costing you money
What does it mean to ‘surrender losses’?
When companies experience losses, they’re not excluded from claiming R&D tax relief. The SME R&D tax relief scheme allows these companies to claim a tax credit in exchange for their losses. This grants a cash credit worth 14.5% of the total of losses surrendered.
Let’s look at an example of how this works:
Your client has a total expenditure of £75,000.
£50,000 is qualifying R&D expenditure, so it experiences an uplift of 130% under the SME scheme. As a result, £50,000 x 130% = £65,000.
The company had a loss of -£25,000, and this is enhanced by £65,000 for a total of -£90,000 in loss for tax purposes.
The value of the R&D tax credit is based on either the total uplifted loss or 230% of the qualifying R&D expenditure (£115,000), whichever turns out to be the lower value.
Therefore, the cash credit is calculated using the uplifted loss: £90,000 x 14.5% = £13,050.
If the company decided instead to carry forward the enhanced loss, they’d receive a benefit of reduction in future corporation tax of £90,000 x 19% = £17,100. The trade off being that no cash is received immediately, and the benefit is only experienced once the company has enough taxable profit.
The case for and against both options
The main appeal for surrendering losses is that your client can claim R&D tax credits, which offer a short-term cash injection. Receiving a cash sum is the most flexible form of financial benefit, as the company can use the money where it makes most business sense. HMRC aims to provide R&D tax credits within 28 days of filing; failing this, they’ll contact businesses regarding their claim within this period.
However, there are benefits to holding onto losses, one of which is the ability to capitalise on past successful years. The benefit comes as a repayment of tax already paid. Therefore, in periods where tax rates have been falling, carrying losses back to previous Corporation Tax rates will grant a greater repayment. Loss carried back can also come with a small interest repayment from HMRC. Companies that are part of a group but that don’t have a previous profitable period to utilise can transfer the loss to a profitable group member.
Carrying losses forward also allows profits in future accounting periods to be offset. Losses incurred in accounting periods before 1 April 2017 can only be used against profits from the same trade. Beyond this, losses can offset total profits. While this encompasses most forms of loss, HMRC outlines rules for accountants to consider when carrying the different types of loss forward.
Our advice
Start by considering whether your client will likely become profitable by the end of their next accounting period. It’s worth getting involved in discussions about their business roadmap to determine this. With the right information on hand, you can make an informed decision regarding the surrendering of losses.
Holding onto losses is only advisable when there are profits that can be offset against it. If your client doesn’t expect to be profitable in the next few years, and they weren’t profitable in the past three years, R&D tax credits in cash are likely the best option. As demonstrated in the above example, the total R&D expenditure will impact how their R&D tax credit is calculated. Therefore, it’s critical to have a clear understanding of how much qualifying R&D work your client has undertaken during each accounting period.
In addition, if your client is a fast-growing business, having cash in the short term could lead to a higher return on investment over time. If this is the case, the 14.5% cash credit could generate more value than the carried over losses, and the R&D tax credit option is more appealing.
Finally, startups can benefit from surrendering their losses before they’ve paid HMRC any form of tax, so it’s critical to check in with your client on this.
Read more on how to claim R&D tax credits for startups
Get in touch with made.simplr
Let the experts help! Making accounting decisions, such as surrendering losses or claiming R&D tax credits, often involves analysing a substantial amount of business data. With made.simplr’s online R&D tax credit platform, you’ll be able to access your client’s figures through Xero integration and, from there, apply it directly to completing R&D tax credit claims.
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