There are two schemes available to companies that want to claim R&D tax credits. The SME (small and medium-sized enterprises) scheme and the RDEC (R&D expenditure credit) scheme. The RDEC incentive scheme was introduced in April 2013, replacing the preexisting large company scheme. It still fulfills a similar role in allowing large companies to access R&D tax credits. It is also available to SMEs in certain circumstances. As such, knowing about the RDEC and how this scheme operates is important as it is likely your client can access R&D tax credits through it.
People falsely believe that R&D tax credits are more beneficial for small and medium-sized businesses. The truth is that there are aspects of large companies which capitalise on R&D tax credits. So although it would appear that the RDEC offers less of a benefit at face value, your client should not dismiss the option.
Read on to find out all about the RDEC scheme – its benefits, limitations and points of contention.
What is the RDEC scheme?
The RDEC is an R&D tax credit incentive scheme administered by the UK government through HMRC. Its purpose is to create more private sector investment in innovation. As a result, it mainly targets larger UK companies. This scheme was a signal that the UK government wanted to ‘level up’ the country and maintain a strong position on the world stage.
Much like the SME scheme, the RDEC scheme allows businesses to claim back a percentage of their R&D costs. This gets delivered as a refund on their corporation tax and/or a payable tax credit. This credit is at a rate of 13% of the company’s total qualifying R&D expenditure.
History of the RDEC
R&D tax credits were first introduced for SMEs in the UK in 2000, but it was 13 years later that the RDEC scheme was introduced. At this time, the RDEC allowed companies to claim R&D tax credits worth 10%. However, due to the taxable nature of the credit, the benefit was in actuality worth only 7.6%. This occurs because R&D tax credits are themselves taxable at the regular corporation tax rate of 19%.
On the 1st of April 2015, the RDEC was updated for the first time. At this time, the rate offered by the RDEC scheme was increased to 11%, translating to an improved benefit of 8.7%.
On the 1st of April 2017, corporation tax in the UK was cut from 20% to 19%. This is a notable development as it meant greater benefit for companies claiming R&D tax credit through the RDEC scheme.
The next update to the RDEC came on the 1st of January 2018, when the RDEC rate moved to 12%. This yielded a post tax return of 10%.
The most recent increase in the RDEC rate came in April last year. This saw the rate rise to 13%, which is what it currently stands at the time of writing. This brought the benefit from the RDEC scheme to 11%.
As the timeline of the RDEC shows, the scheme has been getting more and more attractive in pursuing R&D tax credits. The pattern would suggest further increases to the rate offered by the RDEC will come.
Who can claim through the RDEC?
The main focus of the RDEC is large companies. This gets defined by HMRC as a business that has:
- More than 500 employees.
- A turnover of over €100m and a balance sheet worth more than €86m.
As long as your client’s business is this size and based in the UK they will be eligible for the RDEC scheme.
That said, the RDEC is also accessible to companies with fewer employees and smaller turnovers due to the following eligibility criteria:
1. Connected companies can also claim through the RDEC. The only requirement is that the combined size of both companies is over the parameters outlined above. For example:
- Company A – 340 employees, a turnover of €70m and a balance sheet worth €55m.
- Company B – 170 employees, a turnover of €40m and a balance sheet worth €33m.
, As a group they would have an employee base of 510, a turnover of €110m and a balance sheet of €88m. Together, both companies qualify for the RDEC scheme.
2. SMEs can also claim through the RDEC scheme for a couple of reasons:
- They were subcontracted to do the R&D work in question.
- At the time they were receiving financial aid which they used to fund their R&D projects.
Both of the above scenarios have the potential to disallow an SME from claiming R&D tax credits through the SME scheme, and instead potentially allow them to claim through the RDEC route. In addition, with the past 18 months of the pandemic, more UK businesses than ever have been receiving grant funding. As such, it’s important to know about the RDEC even if your client runs an SME.
How the RDEC defines qualifying R&D activity
The RDEC effectively offers a refund on the R&D work your client has done or is doing. However, it is up to them to correctly identify the work that qualifies as R&D when applying. Just as with the SME scheme, the RDEC scheme uses HMRC’s definition of R&D work.
This is what they say:
To translate, your client’s R&D work must have real world applications that improve a product or process. It should focus on solving a particular technical or scientific uncertainty. ‘Uncertainty’ exists in a field where a problem remains unsolved. It doesn’t matter what sector your client operates, so long as they can provide evidence of their R&D efforts.
The scope of what qualifies as R&D is vast, so don’t dismiss anything! Have a look at our previous blog on the types of work that qualify as R&D.
How to claim through the RDEC
The first step is to calculate your client’s total qualifying expenditure:
- Work out all the costs that come under R&D referring to the appropriate definition.
- Make sure subcontractor costs and payments to external staff providers get reduced by 65%.
- Combine the costs and multiply the total by 13%.
- Add the end figure to your client’s Company Tax Return form.
Next, your client should submit the completed Company Tax Return form (CT600) to HMRC. After this gets done, they can support their claim using HMRC’s online government gateway.
HMRC specifies that the supporting information in an R&D tax credit claim should cover the following:
- How the project looked for an advance in science and technology.
- How it had to overcome uncertainty.
- How it went about overcoming this uncertainty.
- That the work could not be easily worked by a professional in the field.
Your client will have to provide supporting information for each project within their claim. This is so long as there are at least three projects in the claim, which also make up 50% or more of the total qualifying R&D expenditure. They can include a maximum of 10 projects per claim.
Benefits of the RDEC
The first step is to calculate your client’s total qualifying expenditure:
One benefit is that the credit gained from the RDEC scheme gets shown ‘above the line’. This means it is visible as income in your client’s accounts and therefore traceable. As such, the financial gains of R&D tax credits will get taken into account when the profitability of your client’s business gets examined. This can increase the investment opportunities for your client moving forward.
Unlike the previous large company scheme, the RDEC also allows for loss-making companies to claim R&D tax credits. If your client is a large company experiencing loss they can claim up to 9.7% of their qualifying R&D expenditure. Yes, this is a lesser percentage than that offered by the SME scheme. However, this percentage is more likely to translate to higher benefits for large companies.
Larger companies are by their nature in a better position to gain from R&D tax credits. Think economies of scale and larger profits. This means the average claim under the RDEC is usually higher than that made using the SME scheme. For example:
- A company claiming through the SME scheme has a turnover of £400,000 and an R&D expenditure of £100,000.
£100,000 x 130 = £130,000 (enhancement)
£400,000 – £130,000 = £270,000 (revised profit)
£270,000 x 19% = £51,300
£76,000 – £51,300 = £24,700 (corporation tax savings)
This example gives a benefit at a rate of roughly 30%.
- A company claiming through the RDEC scheme with a turnover of £1.5m and an R&D expenditure of £600,000
Original corporation tax: £1.5M x 19% = £285,000
£600,000 x 13% = £114,000
£1.5m + £114,000 = £1,614,000 (increased profits)
The increased profit also leads to an increase in tax of £21,660. As you can see, even though the percentage benefit is lower from the RDEC the value of benefit generated is higher.
Potential limitations of the scheme
The latest data on R&D tax credit claims reveals that 41% of large companies were claiming less than £50,000 last year. Given the size of these companies, the expected value of their R&D tax credit claims should be far higher. The issue here is that large companies consistently fail to recognise all of the R&D costs they could get included in their claim. The scheme is therefore limited by the lack of public knowledge surrounding it.
As you likely know, UK corporation tax is set to increase to 25% from the 1st of April 2023. This jump from 19% to 25% will have huge consequences for businesses looking to utilise the RDEC. This is because the value of the benefit generated by the RDEC is offset by corporation tax. The opposite is true for the SME scheme. There is a caveat, as businesses experiencing yearly profits under £50,000 will still be subject to the 19% tax rate and businesses with profit margins of between £50,000 and £250,000 will have a taper put in place. Beyond that, the new 25% rate of corporation tax will apply.
Don’t go it alone
Collaborating with made.simplr makes the process of applying for the RDEC as straightforward as can be. Our cutting-edge R&D tax credit portal software makes applying for the RDEC or SME scheme easy. Although the RDEC seems quite simple to utilise, it does come with complexities. Chief among these is correctly identifying the costs your client can claim for in their R&D tax credit claim. This is especially true when dealing with large companies as the numbers can get very long (literally and figuratively). Our system bypasses any difficulties by offering integration with your client’s accounts. This is all while our tax credit calculator eliminates any risk of error when adding up the total qualifying expenditure.
Our system also grants you access to a top team of industry professionals in the field of R&D tax credits. They are on hand to advise and review your client’s application at every stage of the process. It’s our mission to ensure their claim is accurate and delivers the maximum benefit possible.
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