Grants and R&D tax credits

Since Brexit and the Covid-19 pandemic, companies across the UK have been offered increased business support through government grants. The Department for Business, Energy & Industrial Strategy has reported on the amount of funding allocated to SMEs through both the Small Business Grants Fund and the Retail, Hospitality and Leisure Business Grants Fund. From December 2020 to August 2021, close to 1 million businesses were eligible to receive funding from these grants, with more than £11bn being claimed across both funds when the schemes closed earlier this year.

The SME R&D tax relief scheme in the UK is classed as notified state aid, which is a form of government funding regulated by the European Commission. To prevent companies from claiming aid for the same project from multiple sources, the government has placed certain limitations and restrictions on how R&D tax credits interact with other grants.  

As a result of the nature of these grants, and their recent prevalence, it is valuable for accountants to be aware of how they interact with R&D tax credits. For example, if your client is looking to expand and develop their business, they will likely be looking for multiple funding sources. They might have accepted grant funding without considering how it will affect their eligibility for receiving other financial benefits, such as R&D tax credits. The good news is that this does not necessarily disallow them from claiming R&D tax credits in the current year or in  the future.

The effect of notified state aid

State aid is defined as an advantage that is selectively given by public authorities using state resources. While these ‘advantages’ are broad in scope, they are typically subsidies or aids businesses cannot obtain on the open market. 

Rules around state aid are outlined by the European Commission to prevent the potential distortion of competition and trade. However, since the Comprehensive Free Trade Agreement between the UK and EU came into effect on 1 January, rules around subsidy control are changing. EU rules still apply when aid is granted within the jurisdiction of the Northern Ireland Protocol or if there has been a disbursement of outstanding Structural Funds payments. 

As these are corner cases, we’ll focus on what these relatively new rules mean for your client.

The UK is currently bound by international commitments on subsidies due to its continued World Trade Organisation (WTO) membership. For the purposes of economic fairness, public authorities are limited to giving out one form of notified state aid per project. In addition, there is guidance from the WTO on the characteristics of subsidies, which you can read on the website.

Government grants and the SME scheme

As previously mentioned, the SME R&D tax credit scheme is classed as notified state aid, mainly because of the high percentage of relief offered by the scheme. This means notified state aid grants have the potential to conflict with your client’s SME claim, however, this will hinge on how the funding has been separated between people and project costs.

For the purposes of R&D tax credits, the funded portion of a businesses’ projects that are funded by non-state aid grants must be claimed through the RDEC scheme. However, the rest of an R&D project’s qualifying expenditure can be claimed through the SME scheme as normal.

Government grants and the RDEC scheme

Unlike the SME scheme for R&D tax credits, the RDEC scheme does not count as notified state aid. This allows companies to claim for qualifying R&D costs that have been subsidised by government grants. SMEs (i.e. enterprises with fewer than 500 employees, plus a turnover of under €100 million, or gross assets of less than €86 million) can also use the RDEC scheme to claim for subsidised costs they wouldn’t have been allowed to claim through the SME scheme. 

According to HMRC, SMEs can claim for R&D expenditure disallowed by the SME scheme if:

  • The expenditure in question would have qualified for R&D tax relief if the SME was a large company.
  • The only reason for the expenditure not qualifying under the SME scheme is because it was subsidised by grant funding. 

The RDEC scheme also allows for corner cases within certain grant schemes, whereby your client may be able to access finances for parts of expenditures. We discuss this on a case-by-case basis further down.

Grants that do and don’t work with R&D tax credits

When determining how a grant will interact with R&D tax credits, you’ll need to ask the following two questions:

  • Is it categorised as notified state aid?
  • Have the funds been used to directly finance your client’s R&D project? 

If the answer to both of these questions is no, R&D tax credits should be claimable alongside the grant you’re looking at. Note that the actual amount of funding received does not influence the compatibility between grants and R&D tax credits.

Types of government funding

Many of the following examples are major sources of government funding brought about by the effects of Covid-19 business restrictions. They could potentially conflict with R&D tax credits, but this won’t always be the case. As such, we advise talking with your client to establish exactly how these grants have been used.

Future Fund

The Future Fund is delivered by the British Business Bank and provides support to UK businesses with a turnover of between £125,000 and £5 million. Although the scheme is now closed to applications, at the end of August 2021, 158 of the loans had been converted into equity shares. This shows the potential for the Future Fund to raise additional private sector capital for your client. 

Funds provided by the Future Fund are not notified state aid. SMEs, therefore, are allowed to claim R&D tax benefits for non-funded portion of a project.

Recovery Loan Scheme

Launched on 6 April 2021, the RLS is designed to aid businesses with post-pandemic recovery and growth. Even though the RLS scheme is classified as notified state aid, your clients R&D tax credits claim won’t be affected. To be eligible, your client will have to prove their business’ viability before the pandemic and how it has been adversely affected since then. They must also not be in collective insolvency proceedings. You should be prepared to take out extra debt finance on behalf of your client as a result. 

Lenders providing RLS support can give up to £10 million in the form of:

  • Invoice finance
  • Term loan
  • Asset finance
  • Overdraft

As the borrower, you will have 100% liability for RLS debt. Also note that if your client borrows more than £250,000, the lender can choose to take personal guarantees. These come with the following caveats:

  • No personal guarantees can be taken over Principal Private Residences.
  • Past £250,000, the maximum amount that can be covered is 20% of the outstanding balance of the RLS facility (this is after the business asset proceeds have been applied). 

In the 2021 Autumn Budget and Spending Review, the HM Treasury announced that the Recovery Loan scheme would be extended for six months until 30 June 2022. However, from the start of 2022, the following changes will apply:

  • Funds will only be available for SMEs.
  • Finance will be capped at £2 million per business and £6 million per group.
  • Guarantee coverage for lenders will be reduced to 70%.

HMRC says businesses that have received funding through other coronavirus loan schemes, namely the Coronavirus Job Retention Scheme and the Coronavirus Business Interruption Loan Scheme, can still claim the RLS. Find the list of accredited lenders currently offering funding through the RLS here. 

CBILS loans and RLS loans are both categorised as notified state aid, so if they are used towards the R&D activity this could reduce the benefit received on the funded costs. 

It is worth noting that HMRC have stated that RLS loans will not be treated in this manner when it comes to their overlap with R&D tax relief, in spite of their state aid status. This is not the case for CBILS loans, which will continue to be treated as state aid when used for R&D expenditure.

Coronavirus Job Retention Scheme (furlough)

The Coronavirus Job Retention Scheme (CJRS) is not a form of notified state aid. Instead, it is classed as a subsidy. Because workers on furlough are not contributing to relevant R&D work (by virtue of them not working at all), HMRC expects these costs to be omitted from R&D claims.  

However, HMRC recognises that holiday and sick pay are a valid aspect of R&D costs as they form a part of employees’ working time. As such, HMRC will allow any period during furlough taken as annual or sick leave to be included in staffing cost calculations.

Coronavirus Statutory Sick Pay Rebate Scheme

With this scheme, employers can recover two weeks’ worth of statutory sick pay for workers affected by the coronavirus. This is notified state aid and so cannot be claimed alongside R&D tax credits. Take care to make the distinction between this scheme and the CJRS.

Coronavirus Business Interruption Loan Scheme

Although it closed to applications in March 2021, the CBILS operated within similar parameters to the Recovery Loan Scheme, both in terms of facilities and lender guarantees. Its lenders offered up to £5 million to businesses that saw their cash flow disrupted and lost revenue as a result of Covid-19. 

The Coronavirus Business Interruption Loan Scheme (CBILS) is classed as notified state aid, but it will only get in the way of R&D tax credit claims if it is specifically used to fund an R&D project. 

Bounce Back Loans

The ability to claim Bounce Back Loans (BBLs) also came to a stop in March 2021. SMEs were able to use BBLs to borrow between £2,000 and 25% of turnover, with the maximum loan being capped at £50,000. 

BBLs are a form of notified state aid. However, it will only interfere with an R&D tax credit claim if the funds directly contribute towards R&D projects. As this funding was meant to deliver all manner of financial support, your client may still be able to benefit from R&D tax credits.

De minimis aid

A grant is classed as de minimis aid if it provides less than €200,000 over a three-year period. De minimis aid, although typically lent by government structures. It is treated muhc like non-notifiable state aid, where the funded portion of a project will have to be claimed through the RDEC scheme, and the reamined can be claimed through the SME scheme. The EU’s innovation grants given out under the Horizon 2020 scheme is an example of de minimis aid.

Example: Notified state aid applied to an R&D project

Let’s take a look at an example of where notified state aid is applied to an R&D project. Your client may be faced with this scenario as a result of receiving project specific aid, such as funding from Innovate UK and GBER. Project specific state aid is funding that a business must allocate towards a certain project. This will mean the business can only claim R&D tax relief through the RDEC for that project.

Say the business has received a grant of £500,000, which they choose to invest in an R&D project (1), alongside £750,000 of their own money. At the same time, they invest a total of £1,500,000 in two other projects that are eligible for R&D tax credits. 

Take a look at the R&D tax credit values that would apply:

Project Capital Investment (£) Grant Investment (£) SME relief rate* RDEC relief rate R&D tax credit value (£)
1 750,000 500,000 / 13% 162,500
2 1,000,000 0 33% / 330,000
3 500,000 0 33% / 165,000
Total 2,250,000 500,000 / / 657,500

So as a result of a total investment of £2,750,000, the company receives an R&D tax credit of £657,500. This gives an aggregate relief rate of almost 24%.

* This is the maximum possible relief rate offered by the SME scheme, this can vary depending on the expenditure and financial position of the business.

What should you do with this information?

Although some of these grant schemes have closed, they can still impact R&D tax credit claims because these can include projects from up to two years before the claims are made. It’s a likely scenario that your client will have R&D projects funded by both notified state aid and non-notified state aid.

While the percentage return on R&D work is less generous through the RDEC scheme, it is certainly still beneficial. Note that 33% is the maximum possible gain on investment through the SME scheme. Whether your client reaches this value depends on their financial position and the nature of the qualifying expenditure included in their claim.

Related: Most common overlooked expenses when making an R&D tax claim

State aid, notified or not, is aimed at benefiting businesses. Funding can be used for cash flow management, investment opportunities, and/or efforts to drive growth. 

Determine the best course of action with made.simplr

When R&D tax credit claims are maximised, the financial benefits can be substantial compared to other sources of government aid. With made.simplr’s software, your claims will be easy and accurate. In addition, our R&D tax experts are happy to provide guidance on how grants can affect your clients’ claims.

Book a demo today!

Eneko Igartua

Eneko Igartua is the Head of Operations at made.simplr. Originally a manufacturing engineer, he is an expert in R&D funding, having worked with R&D tax relief and grant funding from national and European sources. He is interested in helping accountancy firms expand their offering through software solutions.

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