Many businesses investigating R&D tax credits can find it confusing at first. The application process in particular can seem daunting, even though it is in fact relatively straight forward. As long you keep all company records, you will have access to all the information you need when it comes to submitting your claim. It’s just a matter of following the correct process and criteria. Unfortunately, this apparent complexity does mean many businesses ignore R&D tax credit claims for fear of screwing up their claim. However, mistakes are easily avoidable with the right knowledge of R&D and what HMRC requires from companies applying for R&D tax credits.

As with the criteria surrounding R&D tax credits, ‘screwing up’ is an intentionally ambiguous term. This term is used because HMRC themselves intentionally define R&D in a vague way to allow as many businesses as possible to access the benefits of R&D tax credits. Although this ambiguity is recognised, this does lead to some niche cases where executing a claim becomes unclear.

This blog is here to shed light on the simple errors companies make when applying for R&D tax credits. It’s important to know what the possible mistakes are and how they affect a claim ahead of time. This thereby enables you and your client to avoid them altogether and ensure the maximum R&D tax credit benefit.

Common things to avoid before or during an R&D tax credit claim

The following points cover aspects of your client’s business which, if altered, can compromise their R&D tax credit claim. This considers the type of company they are, how they operate and the work they do.

It is advisable to avoid these changes as they can have unforeseen consequences for your client’s R&D tax credit claim. They can limit the amount that’s claimable, alter how to apply, or even make the claim obsolete. Some of these common occurrences result in all three. Continue reading to find out about each example’s context, ramifications and how to avoid it.

• Internal restructuring

The restructuring of your client’s business can affect their claim in a range of ways. However, it almost always happens when the state company’s trade and/or assets are changed. With R&D tax credits, this will mean a claim cannot include any qualifying costs produced after the restructuring. This might seriously limit the amount your client’s claim is worth if they restructure during an R&D project. As such, this mistake can be avoided by completing all outstanding R&D projects before a restructuring. The R&D work undertaken is still claimable at a later date, as per the standard parameters for claiming R&D tax credits.

However, care must be taken when the internal restructuring involves multiple businesses. If a company’s assets and tradables get moved to another company during the restructuring it can disallow them from claiming through the SME scheme. Though this only happens if the original company is ‘wound up’. Winding up, which is also known as ‘compulsory liquidation’, can be done by a third party when they are owed money by a company. The third party can then apply to the court with a ‘winding-up petition’. If successful, it will have the following effects:

• Company assets get sold.
• Legal disputes get settled.
• Funds get paid to all creditors.
• The company collects any money it is owed.

To wind up a company, you must have proof that you are owed at least £750 and that the company in question cannot pay you. This eventuality makes it very important to settle your debts promptly, not only for the purposes of R&D tax credits.

A claim can also get compromised when assets are transferred internally amongst a group of companies. There won’t be a problem so long as both companies are registered in the UK and pay UK Corporation Tax. As a basic requirement of R&D tax credits, this requirement is often overlooked.

There could be a problem if your client’s company outsources most or all of the R&D work to staff employed by another company. When companies incur costs on behalf of one another, the cost-bearing company can recharge the company employing them. As such, if the recharge does not explicitly state that it is for R&D work then it is hard to identify which company is conducting the R&D. Additionally, the recharge may take a while to be sent which may not allow time for the project to be claimed for at all.

• Badly organised outsourcing

As discussed above, outsourcing R&D work can create issues when it comes to claiming R&D tax credits. It is a boon to be able to include the costs of subcontractors and external workers though, so it pays to know how it can screw up a claim.

First of all, it can be difficult to categorise outsourcing between being subcontractors or external workers. Some of your client’s outsourced costs might not fit into either group. Not knowing how to categorise outsourced activities risks the inclusion of costs that aren’t eligible for R&D tax credits.

Furthermore, there are restrictions to subcontracted work within the RDEC scheme. To qualify, the work must be done by an individual, a qualifying body or a group of individuals. If your client includes subcontracted work done by other parties in their claim, it could screw it up.

• Not including all qualifying R&D activities and costs

This is a very common mistake among first-time claimers, who are often unfamiliar with the corner cases of qualifying R&D costs. If your client doesn’t include all their qualifying R&D activities and costs in their claim it won’t reach its full potential. As a result, they’ll be missing out on monetary benefits.

You can find the list of all qualifying costs here.

• Including projects and costs that are ineligible

Businesses sometimes categorise work as R&D when it isn’t. This results in a lot of wasted time in filling out areas of a claim which aren’t relevant. Furthermore, as discussed previously, including ineligible work in a claim can result in rejection and an HMRC investigation.

This takes the previous point a step further as it poses a significant risk to the success of a claim. To avoid this, seek out HMRC’s guidelines for defining R&D and get expert advice.

• Paying Directors large dividends

Often owners pay themselves dividends rather than salaries because it means they are subject to lower levels of income tax. However, dividends are not a qualifying R&D cost as they are not a result of employment. This can drastically reduce the value of a claim if, for example, a major technical director is paid by dividend.

• Lack of record-keeping

Due to the fact that R&D tax credits include work spanning over two years, businesses often forget the work they’ve done. This can lead to valuable projects being missed in a claim. This is also important as records help when it comes to providing supporting information for your client’s projects. Without adequate records to look back on, a business may not be able to explain its R&D processes in enough detail.

Record-keeping is just good business practice to ensure that all qualifying R&D work gets included in your client’s claim.

• Growing beyond the size of an SME

Businesses naturally increase in size as they continue to expand and grow. For R&D tax credits though, being an SME offers a greater benefit than for large companies. As a result, if your client grows beyond SME size then they are effectively losing out when claiming R&D tax credits.

This gets compounded by the fact that the line between SMEs and large companies is very black and white. Once a business exceeds 500 employees, or a turnover of €100m and a balance sheet of €86m, it is classed as a large company with no ifs or buts. Though they then get granted a ‘year of grace’, during which they can still claim as if they were an SME.

• Transitioning from loss-making to profit-making

This might seem strange – why would anyone want to remain in loss? Well, the reason is that companies in loss can surrender their loss to HMRC for a cash credit. For many SMEs, this short-term cash injection is extremely valuable. It may even mean the difference between liquidation and continued trading. At the very least it might facilitate more R&D work. However, if your client expects to be profit-making in the following year, surrendering losses can be detrimental. This affects their accounts because the loss cannot be used to offset corporation tax moving forward.

It is not advisable to deliberately compromise your client’s profit-making ability, but it is worth bearing in mind how it will affect an R&D tax credit claim if they choose to pursue one.

Read more about how to claim R&D tax credits on a failed project.

It should be said that although these examples are detrimental when applying for R&D tax credits, they might be sound business decisions. This is why these examples commonly appear in businesses looking to claim R&D tax credits. If it’s possible to avoid them though, your client is guaranteed to benefit far more from R&D tax credits. As your client’s accountant, however, it’s also important to consider the tradeoff of benefit. For instance, your client may want to delay their restructuring until after they make a successful claim on a busy year of R&D work. Due to this not always being an obvious choice, advice from R&D tax credit experts and specialist software is recommended.

Take extra care with large software claims

A sector that has been growing rapidly with regards to R&D eligibility has been the software industry. More specifically, communication and information, and professional, technical and scientific software. This has manifested in the form of developments like artificial intelligence, cloud computing, augmented reality and more. The difficulty with software R&D is that much of it can be work that does not directly contribute towards the resolution of the project. As such, it’s hard to know what to include in a claim that features software projects.

HMRC outlines what businesses should do when claiming on software projects:

• The scientific and/or technological uncertainties which the project addresses must be clear.
• The technological input for the project needs to be highlighted, as opposed to its commercial output.
• Technological uncertainties get solved by accurately highlighting the challenges faced during the project.

The risks of screwing up a claim

Unsuccessful R&D tax credit claims can result in some dire consequences for the claiming company. Chief among these is an investigation by HMRC. This gets triggered when HMRC identifies or suspects errors or inaccuracies in an R&D tax credit claim. The inquiry then requires the company to produce evidence to validate its claim. If this can’t be done, the company will get hit with a fine. This can be up to 100% of the value of the claim. Given that the business will also have to pay back any benefit already gained, this fine can be devastating to small and medium businesses.

If your client is facing an HMRC inquiry, it is advisable that they act with transparency and professionalism. As long as this occurs, there are unlikely to be any financial consequences. HMRC aren’t trying to catch your client out, they merely aim to discourage fraudulent claims.

Read about the common myths, misconceptions and missed claims of R&D tax credits.

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