The difference between SME R&D Tax Credits vs RDEC
The difference between SME R&D Tax Credits vs RDEC
UPDATE: Please refer to our latest article for the most recent 2023 changes to R&D tax credits.
The government’s plan for long term economic growth in the UK is heavily reliant upon increasing investment in innovation. This is because by focusing on developing innovative products and solutions, more jobs are created, productivity improves, and the impact of innovation can easily spread to boost the wider economy. Research and development are key to stimulating innovation and thus, the government have devised targeted tax relief schemes to encourage businesses to spend on such activities.
What is R&D?
R&D is what ‘research and development’ is commonly referred to within many industries. The government defines R&D as specific projects which aim to make an advance in science or technology but does not include an advance in social sciences such as economics or theoretical fields such as pure mathematics. There must be a clear uncertainty that the project is trying to overcome – either how to achieve a known end goal or trying to find out what the end goal may be. You must be able to demonstrate that you have tried to overcome the uncertainty during your project and that whatever conclusion you came to (whether it was successful or unsuccessful) could not have been worked out by other competent professionals in your field of work without having carried out similar research and development work. These qualifying statements as to what defines research and development are therefore generously broad and can apply to many sectors. The project can aim to develop something completely new or improve something which already exists.
What are the two different R&D tax relief schemes?
The SME R&D tax credit scheme was introduced first in 2000, and as the name suggests, was aimed at small to medium sized enterprises. To attract more investment in R&D, the government then launched the Research and Development Expenditure Credit (RDEC) scheme later in 2013. This scheme enabled larger more established corporations (those also more likely to have capital to fund R&D projects) to benefit from tax relief but at a lower rate.
Why are there two different R&D tax relief schemes?
There are two different R&D tax relief schemes available depending on the size of your company. The SME R&D tax scheme recognises that many innovative businesses are small start-ups with revolutionary ideas, but often only have limited funding to develop a new product or service. The generous SME tax scheme was therefore designed to help them stretch funding further in order to be able to fully complete their R&D activity.
The RDEC scheme on the other hand similarly acknowledged that larger more established companies, often with much more resources, were nonetheless taking financial risk and carrying out R&D activity. So, although the RDEC scheme is not as generous as the SME R&D tax scheme, it still offers the larger companies incentives for pursuing R&D projects. What’s more, the RDEC scheme remains available to smaller companies which may be ineligible to use the SME scheme because they are owned by larger parent companies, or because they have received funding through notifiable state aid grants.
What are the different eligibility criteria for SME R&D vs RDEC?
Companies eligible to use the SME R&D tax scheme must conform to the following conditions:
- Have a turnover of under €100m
- Have a balance sheet of under €86m
- Have no more than 500 employees
There are no set eligibility criteria for companies to be able to use the RDEC scheme, but it will likely be companies that have fallen out of the scope of the above and exceed those limits (unless they are small to mediums size enterprises which are ineligible to use the SME scheme):
- Have a turnover of over €100m
- Have a balance sheet of over €86m
- Have more than 500 employees
What are the different rates for SME R&D vs RDEC?
How much a company can claim will be dependent upon which R&D tax scheme you are eligible to use. With the SME R&D tax scheme, the maximum rate you can receive back as tax relief is 33%. If your company is profit-making and therefore has corporation tax liability to be paid, you can receive between 25% – 33% as tax relief. You’ll be able to get a better idea of how much you could receive by understanding how R&D tax relief is calculated. If your company is loss-making and has no corporation tax to be paid, and you choose to receive tax credit (essentially, this is cash paid back to your company from the government) you receive a rate of 14.5% on your enhanced R&D expenditure.
The RDEC scheme is more simplistic than the SME R&D scheme with a single rate of 13% on eligible R&D expenditure available to companies. This is regardless of whether your company is profit-making or loss-making. Despite its far less generous rates, in 2020, over 10% of all total R&D claims were made through the RDEC scheme, of which 54% of the claimants were SME companies. It can therefore still be considered as a valuable tax relief scheme to be utilised where the SME R&D tax scheme is unavailable.
How are SME R&D vs RDEC taxed differently?
It is important to be aware that there are different tax treatments towards the SME R&D scheme vs RDEC. Any relief received via the SME R&D scheme is not subject to corporation tax. This means that you would calculate how much corporation tax is due first, then calculate your R&D tax relief and deduct it from your corporation tax liability.
The RDEC scheme however is subject to corporation tax. This means that you would calculate your R&D tax relief, include this amount as part of your company’s income and then calculate corporation tax. As an example, you spend £10,000 of eligible R&D expenditure. You would apply the RDEC rate of 13% to calculate your tax relief which is £1,300. You then calculate 19% corporation tax on this amount which is £247. Deducting the corporation tax amount from the tax relief amount leaves £1,053. This is the actual amount you receive as tax relief or tax credit.
What are the maximum claim thresholds for SME R&D vs RDEC?
Both R&D tax relief schemes are subject to the same maximum claim cap, which is also known as the PAYE cap. This is because the cap is based on the amount your company pays in PAYE and national insurance contributions (NIC) for employees. For both the SME R&D scheme and RDEC, the maximum your company can claim in tax credit when it is loss-making is 300% of your PAYE (and NIC) liability for the year, plus a further £20,000 ‘grace amount’. There are some exceptions to this cap if your company is actively working on intellectual property and does not spend more than 15% of your qualifying R&D expenditure on unconnected subcontractors.
How does claiming the costs of using subcontractors differ from SME R&D vs RDEC?
Using subcontractors to carry out R&D work is not uncommon, however the costs of paying for their work have different rules when it comes to the SME R&D scheme vs RDEC. If you are claiming under the SME R&D scheme and have used subcontractors, then 65% of costs will qualify as eligible R&D expenditure.
For RDEC, there are stricter rules. If you are using subcontractors for your R&D projects, the subcontractors must be an individual, a partnership made up of individuals, or an approved body (a charity, an institution of higher education such as a university, a scientific research organisation or a health service body). So long as the subcontractors are from the approved list then 100% of their cost can be claimed as allowable R&D expenditure.
Can a company use both SME R&D and RDEC?
Companies are not prevented from using both the SME R&D tax relief scheme and RDEC scheme, so long as it is not for the same R&D project. Indeed, many companies will use both schemes, especially when they have other sources of funding for R&D projects or carry out R&D activity as a subcontractor.
Where can I get advice on whether to use SME R&D vs RDEC?
We’re here to help! Book in for an introductory consultation with no obligation. We can discuss your R&D projects and help you assess whether the SME R&D scheme vs RDEC would be more suitable for you to use. What’s more, we can advise how to make any external funding you may have for R&D projects go further by carefully protecting their scope parameters. You can get started by booking an appointment that suits you via our online form.
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