A short guide to RDEC tax credits
RDEC tax credits (research and development expenditure credit) are a UK government tax incentive which have been designed to reward innovative companies for investing in R&D. Whilst it is primarily used by large companies, in some instances, it can also be used by SMEs.
You are classed as a large company for the purposes of R&D tax incentives if you employ more than 500 staff or you have a turnover of more than €100 million and more than €86 million in gross assets.
What is RDEC?
RDEC is one of two R&D tax credit schemes offered by the UK government to promote private-sector investment in innovation. The relief is for large UK companies which are subject to corporation tax, carrying out and spending money on qualifying R&D activities. In certain circumstances, SMEs are prevented from using the SME incentive and therefore claim through RDEC instead.
Overview of the rates
Up until 31 March 2023, companies claiming relief under RDEC could obtain 19p tax relief for every £1 of qualifying expenditure. Under RDEC, companies could also claim a taxable credit at the rate of 13% of qualifying R&D expenditure.
The credit was taxable at the normal corporation tax rate of 19% which effectively meant that the benefit was worth 11p for every £1 spent on qualifying R&D.
Since 1 April 2023, the RDEC rate has increased from 13% to 20% which makes the benefit worth 16p for every £1 spent after taking into account the increase in the corporation tax rate to 25%.
What are the benefits of RDEC?
RDEC can be accounted for above-the-line in your income statement, so it provides a positive impact on visible profitability in your accounts.
RDEC also offers a cash credit for loss-making companies.
What is RDEC qualifying activity?
The Department for Science, Innovation and Technology publishes the guidelines for the RDEC incentive, and its definition of research and development is as follows:
- R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology
- The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D
- Certain qualifying indirect activities related to the project are also R&D
R&D for tax purposes does not have to mean reinventing the wheel – it’s about solving problems that your business faces on a day-to-day basis in a new or innovative way, or overcoming a challenge that doesn’t have a straightforward solution.
If you’re taking a risk by spending money creating new products, processes, services, or knowledge, or developing and improving what already exists then it’s quite likely that you’re carrying out R&D can benefit from RDEC.
What expenditure qualifies for RDEC?
Once qualifying activities have been identified, there are specific types of expenditure that can be claimed under RDEC. These are:
- Staff costs, including a proportion of salaries, employer’s National Insurance (NI) and pension contributions
- Payments made to external agencies – both long and short-term, and personal service companies. If provided by an unconnected company, payments are capped at 65%
- Subcontractor costs if they are incurred by a charity, higher education institute, scientific research organisation, health service body, or an individual or partnership of individuals. Payments to unconnected individuals or partnerships are capped at 65%
- Expenditure on consumables including light, power and heat that are consumed or transformed during the R&D process, or materials used for the development of prototypes
- Costs for software involved in R&D activities; from 2023, cloud computing costs and data costs can also be included in claims
- Payments to volunteers in clinical trials – this is most relevant to claims from the pharmaceutical industry RDEC and large companies
Expenditure that is NOT covered under RDEC includes:
- The production and distribution of goods and services
- Capital expenditure
- Rent and rates
- Legal costs associated with patents and trademarks
- Subcontractor payments to companies and other bodies not mentioned in the definition above
The RDEC seven steps
There are seven RDEC steps that must be applied to determine how an organisation will receive its credit. These steps ensure, before cash is paid out, that the credit is used to offset any tax which is owed to HMRC.
The seven steps must be followed in order and, depending on the circumstances, may mean that some credit is carried forward to a later period before being used.
The steps are:
- Discharge any corporation tax liabilities
- Apply the applicable corporation tax rate (this is applied whether the company is loss-making or not)
- Limit the credit to the R&D PAYE/NIC cap – any excess can be carried over
- Honour corporation tax liabilities
- Surrendering the credit for group relief (optional)
- Honour other tax liabilities, such as unpaid VAT or PAYE
- Credit is paid after HMRC tests
Cowgills are experts in R&D tax claims, with over 15 years’ experience in reviewing, managing, and submitting successful claims for all sizes of organisations. Get in touch if you need our help, and find out more via our R&D hub right here.
The information was correct at time of publishing but may now be out of date.