Finding funding for tech start-ups is often a challenge and once you’ve bootstrapped the business and you’re starting to burn through your seed capital at a rate of knots, a fresh cash injection in the form of research and development (R&D) tax credits can provide you with the extra runway you need to get to your next round of funding or to positive cashflow.
R&D Tax Credits De-Mystified
R&D tax credits are intended to incentivise companies to undertake R&D activities to promote innovation. The calculation can be a little complex, but as a rule of thumb, for a loss making start-up, the company may be able to reclaim 33% of costs that relate to an R&D project. If the company is profit making, then the costs can be multiplied by 2.3, so that you can deduct more expenses, therefore lowering your tax bill.
For example for £100k of R&D spend
- For loss making start-ups the tax credit paid by HMRC is approximately £33,000 (£100k X 33%) if claimed,
- If sufficiently profit making then more can be saved.
- £100k X 2.3 = £230k. When deducted from profits, assuming a corporation tax rate of 20%, the tax saving is £230k X 20% = £45k
If you are building an innovative product, you could qualify for even more tax credits.
What are the criteria for a claim?
- Are you taking the financial risk in your development programs?
- Does what you are developing involve science or technology?
- Science or technology can be technical equipment, software, production processes, clever tooling development; in fact anything that is based on conventional science or technology.
- Are you seeking to achieve an advance in science or technology?
- The advance, again requires some specialist advice. Essentially, if you can say “it used to be done this way but our new solution makes it demonstrably better”, then you’re on the right track.
- Are there any technological or scientific uncertainties at the start of your projects that require trials or testing to be sure that they are resolved?
- The uncertainties are trickier to determine and this is where a specialist can advise you. Scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible, and how to achieve it in practice, is not readily available or deducible by a competent professional working in the field.
- The risk is fairly easy to understand, is your business spending money to develop something new?
What costs qualify as R&D spend?
The bulk of R&D claims for technology focused companies will be comprised of the salaries of the research staff. Other costs could potentially be included, however the suitability of these should be reviewed by your online accountant in the UK.
There are essentially 2 types of spend
- Qualifying direct spend – Perhaps a developer or scientist hired onto the project.
- Qualifying indirect spend. For example, allocation of time for the head of product development who is managing the developer or scientist.
Ideally you would set up in advance the schematic to account for R&D expenditure. Payments made to subcontracted workers are allowable but at only 65% of the amount paid. It’s also important to state in the contract with the subcontractor that the IP is accruing to your company.
How is the claim submitted?
The claim is made through the annual corporation tax return and you’ve got 2 years to make a claim.
Presentation and language is very important. You need to make a statement of intent about a true advance in science and technology.
The tax inspector is expecting a prescribed format when presenting these uncertainties. Given the large number of sectors that tax inspectors deal with you will need to make it easy for them by spelling out clearly why there is an uncertainty in science and technology.
Having a patent can help strengthen your claim and this should be included within the documentation as evidence that an innovative, unique product is, or has been created. The chances are that you will qualify for R&D if you have a patent.
What information is required for the claim?
There are 2 main things to do when submitting a claim
- The narrative – This is a document that can extend to many pages. If in doubt include more detail, but remember when writing the report, the HMRC offer isn’t an experienced developer or scientist, so the language used should reflect that. We would expect to see the following points:-
- Key staff profiles associated with the project
- Project background – General overview of the project, why it’s important to the business – in particular how does it enhance your unique selling point / competitive advantage? Tell the story about it not existing elsewhere and why the project is breaking ground, state that there were no 3rd party solutions available to the best of our knowledge. Whether it was achieved, failed or continues into the next financial year.
- Identify the main project components and state why the activity met the following criteria:
- How does the project workstream advance science and technology? What is the technological advance being achieved, why it advances the relevant field (not you as an individual) and why it is not something you could reasonably expect a competent professional to achieve?
- Explain why the outcome was uncertain
- How did you overcome the uncertainty to achieve the advance (or attempted to)? Tell a story about the project plan and document what was done. Failures should be included as this indicates uncertainties and therefore research. Include technical detail, but ensure it can be understood by a layperson also.
- The tax computation – The costs included in this need to tie back to the narrative. This will be handled by your accountant.
When Will I Get Hold of the Cash?
The amount time that it takes for HMRC to pay out will depend on many factors, perhaps the most significant being the level of complexity of the claim. It can pay to make sure that you have an expert accountant on hand to write the report for you and to check the narrative is as complete as possible. This will ensure that you claim for the maximum permitted costs and that your claim is likely to be processed more quickly.