UK R&D Tax Credit For Startups: Get 33% Of Your R&D Paid Back

The R&D tax credit is one of the most under-appreciated government benefit scheme for UK startups. Indeed, 80% of UK founders have never heard of the UK R&D tax credit before. Unfortunately, they are potentially missing on 33% of their R&D costs paid back in cash!

In this article we’ll explain you what exactly is the UK R&D tax credit, how it works and whether your startup is eligible.

Can your startup take advantage of the R&D tax credit? What does it mean for your startup? We will cover:

What Is The R&D Tax Credit?

The R&D tax credit scheme is a government tax incentive to promote UK businesses investing in innovation. R&D tax credits can either be paid back as cash, or reduce companies’ next tax bill.

In reality there are 2 separate tax credit schemes:

  • SME R&D Tax Credit scheme for small and medium-sized businesses (SMEs). Companies must have less than £100M revenue and 500 employees, or less than £86m in assets on their balance sheet to qualify
  • RDEC R&D Tax Credit scheme for large businesses

The tax benefits are slightly different for the 2 schemes. Luckily, the most attractive is the SME R&D Tax Credit. More importantly, the SME R&D Tax Credit is all the more attractive for loss-making businesses, which often is the case for early-stage startups.

Is Your Startup Eligible?

As long as your business is falling under the conditions cited above (£100M revenue and 500 employees, or less than £86m in assets), it is eligible. Good news – as virtually all startups are considered as SMEs from the standpoint of these criteria.

Although R&D tax credits can only be claimed against qualifying R&D expenses (see below), there is no limitation on the sector or industry a business is in. Luckily for tech startups, most businesses that benefit from the UK R&D tax credit typically fall into manufacturing, engineering, pharmaceuticals, and software development sectors.

The question is now: do your research & development costs qualify?

Fortunately, R&D doesn’t necessarily need to be cutting-edge nor pure research. Actually, almost all startups can claim tax credit against their R&D expenses. Yet, what costs can you claim back exactly?

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What R&D Costs Qualify?

There are a number of expenses you can claim under the R&D tax credit scheme. As long as you can justify these expenses are only related to the qualifying research and development work, you can claim expenses such as:

  • Salaries of employees either supporting directly R&D efforts or supervising research (e.g. managers and directors). If one employee is actively engaged 50% of her/his time in R&D, you can claim 50% of her/his wage accordingly under the scheme
  • Subcontractor expenses, including both outsourced labor or research
  • Utilities, hardware supplies and materials cost used in research (including capital expenditures)
  • Software hosting and infrastructure costs

How Much Can You Actually Get?

Startups and SMEs in general can claim up to 33% of their research and development costs in cash. The percentage depends on a number of factors.

Luckily though, most startups can claim the maximum (i.e. 33%) which can significantly reduce their cash burn, and eventually, improve their runway.

How Does It Work

SMEs and startups that incur expenses when developing new products, or improving existing ones, can be eligible for R&D tax relief as long as the expense is considered R&D under HMRC’s conditions.

The amount of money that has been spent already towards R&D can be claimed back from HMRC through a R&D Tax Credit claim. The amount refunded can either be received in the form of a Corporation Tax reduction or a cash payment.

SME R&D relief allows companies to:

  • If the business is profitable: it can deduct an extra 130% of its qualifying R&D costs from its yearly profit, as well as the normal 100% deduction, to make a total 230% deduction
  • If the business is loss-making: it can claim a tax credit worth up to 14.5% of the surrenderable loss OR it can carry forward the loss, added with 130% the R&D expenses, to offset against future profits

Note that since 2021, the maximum amount that can be claimed under the scheme is limited to £20,000 plus 300% of your total qualifying expenditure for employee salaries which are on your PAYE system and their National Insurance contributions. Pensions contributions are excluded though.

UK R&D Tax Credit: A Case study

Are the rules of the UK R&D tax relief confusing to you? Are you struggling to understand how much you can actually claim back for your startup? Let’s use below 2 examples: a profitable and a loss-making business.

Example 1: Profitable businesses

Assuming a business with the following financials:

Profit£200,000
Corporation tax£200,000 x 20% = £40,000
Qualifying R&D expenses£100,000
R&D enhancement£100,000 × 130% = £130,000
New taxable profit£200,000 – £130,000 = £70,000
New corporation tax£70,000 x 20% = £14,000
Cash savings£40,000 – £14,000 = £26,000

In this case the business can save £26,000 i.e. 26% of its R&D expenditures.

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Example 2: Loss-making businesses

Assuming a business with the following financials:

Loss– £200,000
Corporation tax£0
Qualifying R&D expenses£100,000
R&D enhancement£100,000 × 230% = £230,000
Cash savings14.5% x £230,000 = £33,350

In this case the business can save £33,350 i.e. 33% of its R&D expenditures.

Note that the loss-making business can also decide to carry forward the losses, added with 130% of the R&D expenses, to offset against future profits. If so, the benefits would look like this:

Loss– £200,000
Corporation tax£0
Qualifying R&D expenses£100,000
R&D enhancement£100,000 × 130% = £130,000
New loss (carried forward)– £200,000 – £130,000 = £330,000

For more information on what are losses carry forward and how they impact your corporate taxes, have a look at Investopedia’s article here.

Why Does It Matter For Your Runway?

Understanding how the UK R&D tax credit works, including for loss-making businesses (e.g. early-stage startups) is key. Indeed, if used correctly, the R&D tax credit can save startups up to 33% of their R&D expenditures per year, decreasing cash burn and significantly improving cash runway.

That’s why founders should always be mindful of taking into consideration potential UK tax credit benefits in their cash flow forecasts.

Yet, don’t be too optimistic either: as explained earlier, the credit is limited to £20,000 plus 300% of your total qualifying expenditure for employee salaries which are on your PAYE system and their National Insurance contributions.

So when it comes to forecasting tax credits in general, make sure to ask your accountant whether you qualify, and how much you can actually get back to avoid (costly) mistakes.

Note: most startups capitalise a part of their R&D expenses. Indeed, there are clear advantages to capitalise your R&D expenses as a startup. If you aren’t familiar with R&D capitalisation, you might be missing on significant savings. For more information, read our article here.

More Free Resources For UK Startups

We have lots of free resources for UK startups, have a look at our articles below:

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