Closing outside investment from a VC, angel or private equity firm can be a significant moment for any business.
By bolstering your company’s financial security, you can unlock a whole host of new opportunities. But many businesses are unaware of whether this new cash flow impacts research and development eligibility and, in turn, opportunities for innovation.
That’s why, today, we’re taking a deep dive into R&D eligibility criteria and HMRC definitions, helping you understand the ins and outs of the relationship between outside investment and the UK Government’s R&D tax credit scheme.
Does outside investment impact your R&D claim eligibility?
The good news is that outside investment doesn’t stop a business from claiming R&D tax credits entirely. However, it’s slightly more complicated than that.
Although your eligibility won’t be affected, depending on the type of outside investment you’ve received, the amount you’re entitled to may be impacted.
Ultimately, it all depends on how HMRC classifies your relationship with your investors, and how much financial autonomy it determines your business has.
HMRC’s investment classifications
HMRC defines all businesses that receive outside equity investments by one of three classifications:
- Autonomous enterprises
- Linked enterprises
- Partner enterprises
Business-investor partnerships determined to be ‘autonomous enterprises’ won’t have their R&D tax credit claim impacted.
This means that UK limited companies (with under 250 staff and under €50 million turnover) that pay Corporation Tax and invest in qualifying research and development projects can claim on associated costs, including:
- Staff salaries (including NIC, pension contributions and any expenses)
- Materials and consumables used throughout the project
- Clinical trials
- Freelancers and subcontractors
If your investment partnership is determined to be a linked or partner enterprise, on the other hand, it’s possible that your business will lose its status as an SME.
In these instances, businesses are still able to claim on the RDEC scheme, although this scheme offers far less funding than its sibling SME initiative.
The RDEC (Research and Development Expenditure Credit) scheme is tailored to larger companies with over 250 staff and €50 million turnover.
Autonomous enterprises defined
An autonomous enterprise is a business without an external corporate entity that owns 25% or more of its shares. This means, should your investors hold less than 25% of your company’s voting rights, it should be classified as autonomous.
It can get a little more complicated than that if HMRC determines your investors to be linked, though. Linked investors aren’t the same as linked enterprises (which we’ll get to in a moment) - instead, linked investors are investors who share a family connection or are required to vote in tandem.
If your company has linked investors who collectively own 50% or more of your company (or 50% or more of another company within a related industry), you may fail to qualify as an autonomous enterprise.
Linked enterprises defined
HMRC determines a business-investor partnership as a linked enterprise if the investor:
- Owns more than 50% (majority) of a company’s shares
- Can appoint or remove a majority of the business’s management team
- Can exert a ‘dominant influence’ over the company
In short, enterprises are classified as linked if one can exercise control - either directly or indirectly - over the other, or if both are under the control of a third-party company or individual.
If HMRC determines your investment relationship to be a linked enterprise, you’ll have to apply your company’s and investors’ combined turnover, assets and staff count to the SME scheme’s threshold.
This will help HMRC determine the size of your company and whether you’re eligible for the SME or RDEC R&D tax credit schemes.
In April 2020, the RDEC rate was increased from 12% to 13%, meaning RDEC is worth up to 11p for every £1 spent on qualifying expenses. Compare this to the SME scheme (worth 33p for every £1) and it’s easy to see the financial implications of this on your claims.
Partner enterprises defined
Partner enterprises are those business-investor relationships that don’t fall within either the autonomous enterprise or linked enterprise criteria.
Your company will be defined as a partner enterprise should one or more of your investors hold between 25% and 50% of voting rights. In short, your investor has a significant stake, but no majority control.
Partner enterprises may have to claim under the RDEC scheme. However, they have a far greater chance than linked enterprises of falling under the more lucrative SME scheme. This is because your company size is calculated proportionately to the stake of any given investor.
Whereas linked enterprises have to incorporate the total combined turnover, assets and staff count, partner enterprises only factor in a percentage of these costs. This amount is directly proportionate to the stake of each investor - so, if an investor holds a 26% stake in a business, only 26% of their turnover, assets and staff count will be included in the total data.
This all amounts to a partner enterprise being less likely than a linked enterprise to surpass the RDEC threshold. Depending on the amount of investment and size of your investor, though, it’s possible your partner enterprise will still be ineligible for the SME scheme.
Despite falling under the definitions of partner enterprises, an investment can be accepted under the autonomous enterprise classification when the investor is:
- A venture capital company
- A public investment company
- Individual(s) with regular venture capital investment with a collective total of less than €1.25m
- A university or nonprofit research centre
- Institutional investors
- Autonomous local authorities (with fewer than 5,000 inhabitants and an annual budget of less than €10 million)
It should be noted that exceptions do not apply to companies that also satisfy the definition of a linked enterprise.
Understanding how outside investment can affect your business’s R&D tax credit eligibility is key before making any investment decision. Given the impact outside funding can have on the amount you’re able to claim, always consider R&D tax credits when making decisions about external investment - it’s just good business.
If you’re struggling to understand which definition your investment partnership falls under, or you simply want advice on how to make R&D work better for your business, we’re here to help. Get in touch with Lumo today to learn more.