When filing an R&D tax credit claim, you may have encountered the terms ‘R&D enhancement’, ‘R&D enhanced deduction’ and ‘R&D enhanced expenditure’.
But are you familiar with what these terms mean and how they can impact the total sum of R&D tax credits your business is entitled to? If you’re a small to medium-sized enterprise claiming through the UK R&D SME scheme, understanding this could be key.
That’s why, today, we’re exploring all the ins and outs of R&D enhancement to ensure your business is armed with the necessary know-how to maximise its next R&D tax credit claim.
What is R&D enhancement?
Remember: the UK’s R&D tax credit scheme enables eligible companies to claim financial relief on a percentage of their qualifying expenditure. This is paid out as either cash credit or corporation tax relief, depending on the circumstance.
When claiming through the SME scheme, companies are able to artificially inflate the value of this qualifying expenditure by a fixed rate. In turn, this generates a larger sum of relief - this is the practice of R&D enhancement.
You may also see this referred to as the ‘additional deduction’ or ‘enhanced deduction’ in some documentation.
This fixed rate of enhancement is currently 130%, meaning a company with qualifying expenditure of £200,000 could enhance these costs to be worth £260,000.
Total qualifying expenditure x 130% = R&D enhancement
What is your qualifying expenditure?
Qualifying expenditure refers to the expenses that come with pursuing eligible research and development activities.
Typically, these costs include:
- Staff - the members of your workforce on your payroll
- EPWs - externally provided workers from a third-party staff provider (such as staffing agencies and personal service companies) or a hired freelancer
- Subcontracts - outsourcing of qualifying R&D projects could be eligible for up to 65% of relief under an SME R&D tax credit claim
- Consumables - materials consumed or transformed in the pursuit of overcoming scientific uncertainty
Your total qualifying expenditure, then, is the combined value of all these associated costs.
That’s providing they’ve been accurately distributed to eligible activity, of course, which HMRC defines as:
Aim[ing] to achieve an advance in overall knowledge or capability through the resolution of a scientific or technical uncertainty.
What is enhanced expenditure?
Your enhanced expenditure isn’t the same as your R&D enhancement, so it’s important to know the subtle difference between the two.
Enhanced expenditure is calculated by adding your total qualifying expenditure to your R&D enhancement. Alternatively, it can also be calculated by multiplying your total qualifying expenditure by 230%.
So, if your total qualifying expenditure is worth £100,000, your R&D enhancement would be to the sum of £130,000 (100,000 x 130%). In this example, to calculate your enhanced expenditure, you would add 100,000 to 130,000 to reach a total enhanced expenditure of 230,000.
R&D enhancement + total qualifying expenditure = enhanced expenditure
What’s the point of all this?
The purpose of R&D enhancement is simple: increase the total sum of relief available to SMEs pursuing research and development.
What’s the point in this? Well, small and medium-sized enterprises will typically have less manpower and fewer resources available to them to help them conduct successful research and development.
This is the reason enhancement isn’t offered as part of the RDEC scheme - the incentive set up for larger companies with over 250 staff and €50 million turnover.
So, by offering a greater amount of financial subsidisation, the UK Government can incentivise businesses of all sizes to pursue innovation (and boost their chances of success, too).
This, in turn, helps to drive British industry (and, as a result, the British economy) forward.
How does R&D enhancement impact R&D tax credits?
By artificially inflating your project costs, every £1 spent is worth £2.30 of qualifying expenditure on your final balance sheet.
As such, this has the potential to impact your R&D tax credit claim, from how much you claim to whether you surrender your losses .
It all depends on your company’s finances:
- Profitable companies: R&D enhancement artificially increases the costs of profitable companies which, as a result, reduces their total profitability. This means the company will pay less in Corporation Tax, receiving greater subsidisation through increased tax relief
- Unprofitable companies: companies making a loss can reclaim up to 33.35% of their R&D costs on the SME scheme. By enhancing their costs to increase their losses, unprofitable companies can surrender their qualifying expenditure and enhancement for a larger cash credit
- Somewhere in-between: companies breaking even can still enhance their R&D costs, but this will take them into a loss (worth the value of that enhancement). While these losses can still be surrendered for cash credit, only the proportion of enhanced expenditure that forms your total loss can be surrendered. As a result, companies breaking even will receive far less in R&D tax credits than profitable and unprofitable companies enhancing their R&D
R&D enhancement can be a welcome opportunity for small to medium-sized businesses to maximise their tax credit claim and increase their cash flow.
If you’re a profitable or unprofitable company claiming on the UK SME scheme, don’t miss out by failing to understand the ins and outs, or by miscalculating how enhancement can work for you. Take the time to familiarise yourself with the terminology and processes - it could make a whole lot of difference to the sum you’re owed.
Need a helping hand? That’s what we’re here for. Whether it’s accurately recording your enhancements or optimising any other aspect of your claim, we’re here to ensure you maximise the value of your R&D tax credits. Get in touch with Lumo today to learn more.