|
contents
Revenue Policy
Business Tax
Sam Mitha
Assistant Director
Room No: 4W1
22 Kingsway
London
WC2B 6NR
Your Ref:
Our Ref:
Date: December 2002
This special edition of "Tax Bulletin" is devoted to a description
of the UK's three new tax incentives (reliefs) for research and development
(R&D). They are
- the R&D tax credit for small and medium (SME) companies (Schedule
20 Finance Act 2000)
- the R&D tax credit for large companies (Schedule 12 Finance Act
2002),
and
- the vaccines research relief (Schedules 13 and 14 Finance Act 2002).
Research and Development plays a key role in the growth of a modern,
knowledge based economy - both in delivering new, competitive products
and improving productivity for the country as whole through spill-over
benefits. The R&D tax credits are designed to help UK business invest
for the future.
The vaccines research relief has a different focus - it is a humanitarian
measure, designed to promote research into treatments for the killer diseases
of the developing world.
This special edition of "Tax Bulletin", follows up a series
of seminars for companies given jointly by the Inland Revenue, the Treasury
and DTI. It is intended to provide information to companies and their
tax advisers about the new provisions so that those entitled to benefit
from them are enabled to claim.
We hope that you find this special edition of "Tax Bulletin"
useful.
Sam Mitha
Outline
For many years tax relief has been given for virtually all the costs
incurred by businesses on scientific research. Current expenditure received
100% relief under normal tax rules, and capital expenditure was given
equivalent treatment in the form of "Scientific Research Allowances".
These were renamed "Research and Development Allowances" in
April 2000. At that time, some minor alterations were made to these allowances.
Also in April 2000, R&D tax credits were introduced for companies
which are small or medium enterprises (SMEs). From 1 April 2000, SMEs
can claim an extra tax deduction of 50% of their qualifying current R&D
spending. Loss making SMEs can surrender their R&D losses in exchange
for cash.
A further measure was introduced in April 2002, enabling "large"
companies (non SMEs) to claim an extra deduction of 25% of qualifying
current R&D spending.
further relief, specifically targeted at research into drugs and medicines
for TB, malaria and AIDS/ HIV - the so called "killer diseases"
of the developing world - gives an additional 50% tax deduction (and repayments
for loss making SME companies).
The detailed rules of the R&D tax credits for large companies and
for SMEs are slightly different, although many of the basic definitions
are the same. The essential difference is that the SME scheme is targeted
at the company that commissions the work and takes the risks while the
large company scheme is aimed at those companies that undertake the R&D.
This special edition of "Tax Bulletin" sets out the basic concepts
of the R&D tax credits for both SMEs and large companies, and also
those of the vaccines tax credit. Details of the long established R&D
allowances are not covered.
For a full description of all aspects of the schemes, please see the
Inland Revenue's guidance, available online at www.inlandrevenue.gov.uk/r&d
What is a small or medium sized company?
For the purposes of the three R&D reliefs we have incorporated into
our legislation the European Commission definition of a small or medium
sized enterprise. This is set out in Commission recommendation 96/280/EC
of 3 April 1996.
company is a small or medium-sized enterprise (SME) if it
- has fewer than 250 employees,
and
- has either
- an annual turnover not exceeding e40 million, or
- an annual balance sheet total not exceeding e27 million
and
- is independent of one or more large enterprises.
An independent enterprise is one not more than 25% of whose capital or
voting rights are owned by one enterprise or jointly by several enterprises
which are not SMEs.
For example, a company 40% of whose capital is owned jointly by large
companies is not an independent enterprise.
Holdings by venture capital companies, institutional investors and public
investment corporations are ignored, unless they exercise control over
the company. Where there is a change in the status of a company due to
a change in the financial limits or the number of employees there is a
year of grace before this takes effect.
Example Mosler Ltd draws accounts up to 30 June each year. In the year
20 June 2003 it has 235 employees and this is increased to 260 in the
following year and 265 in the year to June 2005. It fails the SME tests
in the year to June 2004 but is held to be an SME in that year and only
becomes a large company in the year to June 2005.
A large company is a company that does not qualify as a small or medium-sized
enterprise.
The three reliefs
1. R&D Tax relief for large companies
R&D tax relief for large companies is available for qualifying R&D
expenditure incurred on or after 1 April 2002. (Schedule 12 Finance Act
2002.) The relief is given as an extra deduction - the scheme allows a
large company to deduct an extra 25% of its revenue spending on R&D
when it calculates its taxable profits. Capital spending on R&D does
not qualify - it qualifies instead for 100% research and development allowances.
Relief is due where a company spends more than £25,000 on qualifying
R&D expenditure in a 12 month accounting period. The £25,000
is adjusted proportionately if the accounting period is not 12 months
long.
Example Green Industries Plc is a large company. In its 12 month
accounting period ended 30 April 2003 it has income of £30 million
and expenses of £20 million including R&D spending of £4
million. Its accounts show a trading profit of £10 million (income
£30 million less expenses £20 million). Its taxable profits,
if there are no other adjustments for tax purposes, are £9 million
(profits per accounts £10 million less R&D tax relief £1
million [= 25% x £4 million]).
Where one company subcontracts work to another, the relief goes to the
company that does the work rather than the company that pays for the work
to be done.
Although the scheme is aimed at large companies, a small or medium sized
(SME) company can obtain the relief (at the large company rate) if it
does R&D as a sub-contractor to a non-SME. Usually, this would be
a large company, but it could include, for example, a Government department
or a university.
Conditions to be satisfied
Expenditure must be incurred on or after 1 April 2002.
Pre-trading expenditure is normally treated as incurred on the day that
trading begins (Section 401 ICTA88). This rule is overridden for the R&D
relief for accounting periods straddling April 2002 - it is the date on
which the pre-trading expenditure is actually incurred rather than the
date on which it is treated as incurred that matters.
R&D tax relief for an accounting period is based on the qualifying
R&D expenditure for that accounting period. Expenditure is qualifying
R&D expenditure for an accounting period if it is deducted in computing
trading profits for that period.
In certain circumstances a company may choose to defer the expenditure
on R&D and not set it against the profits of that period. Where a
company treats R&D expenditure in this way by including it to the
balance sheet when it is incurred, that expenditure does not qualify for
R&D tax relief when it is spent but when it is included it as a deduction
in the profit and loss account (provided all the other conditions are
satisfied in the period it is released).
Expenditure that can be deducted once the company starts trading is included
in the qualifying R&D expenditure for the first period of trading
provided that it is incurred on or after 1 April 2002.
The qualifying R&D expenditure for a 12 month accounting period must
be at least £25,000 for R&D tax relief to be due. If the accounting
period is some other length the £25,000 is adjusted proportionately.
For example, if the accounting period is 8 months long, the qualifying
R&D expenditure must be at least £16,667 (= £25,000 x
8/12).
Where an accounting period straddles 1 April 2002, it is split into two
separate accounting periods and the £25,000 limit applies to the
period that begins 1 April 2002.
Example Alchemists Plc is a large company. It has an accounting date
of 30 June. In the year ended 30 June 2002 it spends £60,000 on
consumable stores for its research at a rate of £5,000 a month.
It cannot claim R&D tax relief for the year ended 30 June 2002 even
though it has spent more than £25,000 on R&D in that year. It
has only spent £15,000 on consumable stores in the three month period
that begins 1 April 2002.
Qualifying R&D expenditure
For a large company there are three types of qualifying R&D expenditure
-
- expenditure on direct research and development
- expenditure on research and development sub-contracted to certain
organisations
- contributions to certain independent research and development organisations.
Qualifying expenditure on direct research and development is expenditure
a company incurs on R&D work either for itself or, as a sub-contractor,
for some other person. In either case, the company carries out the work
itself: it does not pay someone else to do it.
The expenditure must satisfy all of these conditions;
- It is incurred on research and development (see page 14) directly
undertaken by the company.
- It is incurred on staffing costs or consumable stores (see page 13)
- It is attributable to relevant research and development (see page
14) in relation to the company.
- It is not capital expenditure.
Where a company incurs expenditure carrying out activities contracted
out to it, the expenditure does not qualify for R&D tax relief unless
the contracting out was done by
- a large company,
or
- a person not in the course of a trade, profession or vocation assessable
under Case I or II of Schedule D.
This means that a large company may claim relief for research carried
out by it on behalf of another large company, a charity, a government
agency or a company resident overseas - but not for research carried out
on behalf of an SME1, because the SME itself will be covered by the R&D
tax relief scheme for SMEs
Example Green Enterprises Plc is a large company. The government
of Freedonia contracts Green Enterprises Plc. to do some R&D for it.
Green Enterprises spends £2.4 million doing that research in its
accounting year ended 30 April 2004. Green Enterprises can claim an extra
deduction of £600,000 (= 25% x £2.4 million) when it calculates
its taxable profits for the year ended 30 April 2004.
Green Enterprises Plc would also be able to claim R&D tax relief
if the R&D was contracted out to it by another large company or a
charity or a UK government agency.
Qualifying expenditure on research and development sub-contracted
to certain organisations
On occasions, companies may sub-contract part or all of their R&D
to individuals or to organisations that cannot themselves benefit from
the R&D tax relief. To accommodate such situations the legislation
allows the contracting large company to claim relief on payments to certain
persons and organisations who cannot benefit from R&D tax relief in
their own right (but not, in general, when the work is sub-contracted
to another company which could itself benefit).
The R&D must be carried out by an individual, a partnership of individuals,
or a qualifying body (see page 15). These persons and organisations do
not have to be resident in the UK.
Such expenditure must satisfy the following conditions:
- The sub-contracted R&D must be directly undertaken on behalf
of the company
- the expenditure must be attributable to relevant research and development
(see page 14) in relation to the company
and
- the expenditure must not be capital.
"Directly undertaken on behalf of a company" means that the
sub-contractor should do the work itself, not subcontract it in turn to
another party.
Example Green Enterprises Plc. wants to have some research done
into new materials but instead of doing it itself it makes a contract
with Necessity Inc., a company resident in the USA, to do the research
for it for £3 million. It cannot claim R&D tax relief on the
£3 million it pays to Necessity Inc. because Necessity Inc. is not
an individual, a partnership of individuals or a qualifying body.
Green Enterprises Plc could claim R&D tax relief if it paid the £3
million to a university, a scientific research organisation, an individual
or a partnership of individuals, none of which can claim R&D tax relief,
to do the research for it.
Contributions to independent research and development qualify for R&D
tax relief if they are made to a qualifying body, an individual or partnership
of individuals. The R&D towards which the contribution is made must
be relevant research in relation to the company making the contribution.
The sort of contributions this covers are payments which fall outside
a contractual framework. However, the R&D must still be relevant R
& D for the company that makes the payment.
Example Green Enterprises Plc. hears on the grapevine that the
University of Middle Earth is pursuing a line of research that is relevant
research for Green Enterprises Plc and so it makes a payment of £5
million to the university department that is carrying out the research.
Green Enterprises Plc. can claim R&D tax relief on that payment.
Such contributions do not qualify for R&D tax relief if
- the funded research and development is contracted out to the qualifying
body etc by someone else
- the company is connected with an individual or any member of a partnership
to whom the contribution is made.
Insurance companies
There are special rules for insurance companies.
An insurance company that carries on a life assurance business and qualifies
as an SME is treated as a large company for the purposes of R&D tax
relief. This means that it gets R&D tax relief at the large company
rate (and subject to the rules applying specifically to SMEs) rather than
the SME rate.
Group companies
Groups of companies may divide R&D work around the group, depending
on where particular expertise resides or where facilities are available.
When this happens, work undertaken by one of the companies may fall outside
the definition of R&D because, seen only in the narrow context of
the company undertaking the work, it is of a routine nature. For example,
one group company may carry out testing procedures for all the other companies
in the group. For the a company doing this, the testing in itself is not
R&D but if it were done by the company that had carried out the basic
R&D it may be.
When the contractor company and sub-contractor company are members of
the same group, the activities of the contractor and sub-contractor are
taken together in deciding whether the activities of the sub-contractor
company are relevant R &D.
This means that if the sub-contractor company's activities would have
amounted to R&D if the contractor company had carried them out itself,
the sub-contractor company's activities are relevant R&D for it and
it can claim R&D tax relief.
This only applies where R&D is contracted by another group company.
It does not apply to activities contracted out to unconnected companies.
Refunds of payments or contributions
A company that has sub-contracted R&D or made a contribution to independent
R&D may receive a refund of its payment to the sub-contractor or its
contribution. When that happens, an additional 25% of the refund is treated
as Case 1 Schedule D income of the accounting period in which the refund
is made.
2. R & D tax relief for small or medium sized
companies (SME)s
Outline
R&D tax credits for small or medium sized companies (SMEs) were introduced
in 2000 (Schedule 20 Finance Act 2000.) R&D tax relief for SMEs is
available for qualifying R&D expenditure (see page 6) incurred on
or after 1 April 2000. Only companies may claim.
Relief is not due unless a company spends more than £25,000 on
qualifying R&D expenditure in a 12 month accounting period. Non qualifying
expenditure such as the purchase of capital assets is ignored when calculating
whether the £25,000 limit has been reached.
The £25,000 is adjusted proportionately if the accounting period
is not 12 months long. For example, if the accounting period is 10 months
long the limit is £20,491 = £25,000 x 10/12. If an accounting
period straddles 1 April 2000 it is split and the periods before 1 April
2000 and from 1 April 2000 onwards are considered separately.
R&D tax relief allows an SME to deduct an extra 50% of its qualifying
current spending on R&D when it calculates its taxable profits. If
a SME has a "surrenderable loss" for an accounting period for
which it is entitled to R&D tax relief it may surrender the loss arising
from the R&D to the Exchequer in return for a payment. This (and nothing
else), strictly, is the "R&D tax credit", although the term
has passed into more general use to describe both the relief in general
and the similar relief for large companies - which does not have a payable
element.
Only revenue expenditure qualifies. As for large companies, capital expenditure
on R&D qualifies for 100% research and development (capital) allowances.
R&D tax relief is not due unless any intellectual property created
as a result of the R&D is vested at least in part in the SME that
carried it out.
Normally, if a SME contracts out R&D to another person it is the
SME that contracts out the work that may claim R&D tax relief rather
than the person who does the R&D. This is unlike R&D tax relief
for large companies, where in general it is the company that does the
R&D that may claim the additional relief rather than the company that
contracts it out.
There are a few exceptional cases where a SME may claim R&D tax relief
for work that it does as a sub-contractor. A SME may claim R&D tax
relief for work contracted out to it if the contracting out is done by
a large company or a charity, a government agency or a person resident
overseas outside the UK tax net. However, when this happens the SME claims
under the terms of the "large company" R&D tax relief rather
than the SME scheme.
If an SME makes claims under both schemes, its expenditure on its own
behalf (for which it will claim under the SME scheme) and as a subcontractor
(for which it will claim under the large company scheme) is aggregated
for the purposes of the £25,000 yearly minimum in both schemes.
Summary of differences between large company and SME schemes
The rate of the extra R&D tax deduction in the large company scheme
is 25% while the rate in the SME scheme is 50%.
In the SME scheme a company can claim relief for payments that it makes
to sub-contractors but in the large company scheme the relief normally
goes to the company that carries out work as a sub-contractor.
The exception is that a large company may claim relief for subcontract
payments made to persons who cannot benefit from the relief themselves,
such as universities, charities, and individuals
In the large company scheme there is no requirement that any intellectual
property rights arising from the research are vested in the company claiming
the R&D tax relief.
In the large company scheme subsidies received are not deducted from
qualifying R&D expenditure.
Qualifying R&D expenditure
More precisely qualifying R&D expenditure of an SME company is expenditure
that satisfies all of these conditions.
- It is not capital expenditure.
- It is attributable to relevant research and development (see page
14)
- It is incurred on staffing costs (see page 13) or consumable stores
(see page 14)
- Any intellectual property created as a result of the R&D to which
the expenditure is attributable is vested in the company.
- The company does not incur the expenditure as a sub-contractor.
- The expenditure is not subsidised.
- The expenditure is incurred on or after 1 April 2000.
Pre-trading expenditure is normally treated as incurred on the day that
trading begins (Section 401 ICTA88). This rule is overridden for the R&D
relief for accounting periods straddling April 2000 - it is the date on
which the pre-trading expenditure is actually incurred rather than the
date on which it is treated as incurred that matters.
Subsidised Expenditure
R&D tax relief is not available for the part of any expenditure in
respect of which a grant or subsidy (other than a notified State aid)
is obtained.
Example Southside Ltd is an SME. It receives a grant towards the
cost of a new laboratory. R&D tax relief is available in full on its
qualifying costs because the grant was not towards an R&D project.
The grant will be taken into account if the company wants to make a RDA
claim on the capital costs of the laboratory.
If, however, Southside Ltd. receives a grant that covers 50% of the cost
of an R&D project, that grant will be taken into account when R&D
tax relief (and credit) is calculated. Only 50% of the spending on staffing
costs and consumable stores will be taken into account in calculating
the tax relief due, because the other 50% was subsidised.
Where a project has received funding which is a notified State aid (see
page 15) then no expenditure on that project can qualify for the R&D
SME relief, which is itself a notified state aid. Notified state aids
are usually government funded grants such as the SMART award, but not
all government grants are notified State aids - for example, some funding
under the SMART label is not notified State aid (e.g. grants for feasibility
studies and microenterprise awards).
If clarification of the status of a grant is needed, the body that has
provided or arranged the funds should be able to help.
Intellectual Property (IP)
Any intellectual property created as a result of the R&D to which
expenditure is attributable must be vested in the company for R&D
tax credit to be available.
Intellectual property means
- know-how;
- a patent, trade mark, registered design, copyright, design right
or plant breeder's right,
or
- any foreign rights similar to those above.
The IP does not have to be vested for a specified period of time and
it may be held jointly with others. We also recognise that not all R&D
activity results in any IP.
Sub-contracted R&D
A SME (the principal) may claim relief for payments to another person
(the sub-contractor) for relevant R&D that it contracts out to that
other person. The treatment varies depending on whether the two parties
are connected or not.
Principal and sub-contractor connected
For the principal to claim the relief in the accounting period that payment
is made, the sub-contractor must include
- the payment
and
- its expenses incurred in carrying out the sub-contracted work
in its accounts for a period ending not more than 12 months after the
end of the principal's accounting period in which it makes the payment.
The principal can claim the relief on the lower of:
- the payment that it makes to the sub-contractor, and
- the amount that the sub-contractor actually spends on staffing costs
and consumable stores when it arries out the work for the principal
in its accounting periods ending not more than 12 months after the end
of the principal's accounting period in which the payment was made.
Example As in the example above, Southside Ltd. is an SME. It
contracts with Heliotrope Ltd., an SME with which it is connected, for
Heliotrope to do research into the design and construction of mobile solar
powered watchtowers. In its accounts year ended 24 May 2003 it pays Heliotrope
Ltd. £4 million for the R&D.
Heliotrope Ltd. spends £3.5 million on staffing costs and consumable
stores for the research it is doing for Southside Ltd in its accounts
year ended 31 December 2003. It spends a further £1 million in its
accounts year ended 31 December 2004.
Southside Ltd. may claim R&D tax credit of £3.5 million, because
that is the lower of the amount it pays Heliotrope Ltd., £4 million,
and the amount that Heliotrope Ltd. spends on the R&D in its accounts
year ended 31 December 2003. The £1 million that Heliotrope Ltd.
spends in the year ended 31 December 2004 is ignored because that accounting
period ends more than 12 months after 24 May 2003, the end of Southside
Ltd.'s accounting period in which it made the payment.
Principal and sub-contractor not connected
The principal may claim R&D tax relief on 65% of the payment it makes
to the sub-contractor. This reflects the fact that the payment will cover
an element of profit for the sub-contractor and also any other non qualifying
expenditure that may be incurred.
If the principal and sub-contractor are not connected they may make a
joint election to be treated as if they are connected. The election must
be made by notice in writing given to an officer of the Board within 2
years of the end of the principal's accounting period in which the payment
is made.
Example If in the example above Southside Ltd. and Heliotrope
Ltd. are not connected and do not make an election for connected persons
treatment Southside Ltd may claim R&D tax credit of £2.6 million
(= 65% x £4 million).
Work sub-contracted to a SME
Under the SME scheme, a SME may not claim R&D tax relief for work
it does as a sub-contractor but in some cases it may claim under the large
company scheme - see page 3 above.
Relief given as a deduction
A SME company that
- is carrying on a trade,
- is entitled to R&D tax relief,
and
- has qualifying R&D expenditure (see page 6) that is allowable
as a deduction for an accounting period
may deduct 150% of that qualifying R&D expenditure when it computes
its profits or losses.
This means that when it computes its profits for tax purposes it may
deduct an extra 50% of its qualifying expenditure on R&D.
Example Abelard Ltd. is an SME. It draws up its accounts to 30
June each year. In the year ended 30 June 2001 its accounts show a trading
profit of £1.5 million. In arriving at those profits it deducted
R&D expenditure of £2 million. If it makes a claim for R&D
tax credit it may deduct an extra £1 million (150% x £2 million
= £3 million - £2 million already deducted) when it computes
its taxable profits. Its taxable profits, if there are no other adjustments
for tax purposes, are therefore £500,000 (Profit per accounts £1.5
million less extra deduction for R&D tax credit £1 million)
Pre-trading expenditure
A company may incur expenditure on R&D before it starts to trade.
Normally pre-trading expenditure is treated by S 401 ICTA88 as incurred
on the day that trading begins and so there is no relief for it until
trading starts. R&D pre-trading expenditure for SMEs is an exception
to this.
If a company incurs qualifying R&D expenditure in an accounting period
in which it is not trading the company may make an election to treat 150%
of that qualifying R&D expenditure as a trading loss for that accounting
period.
The company can set this trading loss against any other profits it may
have for that accounting period under S 393A(1)(a) ICTA88. For example,
the company may receive interest in that accounting period. If it does,
it can set the loss against that.
he company can carry the loss back and set it against its profits for
the previous 12 months under S 393A(1)(b) ICTA88 provided that it was
entitled to pre-trading R&D tax credit for that earlier accounting
period.
The company can also surrender the loss as group relief or cash it in
for the payable R&D tax credit.
Any unused losses are carried forward until the company starts to carry
on a trade derived from the R&D. They are then treated as losses brought
forward under S 393ICTA88.
The election to treat 150% of the qualifying pre-trading R&D expenditure
as a trading loss for an accounting period must be made by notice in writing
to an officer of the Board within 2 years of the end of the accounting
period to which it relates.
The company will not have accounting periods if it has not started to
trade. It is treated as having the accounting periods it would have had
if it had started to trade when it started the R&D activities.
If an election is made it applies to all of the company's qualifying R&D
expenditure. The company cannot make a claim for part of its qualifying
R&D expenditure.
If the company claims to treat its qualifying pre-trading expenditure
as a loss the expenditure is not treated as incurred on the first day
of trading under S 401 ICTA88.
Example Perception Ltd. is an SME. It has investment income of
£1 million a year. It starts to carry out R&D on 1 April 2001
although it is not trading. It incurs expenditure on staffing costs and
consumable stores at the rate of £30,000 a month. It starts to carry
on a trade derived from the R&D on 1 October 2002.
he company makes an election to treat the pre-trading expenditure on
R&D as a trading loss. It is treated as having a 12 month accounting
period ended 31 March 2002 and so it must make the election for that period
by 31 March 2004. It is also treated as having a 6 month accounting period
from 1 April 2002 to 30 September 2002.
The R&D qualifying expenditure for the accounting period ended 31
March 2002 is £360,000 (= 12 months @ £30,000 a month). Perception
Ltd.'s trading loss for that accounting period is £540,000 (= 150%
x £360,000) and it can set that loss against its investment income
of £1 million.
Payable R&D tax credits
A payable R&D tax credit allows an SME to claim payment from the
Inland Revenue.
The basic rule is that an SME may claim a payable R&D tax credit
for an accounting period in which it has a "surrenderable loss".
The surrenderable loss for an accounting period is the lower of
- 150% of the qualifying R&D expenditure for that accounting period,
and
- the unrelieved trading loss for that accounting period.
The unrelieved trading loss for an accounting period is the trading
loss for that accounting period less
- any claim made, or that could have been made, under S 393A(1)(a)
ICTA88 to set the loss against other profits of the period,
- any other relief given in respect of the loss; this includes losses
set against profits of earlier periods under S 393(1)(b) ICTA88, and
- any loss surrendered under S403 ICTA88 as group or consortium relief.
Any losses brought forward from earlier accounting periods or carried
back from later accounting periods are ignored.
Example. In its accounts year ended 24 May 2003, Southside Ltd.
has qualifying R&D expenditure of £4 million and it makes a
trading loss of £5 million. It surrenders losses of £2 million
as group relief so that its unrelieved trading loss is £3 million
(£5 million - £2 million surrendered as group relief). Its
surrenderable loss for that accounting period is £3 million because
that is the lower of its R&D relief £6 million (£4 million
x 150%), and its unrelieved trading loss, £3 million.
If a company claims R&D tax credit the Inland Revenue pays it an
amount in respect of the credit unless
- the company has outstanding Corporation Tax (CT) liabilities,
- there is an enquiry into the company's return for the accounting
period for which the R&D tax credit is claimed
or
- There are outstanding PAYE and/ or Class 1 NICs for payment periods
ending that accounting period
If there are outstanding Corporation Tax liabilities the R&D
tax credit may be used to discharge them. If that happens the R&D
tax credit is treated as paid to the extent that it is so used.
If there is an enquiry into the company's return the Inland Revenue
may withhold payment until the enquiry is completed: provisional payments
may be made before the enquiry is completed.
If there are outstanding amounts of PAYE and/or Class 1 National Insurance
it may be possible to offset the payable credit against such liabilities.
The amount of payable R&D tax credit to which a company is entitled
for an accounting period is 16% of the surrenderable loss for that period.
There is a limit to this. The R&D tax credit payable to a company
for an accounting period may not be more than the company's PAYE and NIC
liabilities for payment periods ending in that accounting period in respect
of all employees. A payment period is a period that ends on the 5th of
the month and for which the company is liable to account for income tax
and NIC to the Inland Revenue.
Where the company is a member of a group it is only the PAYE and NIC
liabilities of the company making the claim that are taken into account.
The total of the company's PAYE and NIC liabilities for a payment period
is the total of
- The gross amount of income tax for which the company is required
to account to the Inland Revenue for that period, ignoring any deductions
the company is authorised to make for working families' tax credit and
disabled person's tax credit
- The gross Class 1 NICs paid for that payment period, ignoring any
deductions the company is authorised to make for statutory sick pay,
statutory maternity pay, working families' tax credit or disabled person's
tax credit.
A payment of R&D tax credit is not income of the company. The company
does not have to pay tax on it.
Example Southside Ltd. claims R&D tax credit for its accounting
period ended 24 May 2003. It has no outstanding CT liabilities and its
PAYE and NIC payments are up to date. Its PAYE and NIC liabilities for
that accounting period are £450,000. The company is paid £450,000,
because that is the lower of £480,000, 16% of its surrenderable
loss of £3 million for that accounting period, and £450,000,
its PAYE and NIC liabilities. Thus only £2,812,500 of the relief
is used leaving £187,500 to be carried forward.
Restriction of consortium relief
A company entitled to R&D tax relief may be owned by a consortium.
In such a case if at least one of the consortium members is not a SME
the company cannot surrender any losses as group relief to fellow consortium
members that are not SMEs.
3. Vaccines research relief
Outline
Vaccines research relief (VRR) was introduced by Finance Act 2002 (Schedules
13 and 14). However, at the date of writing (November 2002) it had not
been approved by the European Commission as a State aid and therefore
was not in force. If and when it is approved the Inland Revenue will announce
the date that it comes into force, which will be specified in a Treasury
Order2.
VRR gives companies additional relief for spending on research and development
(R&D) (see page x) into vaccines and medicines for the prevention
and treatment of certain diseases. It is only available to companies.
Individuals and partnerships of individuals cannot claim it.
The relief allows companies to deduct an additional 50 per cent of qualifying
current R&D expenditure when they calculate their profits for corporation
tax.
The relief will apply to expenditure incurred on or after the date specified
by the Treasury Order. In determining whether expenditure was incurred
after this appointed day, the rule in S 401ICTA88 (which treats pre-trading
expenditure as incurred on the day the trade begins) is ignored. It is
the date on which the expenditure was actually incurred and not the date
on which it is treated as incurred that matters.
The treatments and diseases covered are:
- vaccines and medicines for the prevention and treatment of tuberculosis
and malaria,
- vaccines for the prevention of infection by human immunodeficiency
virus ["HIV"], and
- vaccines and medicines for the prevention of the onset of, and the
treatment of, acquired immune deficiency syndrome ["AIDS"]
arising from particular strains of HIV found mostly in countries on
the developing world.
Research must be into the diseases in humans. Other treatments do not
qualify for VRR. For example, research into a vaccine to prevent bovine
TB would not qualify for VRR.
VRR is not due unless a company spends more than £25,000 on qualifying
expenditure on vaccines research in a 12 month accounting period. The
£25,000 is adjusted proportionately if the accounting period is
not 12 months long. For example, if a company has an accounting period
that is 8 months long it must spend at least £16,777 (= £25,000
x 8/12) in that accounting period to qualify for VRR
A company may incur expenditure that qualifies for both VRR and
- R&D tax relief for SMEs
or
- R&D tax relief for large companies.
Example Festival Pharmaceuticals is a large company. It has £4
million of qualifying expenditure on research into a treatment for malaria
in its accounts for the year ended 30 June 2005. In addition to its normal
deduction of £4 million from income, it can deduct a further £1
million (= 25% x £4 million) large company R&D relief, since
this work is R&D, and £2 million vaccines research relief (=
50% x £4 million) giving a total deduction of £7 million.
Companies can claim VRR for subcontract payments made to universities,
charities and scientific research organisations, or for contributions
to independent research carried on by such bodies.
Companies may also sub-contract research to other companies. When this
happens VRR goes to the company that sub-contracts the research rather
than the company that carries it out (regardless of the size of the companies
concerned). So a company can claim VRR on sub-contract payments it makes
to other companies. SMEs not in profit can surrender any losses arising
from VRR in return for a payment of a vaccines tax credit (VTC) equal
to 16% of the "surrenderable loss" arising from the VRR (calculated
in a similar fashion to that for the general SME R&D scheme).
Example Inventions unlimited Ltd. is an SME. It spends £3
million on research into anti-HIV vaccines in its accounts year ended
31 May 2004. Those accounts show a loss of £5 million. It can claim
- o VTC of £240,000 (= 16% x 50% x 3m)
and
- o SME R&D tax credit of £720,000 (= 16% x 150% x 3m)
giving a total of £960,000.
Qualifying expenditure
Thereare three types of qualifying expenditure - qualifying expenditure
on.
- direct R&D
- sub-contracted R&D, and
- contributions to independent R&D.
VRR is based on the qualifying expenditure for an accounting period.
There are different definitions of qualifying expenditure on direct or
sub-contracted R&D for an accounting period for SMEs and large companies.
This means that SMEs can claim VRR on pre-trading expenditure when it
is incurred but large companies have to wait until the trade begins.
Qualifying expenditure on direct R&D is expenditure incurred
by a company on staffing costs (see page 13) or consumable stores (see
page 14) for a qualifying R&D activity directly undertaken by the
company and that satisfies the following conditions.
- The qualifying R&D activity must be relevant R&D (see page
14) in relation to the company
- The expenditure must not be capital expenditure and it must not be
subsidised (see page 6).
- The company must not incur the expenditure in carrying out activities
contracted out to it by somebody else.
A qualifying R&D activity is R&D relating to certain specified
diseases (see below).
A company can claim VRR for its qualifying expenditure on R&D which
it has sub-contracted to someone else.
Qualifying expenditure on sub-contracted R&D is payments made by
a company (the principal) for R&D contracted out by it to another
person (the sub-contractor) that satisfy these conditions. There are two
situations - either the sub-contractor is, or is not, a charity, university
or scientific research organisation
(a) Where the sub-contractor is a charity, university or scientific
research organisation
- The expenditure must not be subsidised (see page 6) or be capital
expenditure.
- The expenditure must be on R&D directly undertaken by the sub-contractor
on behalf of the company and must be on qualifying R&D activity.
- The R&D activity in respect of which the expenditure is incurred
must be relevant R&D (see page 14) in relation to the company.
These are the only conditions that have to be satisfied.
(b) Where the sub-contractor is not a charity, university or scientific
research organisation
The above conditions also have to be satisfied but there are further
rules. These are the same as apply in the SME R&D scheme (see page
6)
Sometimes a company can claim VRR on contributions that it makes to
independent R&D. Relief is due if payments are made to
- a charity,
- a university, or
- a scientific research association
to fund qualifying R&D activity that the body carries on provided
that the R&D is related to a trade carried on by the company that
made the payments. Expenditure on contributions to independent R&D
is qualifying expenditure for an accounting period if it is incurred in
that accounting period.
Example, a company that manufactures vaccines may give a contribution
to a charity that is carrying out research into a new AIDS vaccine. If
it does that the company may claim VRR on the contribution.
We use the definitions of "charity" from S 506(1) ICTA88 and
of "scientific research association" in S508 ICTA88. The effect
of these is to restrict charities & SROs to bodies located in the
UK. There is no similar restriction in the case of universities.
How VRR is given: SMEs
The general rule is that when an SME that is carrying on a trade is entitled
to VRR for an accounting period the company may claim an additional deduction
equal to 50% of the qualifying expenditure for that accounting period.
In the exceptional case where the qualifying expenditure does not qualify
for R&D tax credits for SMEs the company may claim a deduction equal
to 150% of the qualifying expenditure for the accounting period.
Pre-trading expenditure
If a SME company is entitled to VRR for pre-trading qualifying expenditure
for an accounting period it may elect to be treated as if that pre-trading
expenditure is a trading loss it had incurred in that accounting period.
The election must specify the accounting period for which it is made and
be made by notice in writing to the Inland Revenue not later that two
years after the end of the accounting period to which it relates.
If the company is not entitled to R&D tax credit for the qualifying
expenditure the trading loss is 150% of the pre-trading qualifying expenditure.
These are the rules that apply where a company has treated pre-trading
qualifying expenditure as a trading loss
- The company cannot treat that expenditure as incurred on the first
day of trading.
- The company cannot carry back the pre-trading loss to set against
profits of an earlier accounting period unless it is entitled to relief
for pre-trading vaccines research expenditure for that earlier period.
- When the company starts to trade it can treat the pre-trading loss
as a trading loss brought forward to the extent that it has not already
had relief for the loss or surrendered it as group relief.
Tax credit
An SME can claim a tax credit, which is known as a vaccines tax credit
(VTC), if it is entitled to VRR for an accounting period and has a trading
loss or a pre-trading loss for that accounting period. When it claims
VTC it receives a payment in exchange for the loss. The amount of the
loss that may be surrendered in exchange for a payment of tax credit is
called a surrenderable loss.
The surrenderable loss for an accounting period is the lower of the unrelieved
trading loss for that period and the VRR for that period.
The unrelieved trading loss for an accounting period is the trading loss
for that period less
- any amounts that could have been set against other income of that
period and
- any losses relieved in some other way, for example by being carried
back against profits of an earlier accounting period.
-Any losses brought forward from earlier accounting periods or carried
back from later accounting periods are ignored.
Example Drugs on demand Plc is entitled to VRR of £4 million
for its accounts year ended 30 June 2003. It has losses brought forward
£2 million and a trading loss of £3 million for that year.
This means that its unrelieved trading loss is £3 million. The losses
brought forward of £2 million are ignored. Its surrenderable loss
is £3 million because that is the lower of its unrelieved trading
loss, £3 million, and the VRR, £4 million.
If a SME company claims VTC the Inland Revenue pays it the amount of
the credit, at a rate of 16%, subject to the same conditions as for the
SME R&D credit generally (see above).
How VRR is given: large companies
The rules are simpler for large companies (but they may not claim VTC).
The general rule is that when a company that is carrying on a trade is
entitled to VRR the company may claim an additional deduction equal to
50% of the qualifying expenditure for an accounting period.
In the exceptional case where the qualifying expenditure is not deductible
in its CT computations, the company may claim a deduction equal to 150%
of the qualifying expenditure for the accounting period. For example,
a company may incur expenditure on contributing to independent vaccines
research that is relevant R&D but is not incurred wholly & exclusively
for the purposes of its trade. If so, the company may deduct 150% of its
qualifying expenditure in the accounting period in which it is incurred.
How VRR is given - insurance companies
There are special rules for taxing insurance companies and so there are
special rules for VRR for them.They apply where the company's profits
from life assurance business are taxed under Case III, V or VI Schedule
D rather than Case I. If the company is taxed Case I Schedule D the normal
rules apply.
Refunds of payments or contributions
A company that has made payments for sub-contracted R&D or made contributions
to independent R&D may receive a refund of all or part of the payment
or contribution.
If it does, the appropriate amount is treated as Case I income.
For SMEs the appropriate amount is
- 50% of the refund where the payment qualified for R&D tax credits
for SMEs,
and
- 150% of the refund in other cases.
For large companies the appropriate amount is
- 50% of the refund where the payment could be deducted in computing
trading profits,
and
- 150% of the refund in other cases.
Specified diseases
Only research and development (see page 13) into vaccines and medicines
for the prevention and treatment of certain diseases in humans qualifies
for VRR. The specified diseases are tuberculosis, malaria and HIV/ AIDS.
- Qualifying R&D may relate either to vaccines or to drugs, for
either prevention (prophylactic) or treatment (therapeutic) of Tuberculosis
- Qualifying R&D activity may include vaccines or medicines for
Malaria, either prophylactic or therapeutic. Research into new or improved
preventative medicines will qualify even if the principal beneficiaries
are travellers to non-infected areas.
- R&D activity into HIV/ AIDs will qualify for relief if it is
directed towards:
- Vaccines for the prevention of infection by HIV,
or
- Vaccines or medicines for the prevention of the onset, or the treatment,
of AIDS resulting from infection by HIV in clades (sub-types of the
virus) A,C,D or E only. (Note that, whilst vaccines will normally
be clade specific, there is no restriction to the relief by reference
to the clades in the case of prophylactic vaccines. Anti- retroviral
medicines are not clade specific, and so research or development aimed
at these will not qualify for relief.)
The Treasury has powers by Regulation, to vary the prescribed clades,
and to make provision further defining the qualifying R&D activity.
These powers are necessary because particularly the HIV virus continues
to mutate. However the number of specified diseases cannot be increased
by Regulations.
Research into any of these is qualifying R&D activity and qualifies
for VRR provided that the other conditions are satisfied
The definition of "research and development"
A new definition of R&D for tax purposes was introduced by Section
68 and Schedule 19 FA 2000 and has effect from 1st April 2000.
An activity will qualify as R&D for tax purposes if it would be treated
as R&D under normal accounting practice for companies in the UK (Statement
of Standard Accountancy Practice 13, SSAP13), as qualified by the "Guidelines
on the Meaning of Research and Development for Tax Purposes" (see
http://www.dti.gov.uk/support/taxcredit_b.htm) issued by the Secretary
of State for Trade and Industry.
The Guidelines have statutory force. They discuss in detail the meaning
of R&D, and illustrate through explanation and examples the boundary
between those activities that are, and are not R&D.
Broadly speaking, an activity may qualify as R&D if it is characterised
by work that contains an appreciable element of innovation and creativity
in the fields of science and technology. The work can range from research
into purely theoretical areas to applied research and experimental development
directed towards a practical aim or product. It is research that aims
to break new ground or to resolve scientific or technological uncertainties.
R&D is "creative work undertaken on a systematic basis in order
to increase the stock of knowledge…and the use of this knowledge
to devise new applications." For an activity to qualify it must meet
three criteria
- t must seek to achieve a scientific or technological advancement
- it must seek to resolve a scientific or technological uncertainty
- it must be by way of systematic investigation.
R&D can include the development of prototypes and pilot plant to
test the R&D, but commercial development without such scientific or
technological investigation, or after the resolution of such uncertainties,
is not R&D for tax purposes.
Other definitions
Staffing costs
Staffing costs are all amounts paid to directors and employees. In more
detail, they are
- all money payments such as salaries, wages, fees and bonuses before
deductions for PAYE, National Insurance, or other agreed sums (such
as season ticket loans etc). But they do not include the costs of providing
benefits in kind.
- the employer's National Insurance contributions paid in respect of
the employee insofar as they relate to the money payments (Class 1 NIC).
However, NIC on benefits in kind (Class 1A, Class 1B NIC) are excluded.
- all payments to a pension fund by the employer in respect of the
company's directors or employees directly engaged in R&D to provide
those R&D staff with a pension, retirement annuity or other superannuation
benefits.
- recruitment costs and related personnel costs such as relocation
expenses are not included. Payments to agencies for the provision of
staff do not qualify
Staffing costs attributable to relevant research and development are
staffing costs paid to or in respect of, directors and employees directly
and actively engaged in R&D.
People directly and actively engaged in R&D are those actually undertaking
the R&D, staff providing technical support and managers who plan and
organise the programme of research.
The costs of people more remotely involved such as those providing clerical
or general administrative services are not staffing costs attributable
to relevant research and development. These staff, despite being peripheral
to the R&D, may be regarded as essential to the successful outcome
of the activity. Nevertheless, their costs do not qualify.
Whether an employee is directly and actively engaged in R&D is a
question of fact based on the duties performed and not on the job title.
"Directly and actively engaged" refers to hands on work. Hands-on
work performed by an employee includes:
- preparing equipment and materials for experiments and analysis, but
not maintaining equipment;
- experimentation and analysis;
- recording measurements, making calculations, and preparing charts
and graphs; and
- performing work with respect to engineering or design, operations
research, mathematical analysis, computer programming, data collection,
Supervisors and managers
Supervisors and managers performing tasks such as described above as
hands-on are also directly and actively engaged. In addition, time they
spend directing the technical course of, or providing direct technical
input into, the ongoing R&D activities can be considered as direct
engagement in R&D. However, time they spend on non-technological management
aspects of activities, such as long-term strategic planning, contract
administration and other decision-making functions that do not directly
influence the on-going R&D activities, is not considered direct engagement
in R&D.
The following are examples of qualifying and non-qualifying staff connected
with a R&D project in the electronics industry:
- Director of Research: would qualify in respect of time spent either
in a hands-on capacity or in the management of the project
- Director's Secretary: would not qualify, assuming involved only in
general secretarial duties
- Engineers: would qualify for work on the R&D project
- Computer Programmers: would qualify for work on the R&D project
- Maintenance Staff: would not qualify as they are not directly engaged
in the R&D activity
- Clerical Support Team: would not qualify even though the support
they give to the engineers, programmers is essential.
- Data Input Staff: would qualify assuming they are directly involved
in the project
- Receptionist: would not qualify
- Technical/Documentation Writer: would not qualify as this work relates
to the commercial or product development.
If staff spend only part of their time on R&D, costs should be apportioned
to arrive at the qualifying staff costs. If an employee spends more than
80% of his or her time on R&D, the whole cost qualifies. Conversely,
if an employee spends less than 20% of his or her time on R&D none
of the cost qualifies. These percentages are by reference to the accounting
period.
Consumable stores
Expenditure on consumable stores is expenditure on materials and equipment
used up in the R&D activity, but which are not in themselves incorporated
or reflected in the product of the R&D. Supplies, materials, or equipment
used only indirectly in the R&D effort e.g. related to general overheads
such as administration will not qualify.
Consumable stores are, by their nature comparatively short-lived, and
spending on them will be revenue expenditure. For example, the consumable
stores of a chemistry-based R&D project may include such items as
disposable laboratory equipment (flasks, test tubes) and chemicals used
in the R&D process, etc. This spending will be revenue expenditure
and could qualify for R&D tax relief. But expenditure on a centrifuge
will usually be on capital account, and will not qualify.
Expenditure on heat, light, power, rent, rates, interest, lease payments
are not consumable stores
Some consumable stores are recyclable; for example, it may be economically
viable to sell the waste products from chemicals used in an R&D activity.
The whole cost of such items can still be claimed as qualifying for the
R&D tax relief.
Relevant research and development
Relevant research and development for a company is research and development
- related to a trade that the company carries on, or
- from which it is intended that a trade to be carried on by the company
will be derived.
R &D related to a trade includes:
- any R&D which may lead to or facilitate an extension of the trade;
and
- medical research which has a special relation to the welfare of workers
employed in that trade, for example research into an occupational disease.
"Medical research which has a special relation to the welfare of
workers employed in a trade" does not include research undertaken
for the benefit of the community as a whole unless, of course, it is pursued
by a company whose trade includes developing new pharmaceuticals.
Qualifying bodies
A qualifying body is a charity, an institution of higher education such
as a university, a scientific research organisation or a health service
body. All of these classes are defined in legislation, and apply to the
UK only. In addition, the Treasury may, by order, add individual bodies
or classes of bodies to the list of qualifying bodies. A list of those
bodies which have been so designated will be kept on the Inland Revenue
website.
Notified State aid
A notified State aid is a State aid which has been notified to, and approved
by, the European Commission.
Notified state aids are usually government funded grants such as the SMART
award, but not all government grants are notified State aids - for example,
some funding under the SMART label is not notified State aid (e.g. grants
for feasibility studies and microenterprise awards).
Sometimes companies carry out work that is funded directly by an initiative
of the European Community. As the funding is not provided by a Member
State, it cannot be notified State aid. So although receipt of such funding
will constitute a subsidy and so reduce the amount of expenditure for
which a company can claim, for example, the SME tax relief, it does not
disallow it completely (unless the project is 100% subsidised).
If clarification of the status of a grant is needed, the body that has
provided or arranged the funds should be able to help.
Artificially inflated claims
There is anti-avoidance legislation to prevent a company getting more
R&D tax relief than it would normally be entitled to.
R&D tax relief is not due for a transaction that forms part of arrangements
entered into wholly of mainly for a disqualifying purpose.
Arrangements are entered into wholly of mainly for a disqualifying purpose
if their object, or one of their main objects, is to let a company obtain
more R&D tax relief than it would otherwise be entitled to.
Arrangements are widely defined to include any scheme, agreement or understanding,
whether or not it is legally enforceable.
How to claim R&D tax relief
To obtain the R&D tax reliefs, including payable R&D or vaccines
tax credit, a company must make a claim in its tax return, form CT600.
It would be useful if the accompanying computations provide a breakdown
of the amount claimed and give a brief synopsis, in layman's terms, of
the activities and the basis on which they constitute R&D.
The claim may be made, amended or withdrawn at any time up to the first
anniversary of the filing date for the return for the accounting period
for which the claim is made.
Interest is payable on a payable R&D tax credit from the later of
- the filing date for the accounting period for which the claim is
made, and
- the date on which the return or amended return containing the claim
was delivered to the inland Revenue
until the date payment is made.
You may find it helpful to discuss the claim with the Inspector beforehand,
especially if this is the company's first claim for any of the R&D
reliefs.
Content
The content of Tax Bulletin gives the views of our technical specialists
on particular issues. The information published is reported because it
may be of interest to tax practitioners. Publication will be six times
a year, and include a cumulative index issued on an annual basis.
- You can expect that interpretations of the law contained in the Bulletin
will normally be applied in relevant cases, but this is subject to a
number of qualifications.
- Particular cases may turn on their own facts, or context, and because
every possible situation cannot be covered, there may be circumstances
in which the interpretation given here will not apply.
- There may also be circumstances in which the Board would find it
necessary to argue for a different interpretation in appeal proceedings.
- The Bulletin does not replace formal Statements of Practice.
- The Board's view of the law may change in the future. Readers will
be notified of any changes in future editions.
Nothing in this Bulletin affects a taxpayer's right of appeal on any
point.
Letters on any article appearing in Tax Bulletin should be sent to the
Editor, Mr Shell Makwana, Room G7, New Wing, Somerset House, Strand, London,
WC2R 1LB or e-mail Shell.Makwana@ir.gsi.gov.uk. We are sorry though that
neither he nor our contributors will normally be able to enter into correspondence
about Tax Bulletin or its contents.
Subscription
The subscription for 2002 is £22. If you would like to subscribe
to Tax Bulletin please send your name and address together with your cheque
to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex
BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue".
If you would like information regarding Tax Bulletin subscription or
distribution please contact Mr Bryan Kearney, Room G7, New Wing, Somerset
House, Strand, London, WC2R 1LB. Telephone: 020 7438 6373. For more general
information regarding Tax Bulletin, please contact Mrs Jayne Harler, Assistant
Editor, on 020 7438 7842 or at the address provided above.
Copyright
Tax Bulletin is covered by Crown Copyright. There is no objection to
firms copying the Bulletin for their own use. Anyone wishing to republish
Tax Bulletin or extracts more widely should write for permission to Miss
Glenda Bishop, Room G12, New Wing, Somerset House, Strand, London, WC2R
1LB.
|
