The research and development expenditure credit (RDEC)

The incentive, in its original form, only applies to accounting periods starting prior to 1 April 2024 and is primarily used by large companies, as well as SMEs in certain circumstances.

For accounting periods starting on or after 1 April 2024, the R&D merged scheme (sometimes referred to as ‘new RDEC’) applies for companies of all sizes. There are many similarities between the merged scheme and the original RDEC incentive, but some material differences in the rules. There is also a separate ERIS scheme for loss making R&D intensive SMEs. For the purposes of this article, ‘RDEC’ refers to the original incentive and ‘merged scheme’ refers to the new version.

This article is for companies looking to claim RDEC under the old rules for accounting periods starting prior to 1 April 2024 (e.g. for year ends up to February 2025). It explores the key features of the RDEC incentive, including the RDEC rate, qualifying activity and qualifying expenditure for the purposes of the relief. It explains how large companies should use the incentive, and how ForrestBrown can help you ensure that your RDEC claim is robust and includes everything to which you are entitled.

What is RDEC?

RDEC is a tax incentive offered by the UK government to promote private sector investment in innovation. It is for UK companies that are subject to UK Corporation Tax, carry out qualifying R&D and spend money on those activities. RDEC only applies to accounting periods beginning prior to 1 April 2024. The incentive is primarily for large companies (businesses with 500 or more employees and either more than €100m turnover or €86m gross assets) but some SMEs use RDEC when prevented from accessing the SME R&D incentive.

From 1 April 2024, RDEC was combined with the SME incentive to become a merged scheme.

Benefits of RDEC?

RDEC can be accounted for above-the-line in your income statement (also known as your profit-and-loss account), providing a positive impact on profitability in your accounts. This visibility in turn has a positive impact on R&D investment decisions.

Since RDEC is largely independent of your company’s tax position, the benefit you receive is easier to forecast. This provides far greater certainty and makes it easier for companies to factor the relief into their investment decisions.

Unlike its predecessor, the large company scheme (defunct as of 1 April 2016), RDEC also offers a cash credit for loss-making companies.

These benefits continue under the merged scheme.

RDEC qualifying activity

RDEC uses the guidelines produced by the Department for Science, Innovation & Technology to define the activities that constitute R&D. These are often referred to as the ‘DSIT’ guidelines and apply to both RDEC and SME R&D tax credits alike. The definition of R&D for tax purposes is purposefully broad and applies equally to all fields of science and technology. This means that companies from a broad range of sectors can potentially carry out R&D.

If your company is taking a risk in carrying out development projects and attempting to advance the field by resolving ‘scientific or technological uncertainties’ then you may be carrying out qualifying activity. If your company is creating new products, processes or services, modifying existing ones, or creating new knowledge, and you have strong technical credentials, there’s a good chance that you’re carrying out qualifying R&D.

RDEC qualifying expenditure

Once you have identified your qualifying activity, you can look at the research and development expenditure associated with it. There are prescribed categories of R&D expenditure that can be included within an RDEC claim.

Qualifying expenditure for RDEC prior to the merged incentive:

• Staff costs, including salaries, employer’s NIC and pension contributions, as well as some reimbursed business expenses.
• Payments for Externally Provided Workers (EPWs).
• Subcontracted R&D in limited circumstances.
• Expenditure on materials and other consumables like light, power and heat that are used up or transformed in the R&D process.
• Software costs – this includes software licence fees, and for accounting periods beginning on or after 1 April 2023 also includes data licence costs and cloud computing costs.
• Money paid to clinical trial volunteers.
• Contributions to independent R&D.

Important: Qualifying expenditure under the R&D merged incentive changed and differs to RDEC. Find out more in our merged scheme essential read.

What is the RDEC rate?

The RDEC rate determines the gross credit a company can claim. The credit is taxable at the normal Corporation Tax rate, meaning the company receives a net benefit equivalent to the RDEC rate minus the prevailing rate of Corporation Tax.

For expenditure incurred up to 31 March 2023 (and since 1 April 2020), the gross RDEC rate was 13% and the Corporation Tax rate was 19%, resulting in a net benefit equivalent to 10.53% of qualifying expenditure. Unlike the scheme for SMEs, this rate remains the same whether you are profit- or loss-making.

For expenditure incurred on or after 1 April 2023, the gross RDEC rate increased to 20% of qualifying spend. At the same time, the main Corporation Tax rate increased from 19% to 25% for profits in excess of £250,000. A small profits rate remains at 19% for profits up to £50,000 and marginal relief is available on profits between these two values. This results in a net benefit of between 15% and 16.2% depending on the effective Corporation Tax rate applicable to the company.

The credit is offset against the company’s tax liability or, in some circumstances, is payable in cash.

The increased rate has been maintained under the merged scheme for accounting periods beginning on or after 1 April 2024.

Periods which straddle 1 April 2023

If an accounting period straddles 1 April 2023, then the expenditure prior to 1 April 2023 will be subject to the RDEC rate of 13%, while the expenditure on or after 1 April 2023 will be subject to the RDEC rate of 20%.

Similarly, for expenditure incurred before 1 April 2023, the RDEC will be subject to Corporation Tax at 19%, but for expenditure incurred on or after 1 April 2023, at either 19% or 25% (and marginal relief may apply), meaning the net benefit from an RDEC claim in a period which straddles 1 April 2023 will depend on the company’s taxable profits and accounting reference date.

Example RDEC calculation

There are a number of different scenarios based on RDEC accounting periods that in turn are calculated differently. We’ve provided some examples of RDEC calculations below to give you an indication of the impact of recent changes:

RDEC for expenditure incurred before 1 April 2023

The following illustration provides an example of how RDEC is calculated based on £1,000,000 of qualifying expenditure.

Note the result is the same regardless of whether the company is profit or loss making.

RDEC for expenditure incurred on or after 1 April 2023

The following illustration provides an example of how RDEC is calculated based on £1,000,000 of qualifying R&D expenditure and assuming the company pays Corporation Tax at the main rate.

The following illustration provides an example of how RDEC is calculated based on £1,000,000 of qualifying R&D expenditure and assuming the company is loss making (and there are no adjustments at steps 3 to 6 – see below).

Note that under the merged scheme, a company which is loss making or has profits of up to £50,000 (not including the gross RDEC) would have the credit capped at the small profits rate of 19% instead of the main rate of 25%.

RDEC steps – how you will receive your RDEC credit

RDEC is designed so that profit-making and loss-making companies claiming RDEC are treated equally and, as such, the credit is taxable and only paid out net of tax.

There are seven RDEC steps that must be applied to determine how you will receive your credit. These seven steps ensure, before cash is paid out, that the credit is used to offset any tax you owe to HMRC.

The seven steps must be followed in order and, depending on your circumstances, may mean that some of your credit is carried forward to use in a later period.

RDEC 7 steps (for accounting periods beginning before 1 April 2024):

RDEC accounting treatment

The RDEC legislation was drafted so that it could be accounted for in profit before tax (PBT), rather than as part of the tax charge/(credit) within the taxation line. This makes it more visible. In addition, many businesses monitor performance based on PBT, so including RDEC in this way makes it more likely to influence business decisions.

For accounting purposes, your gross credit can be recognised above-the-line in your income statement. Typically, it shows as ‘other income’. This treatment is not however compulsory – and the precise accounting treatment followed will depend on a number of factors. These include when you prepare your RDEC claims compared to when you file your accounts and how reliably you can measure your RDEC figures. It is likely that these decisions will involve your accountant, auditor and/or R&D tax adviser.

The credit itself is taxable income regardless of where it is shown in the accounts.

How ForrestBrown delivers value to large companies

If the amount you spend on R&D is significant, ensuring that you can identify and evidence your R&D expenditure is essential to protect your business from risk. It can however add complexity and increase the cost of preparing an RDEC claim. It makes sense to have considerable technical firepower on your side to ensure you claim the full value of that expenditure, and that it is supported with a robust methodology.

ForrestBrown provide the best possible team to efficiently handle complex information, understand the bigger picture and set your business up for success. We tailor our service to your organisational structure and information systems when claiming RDEC. Our expert team is experienced in submitting robust RDEC claims.

We provide a bespoke RDEC service for large companies that can include delivering the full claim or focusing on a specific aspect of the RDEC claim process.

For example:

• Forward-looking planning – forecasting the impact of major changes to R&D tax reliefs on your business and helping you to identify any practical steps required to protect your business, reduce your cost to comply with the changes and/or optimise your RDEC claim.
• Claim review – a review of your claim process and methodology to identify opportunities and risks, calculate the full value of qualifying expenditure and increase efficiencies.
• Risk review – a review of your R&D claim documentation to ensure you are providing HMRC with the information it needs to support your claim.
• Consultancy support – ad hoc consultancy support to provide tax advice on a specific aspect of your claim, type of R&D project or transaction.
• DSIT guidelines – support with understanding and applying the DSIT guidelines to your business and projects, to help you identify qualifying activities. We can also support with articulating your qualifying projects to HMRC.
• Record-keeping – an analysis of your current record-keeping processes and recommendations for improvement.
• Training – facilitate training workshops for your in-house finance, tax or technical teams to support information-gathering for your R&D claims.

Our team is highly skilled and made up of chartered tax advisers, industry-experienced sector specialists, lawyers and a former HMRC inspector. It has considerable experience advising large, complex and multi-national businesses. Our aim is to become a trusted partner for your existing finance or tax team.

The specific service we provide will depend on your business, your needs and any particular challenges you face.

Ultimately, our consultancy service frees up your internal resources by working efficiently, keeping your input to a minimum. It gives you confidence that your RDEC claim is robust and your relationship with HMRC is protected.