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Research and Development Expenditure Credit scheme explained

Director & Head of Policy
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RDEC (research and development expenditure credit) is a UK government tax incentive designed to reward innovative companies for investing in research and development (R&D). It is primarily used by large companies and is also used by SMEs in some circumstances.

There are two iterations of the RDEC incentive. Which one is relevant depends on the accounting period for which you are considering making an R&D claim:

This article explores the key features of the different iterations of RDEC incentives. It includes the R&D expenditure credit rate, qualifying activity and qualifying expenditure for the purposes of the relief. It explains how large companies and SMEs should use the incentive, and how ForrestBrown can help you ensure your RDEC claim is robust and includes everything to which you are entitled.

Are you a large company? Find out more about our RDEC services for large businesses with claims for accounting periods up to 31 March 2023

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Key features of RDEC

In the following section, we explore some of the key features of the RDEC incentive.

What is RDEC?

RDEC is a tax incentive offered by the UK government to promote private sector investment in innovation. 

RDEC tax relief is for UK companies that are subject to UK Corporation Tax, carry out qualifying R&D and spend money on those activities. SMEs are usually eligible for the SME R&D tax credit, which differs from RDEC in its structure, offers a more generous tax credit rate and wider eligible cost base. However, in certain circumstances, SMEs are prevented from using the SME incentive, and therefore claim through RDEC instead. 

From 1 April 2024, RDEC will be combined with the SME incentive to become a merged scheme. This will operate alongside a separate incentive for loss making R&D intensive SMEs.

Changes to R&D tax relief from 1 April 2024

SME R&D tax relief and the Research and Development Expenditure Credit (RDEC) will be merged for accounting periods beginning on or after 1 April 2024, although an enhanced rate for R&D intensive SMEs will continue to be available.

The merged scheme moves to a single rate and set of qualifying rules with elements from the existing two schemes, including clarification of subcontracted out and subsidised R&D. Restrictions on overseas R&D also come into force from 1 April 2024.

ForrestBrown’s expert team is on hand to help businesses understand what these changes will mean and what they can do to prepare.

Looking for help or advice around the changes to R&D tax relief in 2024?

RDEC for accounting periods beginning on or after 1 April 2024

For accounting periods beginning on or after 1 April 2024 all companies (SMEs and large companies) can make an R&D claim under a merged scheme. This will operate in a similar way to the RDEC incentive, although the net benefit and certain other rules will change.

The RDEC tax credit is worth 20% of a company’s qualifying R&D expenditure. The credit is taxable at the normal Corporation Tax rate (19% or 25% depending on the company’s taxable profits). 

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

The net benefit of RDEC is:

15% if the company is subject to Corporation Tax at the main rate of 25%, 

16.2% if the company is subject to Corporation Tax at 19% or is loss making, or

For companies receiving marginal relief, the effective rate of relief of their RDEC claim could be between 14.7% and 15%, depending on the company’s tax position.

This means for every £1 of qualifying spend on R&D, the company will get back somewhere between 14.7p and 15p by way of a tax reduction or payable credit.

Some other key changes as part of the merged incentive include:

  • Overseas R&D – it will no longer be possible to include overseas subcontractor or EPW costs in the R&D claim. There are some limited exceptions to this.
  • Contracted out R&D – it will be possible to include costs in the R&D claim where R&D has been ‘contracted out’ to a subcontractor. There is specific legislation on this point and advice should be sought when considering who can claim for contracted out R&D, and what costs can be included.

RDEC for accounting periods ending on or after 1 April 2023

For accounting periods that end on or after 1 April 2023, the RDEC rate increased from 13% to 20%. The credit is taxable at the normal Corporation Tax rate (19% or 25% depending on the company’s taxable profits).

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

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.  

RDEC for accounting periods ending on or before 31 March 2023

For accounting periods that ended before 31 March 2023, the RDEC rate was 13%. The credit was taxable at the Corporation Tax rate of 19%.

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

The net benefit of the RDEC was therefore 10.53% (the gross credit less Corporation Tax). This means that for every £1 of qualifying spend on R&D, the company would get back 10.53p by way of a tax reduction or payable credit.

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 independent of your company’s tax position, the benefit you receive is easier to forecast. This provides far greater stability 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.

Under the new merged incentive from 1 April 2024, these benefits will continue and in addition, the net benefit from the incentive has now increased from 10.53% up to 16.2% (depending on the rate of Corporation Tax payable).

What is the RDEC rate?

The RDEC rate has changed from 1 April 2023 and is summarised below:

  • Up to March 2023 – the RDEC rate was 13%. 

As the RDEC is paid net of Corporation Tax (at 19% for these periods), the RDEC effective rate received was worth 10.53p for every £1 spent.

  • From 1 April 2023 – the RDEC rate is 20%. 

The main Corporation Tax rate has 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 means that the RDEC effective rate received is normally between 15p and 16.2p for every £1 spent, depending on the effective Corporation Tax rate for the company’s profits.

  • From 1 April 2024 – RDEC rate will be 20%. 

Corporation Tax rates are not changing from 1 April 2024, so the effective rate received will continue to be between 15p and 16.2p per £1 of R&D expenditure. 

However, for loss making companies, the tax rate applied when calculating any payable RDEC amount will be 19%, resulting in an effective rate of 16.2p for every £1 of R&D expenditure for loss making companies. 

Click through for more detail on RDEC rates. You can also read our history of R&D tax incentives timeline for more information on changes to rates and other aspects of the relief.

Calculate the potential value of your RDEC claim with our RDEC claim calculator

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 sometimes 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 or 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 technology projects and attempting to ‘resolve scientific or technological uncertainties’ then you may be carrying out qualifying activity. If your company is creating new products, processes or services, or modifying existing ones, and you have strong scientific or technical credentials, there’s a good chance 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.

The qualifying categories have been updated under the merged RDEC incentive, applicable to accounting periods beginning on or after 1 April 2024.

Qualifying expenditure for RDEC under 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), subject to restrictions for overseas workers.
  • Subcontracted R&D costs, subject to restrictions where activities are carried out overseas.
  • 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, data license costs and cloud computing costs.
  • Money paid to clinical trial volunteers.

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.

What costs qualify for R&D tax credits?

Further detail on each of these qualifying categories is available in our KnowledgeBank.

Read more

The types of expenditure that can be included in an R&D tax relief claim are specific and defined by legislation. This means that accurately identifying qualifying R&D expenditure in your accounting systems can be demanding.

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, but can add complexity and increase the cost of preparing an RDEC claim. It pays 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.

RDEC and large companies

Whether you are handling your RDEC claim in-house or looking to outsource it to a trusted partner, ForrestBrown’s team of chartered tax advisers and accountants, technical specialists and ex-HMRC inspectors can add value to your business. Our expert team will flex and scale to meet even the most complex of requirements. In this section, we explain how to determine the way you will receive your RDEC benefit and what the accounting treatment for RDEC is.

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 a later period before being used.

RDEC 7 steps (under merged incentive):

  1. Discharge any liability to Corporation Tax for the accounting period.
    The gross RDEC rate is offset against your Corporation Tax liability for the period to which your R&D tax credit claim relates.
  2. Adjustment to reduce to net of tax amount.
    To ensure that only the net amount of the credit is payable in cash, if the amount remaining after step 1 exceeds the net value of the credit (gross credit less Corporation Tax), the balance is withheld and carried forward for you to use in future periods.
  3. The payment of the cash credit is subject to a cap based on the PAYE and NIC you have paid to HMRC. Prior to 1 April 2024, the cap referred to the PAYE and NIC paid in respect of R&D workers. Different rules apply to calculate the cap for accounting periods beginning on or after 1 April 2024. Amounts in excess of the cap can be carried forward for use in future periods.
  4. Discharge Corporation Tax liability for any other accounting periods.
    Before the credit is paid in cash, HMRC may offset it against any outstanding Corporation Tax owed for any other accounting periods.
  5. Elect whether to surrender for group relief.
    You are able to surrender up to the credit amount available at this step (as well as any amount restricted at step 2) to a group company to offset against their tax liability. But, you don’t have to do this; you can still receive a cash payment even if other companies in your group have tax liabilities.
  6. Discharge any other liabilities of your company with HMRC.
    Any amounts remaining at this step will be offset by HMRC against other taxes if there are amounts outstanding. For example, overdue PAYE or VAT liabilities.
  7. Cash credit payable to the company.

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 upcoming changes:

RDEC for accounting periods beginning on or after 1 April 2024

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.

£1,000,000 x 20% = £200,000

Gross credit amount = £200,000

£200,000 – 25% Corporation Tax rate = £150,000

£150,000 / £1,000,000 = 15%

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).

£1,000,000 x 20% = £200,000

Gross credit amount = £200,000

£200,000 – payable credit capped at £200,000 less Corporation Tax at 19% = £162,000

£162,000 / £1,000,000 = 16.2%

RDEC for accounting periods ending on or before 31 March 2023

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

£1,000,000 x 13% = £130,000

Gross credit amount = £130,000

£200,000 – 19% Corporation Tax rate = £105,300

£105,300 / £1,000,000 = 10.53%

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 deliver value to large companies

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.
  • 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 of your R&D claim documentation to ensure you are providing HMRC with the information they need to support your claim.
  • Ad hoc consultancy support to provide tax advice on a specific aspect of your claim, type of R&D project or transaction.
  • An analysis of your current record-keeping processes and improvement recommendations. 
  • Facilitated training workshops for your in-house finance, tax or technical teams to support information-gathering for your R&D claims.

Our senior team is highly-skilled and made up of chartered tax advisers, sector specialists with hands-on industry experience and former HMRC inspectors. They have 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.

SMEs and RDEC

For R&D tax credit purposes, SMEs are businesses with fewer than 500 staff and not more than either €100 million turnover or €86 million gross assets.

When it comes to recouping your innovation investment, prior to April 2024, your first consideration will be the SME R&D tax credit scheme. It offers a higher rate of relief – up to 33% (pre 1 April 2023) or up to 21.5% (from 1 April 2023) compared to up to 16.2% for RDEC. But sometimes it will not be possible to use this.

ForrestBrown’s expert advice has proved invaluable to many SMEs who have found they cannot use the SME R&D tax credit and do not appreciate that RDEC is available to them in these circumstances, are unsure how to access it or whether a claim will be worthwhile.

The introduction of a merged scheme for accounting periods beginning on or after 1 April 2024, means that only loss-making R&D intensive SMEs will remain eligible for the SME scheme at a rate of relief of up to 27%. Our expertise will be invaluable for SMEs deciding whether they can access the R&D intensive SME scheme, or need to claim under the new merged scheme, and managing this transition.

SMEs claiming under the merged scheme from 1 April 2024 will move to the RDEC rules outlined in this article. Loss-making SMEs who spent more than 30% of their total business expenditure on R&D qualify for the R&D intensive SME scheme. 

Our technical firepower means we can deal with any level of complexity and it allows us to provide strategic advice to businesses facing changes to their R&D tax credit claims.

SME status and RDEC – for accounting periods ending before 1 April 2024

As an SME, you should be interested in RDEC (rather than R&D tax credits) if:

For accounting periods starting on or after 1 April 2024, SMEs will claim under either the R&D intensive SME scheme or the merged RDEC scheme. Grants and subsidies will no longer impact R&D claims under either of these new schemes, but new rules on contracted out R&D will apply and require careful consideration where there is more than one party involved in the R&D. 

We will look at each of these scenarios in the context of the pre-1 April 2024 rules in more detail:

Grants and subsidies and RDEC

Grants and subsidies are an alternative form of innovation funding to R&D tax credits. There is a common misconception that if an SME receives a grant it cannot claim R&D tax credits at all. This is wrong, because RDEC is still available on any expenditure excluded from the SME R&D tax incentive. In fact, here at ForrestBrown we suggest that companies applying for or in receipt of innovation grants should, without exception, consider R&D tax credits to avoid missing out on relief due.

Accepting a grant may restrict your use of the SME R&D tax credit scheme, but it does not exclude you from RDEC. How the grant is structured and defined will have a large bearing on what relief is available to the SME recipient under each scheme.

Under the merged scheme, for accounting periods starting on or after 1 April 2024, grants and subsidies will no longer impact the R&D claim.

Subcontracted R&D and RDEC

As an SME, if you carry out R&D which has been subcontracted to you, you won’t be able to make a claim via the SME R&D tax credit scheme. If you are carrying out the R&D for another SME company, they will claim for these activities. However if you’re working for a large company, you can claim via RDEC for this expenditure.

Before you decide what route to take you first need to understand the nature of your subcontracting relationship, and, in particular, who owns the R&D. Our Knowledge Bank article on subcontracting explores this issue in further detail.

With the merged scheme, subcontracted R&D is an area of significant complexity, with the legislation changing the definition of contracted out R&D. This will need to be considered in detail when considering which projects to include in the claim and which subcontractors can be included.

What is the difference between RDEC and the SME R&D tax credit prior to 1 April 2024?

RDEC and SME R&D tax credits are both UK government R&D tax credit incentives. What qualifies as R&D is the same for both schemes. But they differ in terms of their eligibility criteria, the R&D tax credit rate, what qualifying costs can be included, and how the benefit is calculated.

Differences in eligibility criteria

There are fewer eligibility criteria for RDEC than there are for the SME R&D tax credit incentive. Most notably, if you’re using RDEC, it doesn’t matter if your R&D is grant-funded. In addition, unlike the SME relief, you can usually claim for R&D activities contracted out to you.

Differences in R&D tax credit rate

The rate of relief for RDEC is less generous than the SME R&D tax credit – 10.53% compared to 33% (pre April 2023) or 15% compared to 21.5% (post April 2023). That said, claims made by large companies often involve much larger qualifying expenditure meaning the value of the benefit they receive is also higher.

Merged scheme – for accounting periods starting on or after 1 April 2024

Under the new merged scheme, the effective rate of relief will be the same for SMEs or larger companies. The effective rate will be 15% for companies paying CT at the main rate or 16.2% for loss makers. Companies receiving marginal relief will receive a slightly different effective rate depending on the level of marginal relief received.

There is an exception to this – loss making SMEs with more than 30% of their total expenditure being spent on R&D will be eligible for a more generous relief:

Differences in qualifying costs

The expenditure types that you can include for subcontracted R&D differ between RDEC and the SME R&D tax credit. If you are making an RDEC claim, money spent on subcontractors does not normally qualify for relief – unless the subcontractor is an individual, a partnership of individuals or a charity, higher education institute, scientific research organisation or health service body. If you are making an SME claim, you can include 65% of payments made to unconnected parties.

Contributions made towards funding relevant independent R&D only count as qualifying expenditure under the RDEC scheme.

Under the merged scheme, it will be possible for companies to include subcontractors, although advice should be sought to establish if they qualify. Overseas subcontractors and EPWs will no longer be eligible.

Differences in how RDEC is calculated

The benefit you receive from RDEC reduces your Corporation Tax liability. If you have no Corporation Tax liability, you can usually claim the credit as a cash payment. The benefit you receive from the SME R&D tax credit scheme reduces your taxable profits; if you have losses attributable to R&D expenditure they can usually be surrendered for a cash payment.

How to make an RDEC claim as an SME

As we hope we have made clear, RDEC can be a useful tax incentive for SMEs and is not just for large companies. The SME R&D tax credit incentive should always be considered first for SMEs – but where you do not qualify for any of the reasons stated above, RDEC might be the answer.

We can help you look at the optimum way to structure your business and, if relevant, grant funding. This will help ensure that the SME R&D tax credit is always used where possible, but RDEC is not missed as an opportunity.

For accounting periods starting on or after 1 April 2024, loss making SMEs will need to consider whether they are eligible for the R&D intensive SME scheme and if not claimed under the merged RDEC scheme.