This article explores the key features of the RDEC scheme, including the R&D tax credit rate, qualifying activity and qualifying expenditure for the relief. It explains how large companies and SMEs should use the incentive, and how ForrestBrown can help you maximise your RDEC R&D tax credit claim.
- The key features of RDEC – the rate, qualifying activities and qualifying expenditure.
- How to claim if you’re a large company (greater than 500 staff and either more than €100 million turnover or €86 million gross assets).
- How to claim if you’re an SME (fewer than 500 staff and either less than €100 million turnover and €86 million gross assets).
Key features of RDEC
What is RDEC?
RDEC is one of two R&D tax credit incentives offered by the UK government to promote private sector investment in innovation. The tax relief is for large 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: it 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.
- An RDEC tax credit is worth 13% of your qualifying R&D expenditure.
- The credit is taxable at the normal Corporation Tax (19%) rate which effectively means the benefit is worth 11p for every £1 you spend on qualifying R&D.
- The benefit can be shown ‘above the line’ (ATL) – this means it is visible as income in your accounts.
- The credit is offset against your tax liability or, in some circumstances, is payable in cash.
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 visible 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 large 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.
What is the RDEC rate?
The RDEC rate is 13%. However, because the RDEC rate is paid net of Corporation Tax, the RDEC effective rate you receive is worth 11p for every £1 spent.
The RDEC rate was increased in the Spring 2020 Budget from 12% to 13%. This was the third time the RDEC rate has increased since its introduction, which is great news for companies using the incentive. Read our history of R&D tax incentives timeline for more information.
Calculate the potential value of an RDEC claim for your business with our RDEC claim calculator.
The following graph shows how the average RDEC claim value has increased its introduction.
RDEC qualifying activity
RDEC uses the guidelines produced by the Department for Business, Energy and Industrial Strategy to define the activities that constitute R&D. These are sometimes referred to as the ‘BIS’ or ‘BEIS 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 to all companies whatever their size or sector.
If your company is taking a risk by 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, 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.
Qualifying expenditure for RDEC is:
- Staff costs, including salaries, employer’s NIC and pension contributions, as well as some reimbursed business expenses.
- Money spent on Externally Provided Workers (EPWs) and some subcontractor costs.
- Expenditure on materials and consumables like light, power and heat that are used up or transformed in the R&D process.
- Some types of software costs.
- Money paid to clinical trial volunteers.
- Contributions to independent research.
What costs qualify for R&D tax credits?
Further detail on each of these qualifying categories is available in our Knowledge Bank.
Large companies are typically more complex than SMEs. This means that identifying qualifying expenditure in a large company’s accounts can be more demanding – especially because the sums involved are often a lot larger. It pays to have considerable technical firepower on your side to ensure your claim value is maximised, and supported with a robust methodology.
RDEC and large companies
Whether you are handling your RDEC claim in-house or outsourcing it, ForrestBrown’s team of chartered tax advisers, technical specialists and ex-HMRC inspectors can add value to your business. In this section, we explain how to determine how 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 13% 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:
- Discharge any liability to Corporation Tax for the accounting period.
The gross RDEC rate (13%) is offset against your Corporation Tax liability for the period to which your R&D tax credit claim relates.
- 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.
- Limit to PAYE/NIC of R&D staff.
The payment of the cash credit is subject to a cap based on the PAYE and NIC paid to HMRC relating to the employees included in your RDEC claim. Amounts in excess of the cap can be carried forward for use in future periods.
- 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.
- 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.
- 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.
- Cash credit payable to company.
Example RDEC calculation
Your exact benefit will depend on the qualifying R&D activities and costs that our team of expert chartered tax advisers identify. The following illustration provides an example of how RDEC is calculated based on £1,000,000 of qualifying R&D expenditure.
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 service for large companies that can include managing the full R&D tax credit claim or focusing on a specific aspect of the RDEC claim process.
Sometimes large companies that are already claiming R&D tax credits ask us to focus our expertise on a specific aspect of their claim process. For example:
- A review of your claim process to identify opportunities and risks, maximise value and increase efficiencies.
- 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. You might like to read an example of A ForrestBrown record-keeping project in action.
- Facilitate training workshops for your in-house finance or technical teams.
Our senior team is highly-skilled and made up of chartered tax advisers, experienced sector specialists and former HMRC inspectors. They have considerable experience advising large, complex 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 and the specific challenge 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 optimised 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, your first consideration will be the SME R&D tax credit scheme. It offers a higher rate of relief – up to 33% compared to 11% 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 or are unsure how to access it.
However, our team of chartered tax advisers, sector specialists and ex-HMRC inspectors are adept at ensuring that RDEC is correctly applied in such circumstances – either alongside the SME R&D tax credit or instead of it.
Our technical firepower means we can deal with any level of complexity and it allows us to strategically use both R&D tax credit incentives together for maximum impact.
SME status and RDEC
As an SME, you should be interested in RDEC if:
- You have received a grant or subsidy.
- You have carried out subcontracted R&D on behalf of a large business.
We will look at each of these scenarios 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. 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.
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 how an SME uses the R&D tax credit schemes.
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, How is an R&D tax credit claim affected by SMEs subcontracting to other SMEs with the same shareholders?, explores this issue in further detail.
What is the difference between RDEC and the SME R&D tax credit?
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 you are grant-funded. In addition, unlike the SME relief, you can usually claim for R&D you are carrying out as a subcontractor.
Differences in R&D tax credit rate
The rate of relief for RDEC is less generous than the SME R&D tax credit – 11% compared to 33%. That said, claims made by large companies often involve much larger qualifying expenditure meaning the benefit they receive is also higher.
HMRC’s latest statistics show the average claim made by a large company using RDEC is worth £632,931 compared to £69,921 for SMEs using RDEC.
Differences in qualifying costs
The costs that you can include for subcontracted R&D differs 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.
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.
You can read more on the benefits of RDEC in relation to the SME R&D tax credit scheme in our KnowledgeBank.
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.
How we make a claim
We have developed an award-winning approach to R&D tax credit claims. It is robust enough to stand close scrutiny from HMRC, and adaptable enough to be tailored to our clients, whatever their size, sector or structure.
ForrestBrown’s view: RDEC for all
HMRC’s latest R&D tax credits statistics (2018-2019) show that the number of companies making a claim via RDEC is increasing. This success of RDEC is most evident when we look at the number of SMEs accessing it. Claims for RDEC by SMEs are up 400% since its introduction in 2013.
For some time now, we have argued for RDEC to be made accessible to all qualifying companies. We believe that introducing the RDEC model for SMEs would reduce the overall complexity of the R&D tax incentives. The government would still be able to target relief to SMEs. And it could offer an SME RDEC rate to deliver a benefit comparable to the SME R&D tax credit incentive.
In our view, this change would boost the number of claims made by SMEs for the same reason (see benefits of RDEC above) as it has done for large companies so far.
To discuss how our team of chartered tax advisers, sector specialists and former HMRC inspectors can help you with RDEC, please get in touch. Whether you want us to review a previous claim, make a claim on your behalf, or plan a future claim, our service will give you confidence your position is optimised and your relationship with HMRC protected.
What to consider when choosing a new R&D tax credit adviser
When choosing a new R&D tax credit adviser, you need to assess a firm’s experience of R&D tax credits, their understanding of the wider tax landscape and their industry knowledge. It doesn’t matter if it is your first time using an R&D tax adviser or not, you should still carry out this assessment. You will also want to find out how much of your time will be required, the chances of things going wrong, the terms of engagement, and how relationships will work between them and your current advisers.