Investing in R&D
A lot of focus in the media is placed on the R&D tax relief schemes, which incentivise operational costs such as labour and materials; less is said about maximising relief for capital costs linked to R&D.
For a lot of companies, capital allowances are the single largest adjustment available to reduce taxable profits (typically only R&D tax relief rivals it for quantum); however, as capital allowances and R&D tax relief are often separately considered, many R&D companies are not fully maximising the capital allowances available to them.
R&D capital allowances (RDAs) are less known than other capital allowances such as Plant and Machinery Allowances (PMAs) and the Annual Investment Allowance (AIA). In spite of this, they offer a 100% deduction for any capital expenditure on R&D which is as generous as capital allowances get. Expenditure eligible for RDAs includes the cost of purchasing capital equipment for use in R&D activities, and building, extending, refurbishing and sometimes purchasing property in which R&D activities take place. The key here is ‘R&D activities’ – RDAs work from the same definition of R&D that R&D tax reliefs do, if you are making a claim for R&D tax relief, you are likely to qualify for RDAs.
It is not possible to consider RDAs in isolation, this is because in order to optimise your relief for capital costs you need to understand the different types of capital allowances and how they interact. Each case needs to be considered on its own facts and circumstances. For example, the AIA was introduced in 2008 to simplify the process of calculating capital allowances for smaller businesses by allowing all plant and machinery costs, up to a set maximum value, to be deducted in full for tax purposes. Since its introduction, it has been the subject of much tinkering – rising from an initial level of £25k per annum right up to £500k, and most recently down again to £200k. Effectively, the AIA and RDAs are both types of capital allowance which offer a 100% deduction for certain capital expenditure; expenditure may fall into both but can only be claimed under one.
So…if they both offer the same rate of relief, why worry about RDAs?
They are not always the same type of expenditure.
For AIA, that capital expenditure has to be incurred on plant or machinery, i.e. costs that would otherwise fall under the far less generous PMAs. RDAs however, may be claimed for any capital expenditure on R&D, excluding the cost of land. Whilst this may include the same plant and machinery that you can use the AIA for, it also includes build costs, which do not generally attract any other form of tax deduction.
If you are spending more than £200k per annum.
From 1 January 2016, the AIA will settle at a permanent level of £200k per annum, subject to future tinkering. This means costs in excess of this amount drop into PMAs, attracting 18% on a reducing balance basis at best (NB. You never get to fully deduct the costs and it takes in excess of 20 years to get most of the value back). And you only get one AIA to share per group of companies. There is no limit on RDAs, so for companies spending in excess of £200k, RDAs can potentially sweep up the balance to maximise the deduction.
Any company making, or considering, a claim for R&D tax relief and incurring capital expenditure should think about RDAs. They can’t always help, but if you don’t bother and miss the deadline for claiming (2 years after the end of the accounting period), you have missed your chance permanently.
To clarify these concepts, we’ve created a case study that illustrates the interaction between RDAs and R&D Tax Relief in practical terms.
Case study: Happy Engineering Ltd
Happy Engineering Ltd has owned and operated from a factory for a number of years. Happy is approached by a firm of R&D tax relief specialists about making claims for its manufacturing development work, and subsequently goes on to make three successful claims for relief, generating tax credits of around £150k. Happy decides to use this money to invest in furthering its manufacturing capability and invests in new manufacturing equipment, which requires an extension of the factory. In all, Happy spends £200k on the building work and new equipment, as well as a further £50k in labour costs to get the machine up and running and working efficiently. Happy’s R&D tax relief adviser investigates the eligibility of the labour costs for R&D tax relief, whilst Happy’s accountant prepares the company tax return and capital allowances calculation. As a result, equipment and other plant totalling £100k is allocated to the AIA and deducted in full. The balance of the capital expenditure, relating to the building work, is not deducted.
Had Happy made the link between its R&D activities and its capital expenditure, it might have spotted that some of its equipment is used for R&D purposes. Such equipment is used during manufacturing trials and – more generally – the factory is in part there to provide facilities for carrying out R&D, the same R&D for which it is making R&D tax relief claims. Although the equipment and the facility are also used for normal manufacturing activities (not R&D), a proportion of the capital expenditure should be eligible for RDAs at 100%. Compared to taking no tax deduction at all, this is quite a thing to have missed.
Happy’s R&D tax adviser visited the site during preparation of the R&D tax relief claim and spotted the shiny new factory extension and equipment and raised the possibility of claiming RDAs. The adviser then went on to work with the company’s accountant to apportion the costs, based on the work done to prepare the R&D tax relief claim. As a result of this approach, £45k of the previously unrelieved build costs were allocated to RDAs. This reduced the company’s taxable profit such that its R&D tax relief claim created a tax loss, which it surrendered for a payable credit of £5,000. A happy result.
Get a specialist advice on your R&D activities
Like most things tax, capital allowances are not as simple as they try to be. The only way to truly ensure that you have maximised the reliefs available for your capex is to consult with someone who knows how all the different rules work. The conundrum is that that typically capital allowances specialists know capital allowances, but not R&D. R&D specialists know R&D, but are not generally well versed in capital allowances.
With a collective tax experience of over 190 years, ForrestBrown are a firm of chartered tax advisers specialising exclusively in R&D tax incentives. As such we have a thorough understanding of tax and we have technical knowledge of R&D. If you believe you might qualify for R&D tax relief, RDAs or both get in touch with us for a free consultation on your potential.