What is R&D tax credit and why do startups care?

Full Explanation

An R&D tax credit is a corporation tax incentive on qualifying research and development spend. In the UK, the merged scheme gives a 20% taxable credit, and loss-making R&D-intensive SMEs can claim ERIS instead, which can pay out cash.

For accounting periods beginning on or after 1 April 2024, the merged R&D expenditure credit (RDEC) and enhanced R&D intensive support (ERIS) replace the old SME and RDEC schemes (HMRC guidance; check it for current rules). The merged RDEC is 20% of qualifying expenditure for a company of any size; it is taxable, so a company paying the 25% main rate keeps about 15%. Qualifying costs include staff, externally provided workers, subcontractors (generally 65% of payments to unconnected parties), consumables, software, data and cloud computing. A loss-making SME whose qualifying R&D is at least 30% of its total relevant expenditure can claim ERIS instead: an extra 86% deduction, and a payable credit of 14.5% of the surrenderable loss, which is not taxable. For an R&D-intensive startup with £1M of qualifying spend and no profit, surrendering the full enhanced loss could produce up to about £270K in cash, material funding; the merged RDEC can also be paid out to a loss-making company, subject to a cap linked to its PAYE and National Insurance. The US R&D Credit (Section 41) works differently, allowing credits of up to 20% of incremental R&D costs. Qualifying activities include developing new software, improving existing products, and conducting technical experiments (but not market research or basic business operations). Many startups significantly underutilise these credits because they are not profitable and assume credits do not apply. In fact, both ERIS and the merged RDEC can produce a payable credit for a loss-making company. Claiming requires documenting your R&D activities (project descriptions, staff time logs, cost tracking) — most advisors recommend keeping contemporaneous records to support claims. First-time claimants, and companies whose last claim was more than three years earlier, must notify HMRC within six months of the end of the period of account, every claim needs an additional information form, and HMRC scrutiny of claims has increased, so take advice from a qualified adviser before claiming.

For how a claim interacts with development costs capitalised in the accounts, see R&D tax relief vs capitalisation.

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