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

Full Explanation

In the UK, the R&D Tax Relief scheme allows companies to claim relief on qualifying R&D costs, including staff costs, materials, and subcontracted R&D. The relief is either a deduction (loss-making companies) or a credit (profitable companies). Loss-making companies can claim an R&D Tax Credit (R&D Fraction Scheme), which can result in a cash rebate of up to 14.5% of qualifying costs. For a startup spending £1M annually on R&D with no profit, the credit could be £145K cash back — material funding. The US R&D Credit (Section 41) is similar, 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, the UK R&D Fraction Scheme explicitly aids loss-making companies. Claiming requires documenting your R&D activities (project descriptions, staff time logs, cost tracking) — most advisors recommend keeping contemporaneous records to support claims. For venture-backed startups, working with an advisor to maximise R&D claims can add 10-15% to total capital available.

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