The UK R&D tax relief regime was introduced for Small & Medium Sized Enterprises (“SMEs”) from 1 April 2000 and for Large Companies from 1 April 2002. As the twelfth and tenth anniversaries respectively have just recently passed, a number of new measures and enhancements have been introduced that will improve the regime's attractiveness, which is great news for companies in the UK and NI investing in R&D.

What is a SME for R&D Tax Relief Purposes?

For the purposes of the R&D tax relief regime only, a company is defined as an SME where it meets the following tests:

• Less than 500 employees; and
• Less than €100m Turnover; or
• Less than €86m Gross Assets.

Where a company does not meet these tests it is considered large and must apply the rules under the R&D tax relief regime for large companies.

What is the Experience of Northern Ireland Companies Claiming R&D Tax Relief?

The UK Government, in introducing the regime, recognised that encouraging innovation was a vital component in the strategy for improving the UK's productivity, performance and competitiveness. However, in reviewing the level of uptake of R&D tax relief for companies in Northern Ireland, where the majority of companies fall within the SME definition, it has only been in the past three to four years that the level of claims has substantially increased.

In 2007 Northern Ireland was reported as having the lowest level of R&D tax relief claims of any region in the UK. That position has improved markedly since then, with around 210 companies now claiming in excess of £200m in enhanced deductions.

One of the factors contributing to the low levels of R&D tax relief claims was the perception that the rules applied only to pharma-ceutical or bioscience companies, but this is far from the reality. Such claims are also relevant to a range of companies across a number of sectors and industries, covering food and drink, manufacturing, engineering, ICT and aerospace.

Recent Changes to the R&D Tax Relief Regime

With effect from 1 April 2012, a number of changes have been made to the R&D tax relief regime which further enhances its attractiveness.

These changes involve the following measures:

• Removing the rule limiting a company's repayable R&D tax credit to the amount of PAYE and NIC it pays. The repayable R&D tax credit is available to a company investing in R&D, but incurring tax losses which can be surrendered in exchange for a cash payment, where the claim is made under the SME rules;
• Removing the £10,000 per annum minimum expenditure condition; and
• Increasing the additional deduction for R&D tax relief by SMEs by a further 25% making the total deduction 225% of actual expenditure – meaning that £100,000 of qualifying R&D expenditure by an SME equates to a corporation tax saving of £30,000, where the company pays Corporation Tax at the rate of 24%.

To encourage R&D activity, it has also been announced that there will be an “above the line” R&D tax credit with a minimum rate of 9.1% before tax, to be introduced from 1 April 2013 – similar to that in operation in the Republic of Ireland. This change will allow the benefit of the tax credit to be recorded in the company's accounts in profit before tax, rather than as a reduction in the tax charge, as is the case now, and will provide an increased incentive to the individuals who control R&D budgets.

What is the Benefit of an R&D Tax Relief Claim Under the SME Scheme?

Using the example of £100,000 of qualifying R&D costs for the purposes of claiming R&D tax relief, a claim under the SME Scheme would result in the following:

R&D tax relief claim under the SME Scheme

Qualifying R&D spend	£100,000
Enhanced deduction under SME Scheme	£125,000
Total deduction	£225,000
Corporation tax saving at 24% (£125,000 @ 24%)	£30,000

Where the company is investing in R&D and prerevenue, incurring tax losses, in making an R&D tax relief claim under the SME Scheme these losses will be increased further, and can be surrendered to HM Revenue & Customs in exchange for a cash payment. Assuming the same level of £100,000 of qualifying R&D expenditure with no other income and expenditure, the company will incur a tax loss as follows:

Repayable R&D tax credits under SME Scheme

Qualifying R&D spend	£100,000
Enhanced deduction under SME Scheme	£125,000
Tax Losses incurred	£225,000
Repayable R&D tax credits at rate of 11% (£225,000 @ 11%)	£24,750

The amount of tax loss that can be surrendered is the lower of:

1. The trading loss that is unrelieved; or
2. The enhanced R&D expenditure.

The company has the choice of either surrendering the tax losses in exchange for the repayable R&D tax credit, as outlined above, or carrying forward the enhanced tax losses to be offset against the first available profits. The corporation tax saving in the future would be at the prevailing rate of corporation tax. Therefore it would be worth considering whether it is preferable to have a cash repayment now at the rate of 11% or to carry forward the tax losses benefiting from a higher rate of relief, though corporation tax rates are reducing in future.

How Does the Claiming of a Grant for R&D Impact on R&D Tax Relief?

Additionally, it is worth highlighting that where a company has availed of an R&D Grant for a particular R&D Project, for example from Invest Northern Ireland, it is still possible to claim R&D tax relief on that Project in addition to the Grant funding.

The rate at which R&D tax relief may be claimed will be dependent on the nature of the R&D Grant and whether it falls within the definition of a “Notified State Aid”.

Where a company avails of a Grant for R&D which is defined as a Notified State Aid, the company's expenditure on the project which qualifies for R&D tax relief will attract relief at the large company R&D tax relief rate of 130%, which based on a qualifying spend of £100,000 still equates to a corporation tax saving of £7,200 at a corporation tax rate of 24%.

In this situation, where a SME company in receipt of a Notified State Aid R&D Grant falls into the large company R&D tax relief regime, the cash-back option outlined above will not be available. Companies seeking to apply for such Notified State Aid R&D Grants should therefore consider the impact on its ability to claim R&D tax relief, and the impact of claiming both.

Capital Spend on R&D Tax Relief Projects

The rate of R&D tax relief for SMEs at 225% from 1 April 2012, and the Large Company rate of 130% applies to revenue spend on qualifying R&D projects, however for capital spend Research & Development Allowances (“RDAs”) at the rate of 100% are available. This is particularly attractive in view of the demise of Industrial Building Allowances, and the reduction in rates of writing-down allowances for general plant and machinery to 18% from 1 April 2012 for companies.

The costs incurred on buildings, structures and plant in establishing or adding to an R&D facility are likely to be fairly significant, and therefore the availability of RDAs serve to help the cash-flow of investing in the overall project.

Is the R&D capable of being Patented?

As outlined in the July 2012 issue of tax.point, a further development relates to the Government confirming that it will introduce a Patent Box regime. Over the last decade, six European Union countries have adopted Patent Box tax regimes designed to increase innovation activities, create and maintain high-value jobs, and foster global leadership in innovation.

The essence of the legislation is to allow companies to elect to have a 10% rate of Corporation Tax on all profits attributable to qualifying intellectual property (“IP”). This change is good news for companies with patented IP in the UK or a UK company that could patent their technology in the future. These new rules will benefit companies from a wide range of industry sectors.

The full benefit of the regime will be phased in over the first four financial years following commencement on 1 April 2013. In the first year the proportion of relevant profits to which the 10% rate will apply is 60% and this will then increase annually to 100% from April 2017.

In addition to claiming R&D tax relief on the costs as they are incurred in developing new advances, there will also be the opportunity to consider whether the developments can be patented, and to benefit from a lower corporation tax on profits derived from the patent.

So, looking forward there are a number of extremely generous reliefs available to companies in the UK investing in R&D to stay ahead of the game, and in striving to differentiate their products and services. Any business engaging in developing new products or processes should consider whether an R&D tax relief claim can be made, and whether the new technology being developed is capable of being patented to avail of the extremely generous 10% corporate tax rate on profits attributable to the patent.

Caroline Keenan is Tax Director with ASM Chartered Accountants

Tel: +44 (0) 2890 249 222

Email: caroline.keenan@asmbelfast.com

Website: http://www.asmaccountants.com