Tax Bulletin - Special Edition
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Revenue Policy Sam Mitha Your Ref: This special edition of "Tax Bulletin" is devoted to a description of the UK's three new tax incentives (reliefs) for research and development (R&D). They are
Research and Development plays a key role in the growth of a modern, knowledge based economy - both in delivering new, competitive products and improving productivity for the country as whole through spill-over benefits. The R&D tax credits are designed to help UK business invest for the future. The vaccines research relief has a different focus - it is a humanitarian measure, designed to promote research into treatments for the killer diseases of the developing world. This special edition of "Tax Bulletin", follows up a series of seminars for companies given jointly by the Inland Revenue, the Treasury and DTI. It is intended to provide information to companies and their tax advisers about the new provisions so that those entitled to benefit from them are enabled to claim. We hope that you find this special edition of "Tax Bulletin" useful. Sam Mitha For many years tax relief has been given for virtually all the costs incurred by businesses on scientific research. Current expenditure received 100% relief under normal tax rules, and capital expenditure was given equivalent treatment in the form of "Scientific Research Allowances". These were renamed "Research and Development Allowances" in April 2000. At that time, some minor alterations were made to these allowances. Also in April 2000, R&D tax credits were introduced for companies
which are small or medium enterprises (SMEs). From 1 April 2000, SMEs
can claim an extra tax deduction of 50% of their qualifying current R&D
spending. Loss making SMEs can surrender their R&D losses in exchange
for cash. further relief, specifically targeted at research into drugs and medicines for TB, malaria and AIDS/ HIV - the so called "killer diseases" of the developing world - gives an additional 50% tax deduction (and repayments for loss making SME companies). The detailed rules of the R&D tax credits for large companies and for SMEs are slightly different, although many of the basic definitions are the same. The essential difference is that the SME scheme is targeted at the company that commissions the work and takes the risks while the large company scheme is aimed at those companies that undertake the R&D. This special edition of "Tax Bulletin" sets out the basic concepts of the R&D tax credits for both SMEs and large companies, and also those of the vaccines tax credit. Details of the long established R&D allowances are not covered. For a full description of all aspects of the schemes, please see the Inland Revenue's guidance, available online at www.inlandrevenue.gov.uk/r&d What is a small or medium sized company? For the purposes of the three R&D reliefs we have incorporated into our legislation the European Commission definition of a small or medium sized enterprise. This is set out in Commission recommendation 96/280/EC of 3 April 1996. company is a small or medium-sized enterprise (SME) if it
and
and
An independent enterprise is one not more than 25% of whose capital or voting rights are owned by one enterprise or jointly by several enterprises which are not SMEs. For example, a company 40% of whose capital is owned jointly by large companies is not an independent enterprise. Holdings by venture capital companies, institutional investors and public investment corporations are ignored, unless they exercise control over the company. Where there is a change in the status of a company due to a change in the financial limits or the number of employees there is a year of grace before this takes effect. Example Mosler Ltd draws accounts up to 30 June each year. In the year 20 June 2003 it has 235 employees and this is increased to 260 in the following year and 265 in the year to June 2005. It fails the SME tests in the year to June 2004 but is held to be an SME in that year and only becomes a large company in the year to June 2005. A large company is a company that does not qualify as a small or medium-sized enterprise. The three reliefs 1. R&D Tax relief for large companies R&D tax relief for large companies is available for qualifying R&D expenditure incurred on or after 1 April 2002. (Schedule 12 Finance Act 2002.) The relief is given as an extra deduction - the scheme allows a large company to deduct an extra 25% of its revenue spending on R&D when it calculates its taxable profits. Capital spending on R&D does not qualify - it qualifies instead for 100% research and development allowances. Relief is due where a company spends more than £25,000 on qualifying R&D expenditure in a 12 month accounting period. The £25,000 is adjusted proportionately if the accounting period is not 12 months long. Example Green Industries Plc is a large company. In its 12 month accounting period ended 30 April 2003 it has income of £30 million and expenses of £20 million including R&D spending of £4 million. Its accounts show a trading profit of £10 million (income £30 million less expenses £20 million). Its taxable profits, if there are no other adjustments for tax purposes, are £9 million (profits per accounts £10 million less R&D tax relief £1 million [= 25% x £4 million]). Where one company subcontracts work to another, the relief goes to the company that does the work rather than the company that pays for the work to be done. Although the scheme is aimed at large companies, a small or medium sized (SME) company can obtain the relief (at the large company rate) if it does R&D as a sub-contractor to a non-SME. Usually, this would be a large company, but it could include, for example, a Government department or a university. Expenditure must be incurred on or after 1 April 2002. Pre-trading expenditure is normally treated as incurred on the day that trading begins (Section 401 ICTA88). This rule is overridden for the R&D relief for accounting periods straddling April 2002 - it is the date on which the pre-trading expenditure is actually incurred rather than the date on which it is treated as incurred that matters. R&D tax relief for an accounting period is based on the qualifying R&D expenditure for that accounting period. Expenditure is qualifying R&D expenditure for an accounting period if it is deducted in computing trading profits for that period. In certain circumstances a company may choose to defer the expenditure on R&D and not set it against the profits of that period. Where a company treats R&D expenditure in this way by including it to the balance sheet when it is incurred, that expenditure does not qualify for R&D tax relief when it is spent but when it is included it as a deduction in the profit and loss account (provided all the other conditions are satisfied in the period it is released). Expenditure that can be deducted once the company starts trading is included
in the qualifying R&D expenditure for the first period of trading
provided that it is incurred on or after 1 April 2002. Where an accounting period straddles 1 April 2002, it is split into two separate accounting periods and the £25,000 limit applies to the period that begins 1 April 2002. Example Alchemists Plc is a large company. It has an accounting date of 30 June. In the year ended 30 June 2002 it spends £60,000 on consumable stores for its research at a rate of £5,000 a month. It cannot claim R&D tax relief for the year ended 30 June 2002 even though it has spent more than £25,000 on R&D in that year. It has only spent £15,000 on consumable stores in the three month period that begins 1 April 2002. For a large company there are three types of qualifying R&D expenditure -
Qualifying expenditure on direct research and development is expenditure a company incurs on R&D work either for itself or, as a sub-contractor, for some other person. In either case, the company carries out the work itself: it does not pay someone else to do it. The expenditure must satisfy all of these conditions;
This means that a large company may claim relief for research carried out by it on behalf of another large company, a charity, a government agency or a company resident overseas - but not for research carried out on behalf of an SME1, because the SME itself will be covered by the R&D tax relief scheme for SMEs Example Green Enterprises Plc is a large company. The government of Freedonia contracts Green Enterprises Plc. to do some R&D for it. Green Enterprises spends £2.4 million doing that research in its accounting year ended 30 April 2004. Green Enterprises can claim an extra deduction of £600,000 (= 25% x £2.4 million) when it calculates its taxable profits for the year ended 30 April 2004. Green Enterprises Plc would also be able to claim R&D tax relief if the R&D was contracted out to it by another large company or a charity or a UK government agency. Qualifying expenditure on research and development sub-contracted to certain organisations On occasions, companies may sub-contract part or all of their R&D to individuals or to organisations that cannot themselves benefit from the R&D tax relief. To accommodate such situations the legislation allows the contracting large company to claim relief on payments to certain persons and organisations who cannot benefit from R&D tax relief in their own right (but not, in general, when the work is sub-contracted to another company which could itself benefit). The R&D must be carried out by an individual, a partnership of individuals, or a qualifying body (see page 15). These persons and organisations do not have to be resident in the UK. Such expenditure must satisfy the following conditions:
"Directly undertaken on behalf of a company" means that the sub-contractor should do the work itself, not subcontract it in turn to another party. Example Green Enterprises Plc. wants to have some research done into new materials but instead of doing it itself it makes a contract with Necessity Inc., a company resident in the USA, to do the research for it for £3 million. It cannot claim R&D tax relief on the £3 million it pays to Necessity Inc. because Necessity Inc. is not an individual, a partnership of individuals or a qualifying body. Green Enterprises Plc could claim R&D tax relief if it paid the £3 million to a university, a scientific research organisation, an individual or a partnership of individuals, none of which can claim R&D tax relief, to do the research for it. Contributions to independent research and development qualify for R&D tax relief if they are made to a qualifying body, an individual or partnership of individuals. The R&D towards which the contribution is made must be relevant research in relation to the company making the contribution. The sort of contributions this covers are payments which fall outside a contractual framework. However, the R&D must still be relevant R & D for the company that makes the payment. Example Green Enterprises Plc. hears on the grapevine that the University of Middle Earth is pursuing a line of research that is relevant research for Green Enterprises Plc and so it makes a payment of £5 million to the university department that is carrying out the research. Green Enterprises Plc. can claim R&D tax relief on that payment. Such contributions do not qualify for R&D tax relief if
There are special rules for insurance companies. An insurance company that carries on a life assurance business and qualifies as an SME is treated as a large company for the purposes of R&D tax relief. This means that it gets R&D tax relief at the large company rate (and subject to the rules applying specifically to SMEs) rather than the SME rate. Groups of companies may divide R&D work around the group, depending on where particular expertise resides or where facilities are available. When this happens, work undertaken by one of the companies may fall outside the definition of R&D because, seen only in the narrow context of the company undertaking the work, it is of a routine nature. For example, one group company may carry out testing procedures for all the other companies in the group. For the a company doing this, the testing in itself is not R&D but if it were done by the company that had carried out the basic R&D it may be. When the contractor company and sub-contractor company are members of the same group, the activities of the contractor and sub-contractor are taken together in deciding whether the activities of the sub-contractor company are relevant R &D. This means that if the sub-contractor company's activities would have amounted to R&D if the contractor company had carried them out itself, the sub-contractor company's activities are relevant R&D for it and it can claim R&D tax relief. This only applies where R&D is contracted by another group company. It does not apply to activities contracted out to unconnected companies. Refunds of payments or contributions A company that has sub-contracted R&D or made a contribution to independent R&D may receive a refund of its payment to the sub-contractor or its contribution. When that happens, an additional 25% of the refund is treated as Case 1 Schedule D income of the accounting period in which the refund is made. 2. R & D tax relief for small or medium sized companies (SME)s Outline R&D tax credits for small or medium sized companies (SMEs) were introduced in 2000 (Schedule 20 Finance Act 2000.) R&D tax relief for SMEs is available for qualifying R&D expenditure (see page 6) incurred on or after 1 April 2000. Only companies may claim. Relief is not due unless a company spends more than £25,000 on qualifying R&D expenditure in a 12 month accounting period. Non qualifying expenditure such as the purchase of capital assets is ignored when calculating whether the £25,000 limit has been reached. The £25,000 is adjusted proportionately if the accounting period is not 12 months long. For example, if the accounting period is 10 months long the limit is £20,491 = £25,000 x 10/12. If an accounting period straddles 1 April 2000 it is split and the periods before 1 April 2000 and from 1 April 2000 onwards are considered separately. R&D tax relief allows an SME to deduct an extra 50% of its qualifying current spending on R&D when it calculates its taxable profits. If a SME has a "surrenderable loss" for an accounting period for which it is entitled to R&D tax relief it may surrender the loss arising from the R&D to the Exchequer in return for a payment. This (and nothing else), strictly, is the "R&D tax credit", although the term has passed into more general use to describe both the relief in general and the similar relief for large companies - which does not have a payable element. Only revenue expenditure qualifies. As for large companies, capital expenditure on R&D qualifies for 100% research and development (capital) allowances. R&D tax relief is not due unless any intellectual property created as a result of the R&D is vested at least in part in the SME that carried it out. Normally, if a SME contracts out R&D to another person it is the SME that contracts out the work that may claim R&D tax relief rather than the person who does the R&D. This is unlike R&D tax relief for large companies, where in general it is the company that does the R&D that may claim the additional relief rather than the company that contracts it out. There are a few exceptional cases where a SME may claim R&D tax relief for work that it does as a sub-contractor. A SME may claim R&D tax relief for work contracted out to it if the contracting out is done by a large company or a charity, a government agency or a person resident overseas outside the UK tax net. However, when this happens the SME claims under the terms of the "large company" R&D tax relief rather than the SME scheme. If an SME makes claims under both schemes, its expenditure on its own behalf (for which it will claim under the SME scheme) and as a subcontractor (for which it will claim under the large company scheme) is aggregated for the purposes of the £25,000 yearly minimum in both schemes. Summary of differences between large company and SME schemes The rate of the extra R&D tax deduction in the large company scheme is 25% while the rate in the SME scheme is 50%. In the SME scheme a company can claim relief for payments that it makes to sub-contractors but in the large company scheme the relief normally goes to the company that carries out work as a sub-contractor. The exception is that a large company may claim relief for subcontract payments made to persons who cannot benefit from the relief themselves, such as universities, charities, and individuals In the large company scheme there is no requirement that any intellectual property rights arising from the research are vested in the company claiming the R&D tax relief. In the large company scheme subsidies received are not deducted from qualifying R&D expenditure. More precisely qualifying R&D expenditure of an SME company is expenditure that satisfies all of these conditions.
Pre-trading expenditure is normally treated as incurred on the day that trading begins (Section 401 ICTA88). This rule is overridden for the R&D relief for accounting periods straddling April 2000 - it is the date on which the pre-trading expenditure is actually incurred rather than the date on which it is treated as incurred that matters. R&D tax relief is not available for the part of any expenditure in respect of which a grant or subsidy (other than a notified State aid) is obtained. Example Southside Ltd is an SME. It receives a grant towards the cost of a new laboratory. R&D tax relief is available in full on its qualifying costs because the grant was not towards an R&D project. The grant will be taken into account if the company wants to make a RDA claim on the capital costs of the laboratory. If, however, Southside Ltd. receives a grant that covers 50% of the cost of an R&D project, that grant will be taken into account when R&D tax relief (and credit) is calculated. Only 50% of the spending on staffing costs and consumable stores will be taken into account in calculating the tax relief due, because the other 50% was subsidised. Where a project has received funding which is a notified State aid (see page 15) then no expenditure on that project can qualify for the R&D SME relief, which is itself a notified state aid. Notified state aids are usually government funded grants such as the SMART award, but not all government grants are notified State aids - for example, some funding under the SMART label is not notified State aid (e.g. grants for feasibility studies and microenterprise awards). If clarification of the status of a grant is needed, the body that has provided or arranged the funds should be able to help. Any intellectual property created as a result of the R&D to which expenditure is attributable must be vested in the company for R&D tax credit to be available. Intellectual property means
The IP does not have to be vested for a specified period of time and it may be held jointly with others. We also recognise that not all R&D activity results in any IP. A SME (the principal) may claim relief for payments to another person (the sub-contractor) for relevant R&D that it contracts out to that other person. The treatment varies depending on whether the two parties are connected or not. Principal and sub-contractor connected For the principal to claim the relief in the accounting period that payment is made, the sub-contractor must include
in its accounts for a period ending not more than 12 months after the end of the principal's accounting period in which it makes the payment. The principal can claim the relief on the lower of:
Example As in the example above, Southside Ltd. is an SME. It contracts with Heliotrope Ltd., an SME with which it is connected, for Heliotrope to do research into the design and construction of mobile solar powered watchtowers. In its accounts year ended 24 May 2003 it pays Heliotrope Ltd. £4 million for the R&D. Heliotrope Ltd. spends £3.5 million on staffing costs and consumable stores for the research it is doing for Southside Ltd in its accounts year ended 31 December 2003. It spends a further £1 million in its accounts year ended 31 December 2004. Southside Ltd. may claim R&D tax credit of £3.5 million, because that is the lower of the amount it pays Heliotrope Ltd., £4 million, and the amount that Heliotrope Ltd. spends on the R&D in its accounts year ended 31 December 2003. The £1 million that Heliotrope Ltd. spends in the year ended 31 December 2004 is ignored because that accounting period ends more than 12 months after 24 May 2003, the end of Southside Ltd.'s accounting period in which it made the payment. Principal and sub-contractor not connected The principal may claim R&D tax relief on 65% of the payment it makes to the sub-contractor. This reflects the fact that the payment will cover an element of profit for the sub-contractor and also any other non qualifying expenditure that may be incurred. If the principal and sub-contractor are not connected they may make a joint election to be treated as if they are connected. The election must be made by notice in writing given to an officer of the Board within 2 years of the end of the principal's accounting period in which the payment is made. Example If in the example above Southside Ltd. and Heliotrope Ltd. are not connected and do not make an election for connected persons treatment Southside Ltd may claim R&D tax credit of £2.6 million (= 65% x £4 million). Work sub-contracted to a SME Under the SME scheme, a SME may not claim R&D tax relief for work it does as a sub-contractor but in some cases it may claim under the large company scheme - see page 3 above. A SME company that
Example Abelard Ltd. is an SME. It draws up its accounts to 30 June each year. In the year ended 30 June 2001 its accounts show a trading profit of £1.5 million. In arriving at those profits it deducted R&D expenditure of £2 million. If it makes a claim for R&D tax credit it may deduct an extra £1 million (150% x £2 million = £3 million - £2 million already deducted) when it computes its taxable profits. Its taxable profits, if there are no other adjustments for tax purposes, are therefore £500,000 (Profit per accounts £1.5 million less extra deduction for R&D tax credit £1 million) A company may incur expenditure on R&D before it starts to trade. Normally pre-trading expenditure is treated by S 401 ICTA88 as incurred on the day that trading begins and so there is no relief for it until trading starts. R&D pre-trading expenditure for SMEs is an exception to this. If a company incurs qualifying R&D expenditure in an accounting period in which it is not trading the company may make an election to treat 150% of that qualifying R&D expenditure as a trading loss for that accounting period. The company can set this trading loss against any other profits it may have for that accounting period under S 393A(1)(a) ICTA88. For example, the company may receive interest in that accounting period. If it does, it can set the loss against that. he company can carry the loss back and set it against its profits for the previous 12 months under S 393A(1)(b) ICTA88 provided that it was entitled to pre-trading R&D tax credit for that earlier accounting period. The company can also surrender the loss as group relief or cash it in
for the payable R&D tax credit. The election to treat 150% of the qualifying pre-trading R&D expenditure as a trading loss for an accounting period must be made by notice in writing to an officer of the Board within 2 years of the end of the accounting period to which it relates. The company will not have accounting periods if it has not started to
trade. It is treated as having the accounting periods it would have had
if it had started to trade when it started the R&D activities. If the company claims to treat its qualifying pre-trading expenditure as a loss the expenditure is not treated as incurred on the first day of trading under S 401 ICTA88. Example Perception Ltd. is an SME. It has investment income of
£1 million a year. It starts to carry out R&D on 1 April 2001
although it is not trading. It incurs expenditure on staffing costs and
consumable stores at the rate of £30,000 a month. It starts to carry
on a trade derived from the R&D on 1 October 2002. he company makes an election to treat the pre-trading expenditure on R&D as a trading loss. It is treated as having a 12 month accounting period ended 31 March 2002 and so it must make the election for that period by 31 March 2004. It is also treated as having a 6 month accounting period from 1 April 2002 to 30 September 2002. The R&D qualifying expenditure for the accounting period ended 31 March 2002 is £360,000 (= 12 months @ £30,000 a month). Perception Ltd.'s trading loss for that accounting period is £540,000 (= 150% x £360,000) and it can set that loss against its investment income of £1 million. A payable R&D tax credit allows an SME to claim payment from the Inland Revenue. The basic rule is that an SME may claim a payable R&D tax credit for an accounting period in which it has a "surrenderable loss". The surrenderable loss for an accounting period is the lower of
Example. In its accounts year ended 24 May 2003, Southside Ltd. has qualifying R&D expenditure of £4 million and it makes a trading loss of £5 million. It surrenders losses of £2 million as group relief so that its unrelieved trading loss is £3 million (£5 million - £2 million surrendered as group relief). Its surrenderable loss for that accounting period is £3 million because that is the lower of its R&D relief £6 million (£4 million x 150%), and its unrelieved trading loss, £3 million. If a company claims R&D tax credit the Inland Revenue pays it an amount in respect of the credit unless
If there are outstanding Corporation Tax liabilities the R&D tax credit may be used to discharge them. If that happens the R&D tax credit is treated as paid to the extent that it is so used. If there is an enquiry into the company's return the Inland Revenue may withhold payment until the enquiry is completed: provisional payments may be made before the enquiry is completed. If there are outstanding amounts of PAYE and/or Class 1 National Insurance it may be possible to offset the payable credit against such liabilities. The amount of payable R&D tax credit to which a company is entitled for an accounting period is 16% of the surrenderable loss for that period. There is a limit to this. The R&D tax credit payable to a company for an accounting period may not be more than the company's PAYE and NIC liabilities for payment periods ending in that accounting period in respect of all employees. A payment period is a period that ends on the 5th of the month and for which the company is liable to account for income tax and NIC to the Inland Revenue. Where the company is a member of a group it is only the PAYE and NIC liabilities of the company making the claim that are taken into account. The total of the company's PAYE and NIC liabilities for a payment period is the total of
A payment of R&D tax credit is not income of the company. The company does not have to pay tax on it. Example Southside Ltd. claims R&D tax credit for its accounting period ended 24 May 2003. It has no outstanding CT liabilities and its PAYE and NIC payments are up to date. Its PAYE and NIC liabilities for that accounting period are £450,000. The company is paid £450,000, because that is the lower of £480,000, 16% of its surrenderable loss of £3 million for that accounting period, and £450,000, its PAYE and NIC liabilities. Thus only £2,812,500 of the relief is used leaving £187,500 to be carried forward. Restriction of consortium relief A company entitled to R&D tax relief may be owned by a consortium. In such a case if at least one of the consortium members is not a SME the company cannot surrender any losses as group relief to fellow consortium members that are not SMEs. Outline Vaccines research relief (VRR) was introduced by Finance Act 2002 (Schedules 13 and 14). However, at the date of writing (November 2002) it had not been approved by the European Commission as a State aid and therefore was not in force. If and when it is approved the Inland Revenue will announce the date that it comes into force, which will be specified in a Treasury Order2. VRR gives companies additional relief for spending on research and development (R&D) (see page x) into vaccines and medicines for the prevention and treatment of certain diseases. It is only available to companies. Individuals and partnerships of individuals cannot claim it. The relief allows companies to deduct an additional 50 per cent of qualifying current R&D expenditure when they calculate their profits for corporation tax. The relief will apply to expenditure incurred on or after the date specified by the Treasury Order. In determining whether expenditure was incurred after this appointed day, the rule in S 401ICTA88 (which treats pre-trading expenditure as incurred on the day the trade begins) is ignored. It is the date on which the expenditure was actually incurred and not the date on which it is treated as incurred that matters. The treatments and diseases covered are:
Research must be into the diseases in humans. Other treatments do not qualify for VRR. For example, research into a vaccine to prevent bovine TB would not qualify for VRR. VRR is not due unless a company spends more than £25,000 on qualifying expenditure on vaccines research in a 12 month accounting period. The £25,000 is adjusted proportionately if the accounting period is not 12 months long. For example, if a company has an accounting period that is 8 months long it must spend at least £16,777 (= £25,000 x 8/12) in that accounting period to qualify for VRR A company may incur expenditure that qualifies for both VRR and
Example Festival Pharmaceuticals is a large company. It has £4 million of qualifying expenditure on research into a treatment for malaria in its accounts for the year ended 30 June 2005. In addition to its normal deduction of £4 million from income, it can deduct a further £1 million (= 25% x £4 million) large company R&D relief, since this work is R&D, and £2 million vaccines research relief (= 50% x £4 million) giving a total deduction of £7 million. Companies can claim VRR for subcontract payments made to universities, charities and scientific research organisations, or for contributions to independent research carried on by such bodies. Companies may also sub-contract research to other companies. When this happens VRR goes to the company that sub-contracts the research rather than the company that carries it out (regardless of the size of the companies concerned). So a company can claim VRR on sub-contract payments it makes to other companies. SMEs not in profit can surrender any losses arising from VRR in return for a payment of a vaccines tax credit (VTC) equal to 16% of the "surrenderable loss" arising from the VRR (calculated in a similar fashion to that for the general SME R&D scheme). Example Inventions unlimited Ltd. is an SME. It spends £3 million on research into anti-HIV vaccines in its accounts year ended 31 May 2004. Those accounts show a loss of £5 million. It can claim
giving a total of £960,000. Thereare three types of qualifying expenditure - qualifying expenditure on.
VRR is based on the qualifying expenditure for an accounting period. There are different definitions of qualifying expenditure on direct or sub-contracted R&D for an accounting period for SMEs and large companies. This means that SMEs can claim VRR on pre-trading expenditure when it is incurred but large companies have to wait until the trade begins. Qualifying expenditure on direct R&D is expenditure incurred by a company on staffing costs (see page 13) or consumable stores (see page 14) for a qualifying R&D activity directly undertaken by the company and that satisfies the following conditions.
A qualifying R&D activity is R&D relating to certain specified diseases (see below). A company can claim VRR for its qualifying expenditure on R&D which it has sub-contracted to someone else. Qualifying expenditure on sub-contracted R&D is payments made by a company (the principal) for R&D contracted out by it to another person (the sub-contractor) that satisfy these conditions. There are two situations - either the sub-contractor is, or is not, a charity, university or scientific research organisation (a) Where the sub-contractor is a charity, university or scientific research organisation
These are the only conditions that have to be satisfied. (b) Where the sub-contractor is not a charity, university or scientific research organisation The above conditions also have to be satisfied but there are further
rules. These are the same as apply in the SME R&D scheme (see page
6)
to fund qualifying R&D activity that the body carries on provided that the R&D is related to a trade carried on by the company that made the payments. Expenditure on contributions to independent R&D is qualifying expenditure for an accounting period if it is incurred in that accounting period. Example, a company that manufactures vaccines may give a contribution to a charity that is carrying out research into a new AIDS vaccine. If it does that the company may claim VRR on the contribution. We use the definitions of "charity" from S 506(1) ICTA88 and of "scientific research association" in S508 ICTA88. The effect of these is to restrict charities & SROs to bodies located in the UK. There is no similar restriction in the case of universities. The general rule is that when an SME that is carrying on a trade is entitled to VRR for an accounting period the company may claim an additional deduction equal to 50% of the qualifying expenditure for that accounting period. In the exceptional case where the qualifying expenditure does not qualify for R&D tax credits for SMEs the company may claim a deduction equal to 150% of the qualifying expenditure for the accounting period. Pre-trading expenditure If a SME company is entitled to VRR for pre-trading qualifying expenditure for an accounting period it may elect to be treated as if that pre-trading expenditure is a trading loss it had incurred in that accounting period. The election must specify the accounting period for which it is made and be made by notice in writing to the Inland Revenue not later that two years after the end of the accounting period to which it relates. If the company is not entitled to R&D tax credit for the qualifying expenditure the trading loss is 150% of the pre-trading qualifying expenditure. These are the rules that apply where a company has treated pre-trading
qualifying expenditure as a trading loss
An SME can claim a tax credit, which is known as a vaccines tax credit (VTC), if it is entitled to VRR for an accounting period and has a trading loss or a pre-trading loss for that accounting period. When it claims VTC it receives a payment in exchange for the loss. The amount of the loss that may be surrendered in exchange for a payment of tax credit is called a surrenderable loss. The surrenderable loss for an accounting period is the lower of the unrelieved trading loss for that period and the VRR for that period. The unrelieved trading loss for an accounting period is the trading loss for that period less
- any amounts that could have been set against other income of that period and - any losses relieved in some other way, for example by being carried back against profits of an earlier accounting period. -Any losses brought forward from earlier accounting periods or carried back from later accounting periods are ignored. Example Drugs on demand Plc is entitled to VRR of £4 million for its accounts year ended 30 June 2003. It has losses brought forward £2 million and a trading loss of £3 million for that year. This means that its unrelieved trading loss is £3 million. The losses brought forward of £2 million are ignored. Its surrenderable loss is £3 million because that is the lower of its unrelieved trading loss, £3 million, and the VRR, £4 million. If a SME company claims VTC the Inland Revenue pays it the amount of the credit, at a rate of 16%, subject to the same conditions as for the SME R&D credit generally (see above). How VRR is given: large companies The rules are simpler for large companies (but they may not claim VTC). The general rule is that when a company that is carrying on a trade is entitled to VRR the company may claim an additional deduction equal to 50% of the qualifying expenditure for an accounting period. In the exceptional case where the qualifying expenditure is not deductible in its CT computations, the company may claim a deduction equal to 150% of the qualifying expenditure for the accounting period. For example, a company may incur expenditure on contributing to independent vaccines research that is relevant R&D but is not incurred wholly & exclusively for the purposes of its trade. If so, the company may deduct 150% of its qualifying expenditure in the accounting period in which it is incurred. How VRR is given - insurance companies There are special rules for taxing insurance companies and so there are special rules for VRR for them.They apply where the company's profits from life assurance business are taxed under Case III, V or VI Schedule D rather than Case I. If the company is taxed Case I Schedule D the normal rules apply. Refunds of payments or contributions A company that has made payments for sub-contracted R&D or made contributions to independent R&D may receive a refund of all or part of the payment or contribution. If it does, the appropriate amount is treated as Case I income. For SMEs the appropriate amount is
For large companies the appropriate amount is
Only research and development (see page 13) into vaccines and medicines for the prevention and treatment of certain diseases in humans qualifies for VRR. The specified diseases are tuberculosis, malaria and HIV/ AIDS.
The Treasury has powers by Regulation, to vary the prescribed clades, and to make provision further defining the qualifying R&D activity. These powers are necessary because particularly the HIV virus continues to mutate. However the number of specified diseases cannot be increased by Regulations. Research into any of these is qualifying R&D activity and qualifies for VRR provided that the other conditions are satisfied The definition of "research and development" A new definition of R&D for tax purposes was introduced by Section 68 and Schedule 19 FA 2000 and has effect from 1st April 2000. An activity will qualify as R&D for tax purposes if it would be treated as R&D under normal accounting practice for companies in the UK (Statement of Standard Accountancy Practice 13, SSAP13), as qualified by the "Guidelines on the Meaning of Research and Development for Tax Purposes" (see http://www.dti.gov.uk/support/taxcredit_b.htm) issued by the Secretary of State for Trade and Industry. The Guidelines have statutory force. They discuss in detail the meaning of R&D, and illustrate through explanation and examples the boundary between those activities that are, and are not R&D. Broadly speaking, an activity may qualify as R&D if it is characterised by work that contains an appreciable element of innovation and creativity in the fields of science and technology. The work can range from research into purely theoretical areas to applied research and experimental development directed towards a practical aim or product. It is research that aims to break new ground or to resolve scientific or technological uncertainties. R&D is "creative work undertaken on a systematic basis in order to increase the stock of knowledge…and the use of this knowledge to devise new applications." For an activity to qualify it must meet three criteria
R&D can include the development of prototypes and pilot plant to test the R&D, but commercial development without such scientific or technological investigation, or after the resolution of such uncertainties, is not R&D for tax purposes. Staffing costs Staffing costs are all amounts paid to directors and employees. In more detail, they are
Staffing costs attributable to relevant research and development are staffing costs paid to or in respect of, directors and employees directly and actively engaged in R&D. People directly and actively engaged in R&D are those actually undertaking the R&D, staff providing technical support and managers who plan and organise the programme of research. The costs of people more remotely involved such as those providing clerical or general administrative services are not staffing costs attributable to relevant research and development. These staff, despite being peripheral to the R&D, may be regarded as essential to the successful outcome of the activity. Nevertheless, their costs do not qualify. Whether an employee is directly and actively engaged in R&D is a question of fact based on the duties performed and not on the job title. "Directly and actively engaged" refers to hands on work. Hands-on work performed by an employee includes:
Supervisors and managers Supervisors and managers performing tasks such as described above as hands-on are also directly and actively engaged. In addition, time they spend directing the technical course of, or providing direct technical input into, the ongoing R&D activities can be considered as direct engagement in R&D. However, time they spend on non-technological management aspects of activities, such as long-term strategic planning, contract administration and other decision-making functions that do not directly influence the on-going R&D activities, is not considered direct engagement in R&D. The following are examples of qualifying and non-qualifying staff connected with a R&D project in the electronics industry:
If staff spend only part of their time on R&D, costs should be apportioned to arrive at the qualifying staff costs. If an employee spends more than 80% of his or her time on R&D, the whole cost qualifies. Conversely, if an employee spends less than 20% of his or her time on R&D none of the cost qualifies. These percentages are by reference to the accounting period. Expenditure on consumable stores is expenditure on materials and equipment used up in the R&D activity, but which are not in themselves incorporated or reflected in the product of the R&D. Supplies, materials, or equipment used only indirectly in the R&D effort e.g. related to general overheads such as administration will not qualify. Consumable stores are, by their nature comparatively short-lived, and spending on them will be revenue expenditure. For example, the consumable stores of a chemistry-based R&D project may include such items as disposable laboratory equipment (flasks, test tubes) and chemicals used in the R&D process, etc. This spending will be revenue expenditure and could qualify for R&D tax relief. But expenditure on a centrifuge will usually be on capital account, and will not qualify. Expenditure on heat, light, power, rent, rates, interest, lease payments
are not consumable stores Relevant research and development Relevant research and development for a company is research and development
"Medical research which has a special relation to the welfare of workers employed in a trade" does not include research undertaken for the benefit of the community as a whole unless, of course, it is pursued by a company whose trade includes developing new pharmaceuticals. A qualifying body is a charity, an institution of higher education such as a university, a scientific research organisation or a health service body. All of these classes are defined in legislation, and apply to the UK only. In addition, the Treasury may, by order, add individual bodies or classes of bodies to the list of qualifying bodies. A list of those bodies which have been so designated will be kept on the Inland Revenue website. A notified State aid is a State aid which has been notified to, and approved
by, the European Commission. Sometimes companies carry out work that is funded directly by an initiative
of the European Community. As the funding is not provided by a Member
State, it cannot be notified State aid. So although receipt of such funding
will constitute a subsidy and so reduce the amount of expenditure for
which a company can claim, for example, the SME tax relief, it does not
disallow it completely (unless the project is 100% subsidised). There is anti-avoidance legislation to prevent a company getting more R&D tax relief than it would normally be entitled to. R&D tax relief is not due for a transaction that forms part of arrangements entered into wholly of mainly for a disqualifying purpose. Arrangements are entered into wholly of mainly for a disqualifying purpose
if their object, or one of their main objects, is to let a company obtain
more R&D tax relief than it would otherwise be entitled to. To obtain the R&D tax reliefs, including payable R&D or vaccines tax credit, a company must make a claim in its tax return, form CT600. It would be useful if the accompanying computations provide a breakdown of the amount claimed and give a brief synopsis, in layman's terms, of the activities and the basis on which they constitute R&D. The claim may be made, amended or withdrawn at any time up to the first anniversary of the filing date for the return for the accounting period for which the claim is made. Interest is payable on a payable R&D tax credit from the later of
You may find it helpful to discuss the claim with the Inspector beforehand, especially if this is the company's first claim for any of the R&D reliefs. Content The content of Tax Bulletin gives the views of our technical specialists on particular issues. The information published is reported because it may be of interest to tax practitioners. Publication will be six times a year, and include a cumulative index issued on an annual basis.
Nothing in this Bulletin affects a taxpayer's right of appeal on any point. Letters on any article appearing in Tax Bulletin should be sent to the Editor, Mr Shell Makwana, Room G7, New Wing, Somerset House, Strand, London, WC2R 1LB or e-mail Shell.Makwana@ir.gsi.gov.uk. We are sorry though that neither he nor our contributors will normally be able to enter into correspondence about Tax Bulletin or its contents. Subscription The subscription for 2002 is £22. If you would like to subscribe to Tax Bulletin please send your name and address together with your cheque to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue". If you would like information regarding Tax Bulletin subscription or distribution please contact Mr Bryan Kearney, Room G7, New Wing, Somerset House, Strand, London, WC2R 1LB. Telephone: 020 7438 6373. For more general information regarding Tax Bulletin, please contact Mrs Jayne Harler, Assistant Editor, on 020 7438 7842 or at the address provided above. Copyright Tax Bulletin is covered by Crown Copyright. There is no objection to firms copying the Bulletin for their own use. Anyone wishing to republish Tax Bulletin or extracts more widely should write for permission to Miss Glenda Bishop, Room G12, New Wing, Somerset House, Strand, London, WC2R 1LB. |
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