Calculating Research and Development R&D tax breaks for SMEs
Research and development is critical to your company's growth and progress, but it may also save you a lot of money on your Corporation Tax bill.
In our last post, a guide to research and development accounting, we discussed the types of expenses that could be claimed as permissible expenses against Corporation Tax.
In this post, we provide an example of the calculations you must perform to determine how much money you have saved on your tax bill. The savings apply to both profitable and losing businesses, and we have included examples for both.
According to HMRC standards, you can claim tax refund if you have less than 500 employees and a turnover of less than 100 million euros or a balance sheet total of less than 86 million euros.
SME R&D relief permits your company to deduct an additional 130 percent of qualified R&D costs from your yearly profit, in addition to the standard 100 percent deduction, for a total deduction of 230 percent.
If your company is losing money, you can claim a tax credit for up to 14.5 percent of the surrender able loss.
R&D tax breaks for profitable businesses
In this simplified example, we'll say your company has a turnover of £10,000, with £5000 in acceptable commercial expenses and £1000 in allowable R&D expenses.
Your taxable profit is £4000. Your bill would be £760 at a Corporation Tax rate of 19%.
Deducting an additional 130% of your qualified R&D costs lowers your gross profit to £2700.
With a 19% Corporation Tax rate, your bill would be lowered to £513, a £247 savings.
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Here's an illustration of how it works.
- Sales
- £10,000
- Sales price
- (£5,000)
- R&D expenditure that qualifies
- (£1,000)
- Profit after tax
- £4,000
- The 19% tax is required.
- £760
- 130 percent of qualifying R&D cost
- (£1,300)
- Gross profit has been revised.
- £2,700
- The 19% tax is required.
- £513
- Tax breaks
- £247
R&D tax breaks for businesses who are losing money
In this simplified scenario, we assume your company has a turnover of £10,000 but a loss of £12,000, which includes £1000 in permitted R&D investment.
Because of the loss, no Corporation Tax is required.
Deducting an additional 130% of your qualifying R&D costs raises your loss to £13,300.
You can carry the £13,000 loss forward to offset taxable profits in future years.
Alternatively, you can renounce your enhanced R&D spending of £2300 (230 percent of £1000) in exchange for a maximum tax credit of 14.5 percent of the expenditure of £2300-£333.
Here's an illustration of how it works.
- Sales
- £10,000
- Loss including £1000 in qualified R&D cost
- (£12,000)
- 130 percent of qualifying R&D cost
- (£1300)
- The total loss
- (£13,300)
- Increased R&D spending (230 percent of £1000)
- £2,300
- Tax credit equal to 14.5 percent of £2300
- £333
Other possibilities
The regulations differ if your R&D project involves a third party, as explained in the article A guide to research and development accounting. If your company conducts research for or with a third party, certain accounting standards apply to the transactions between the two parties. For example, you could conduct research for a sponsor in exchange for a fee or a percentage of future revenues. There are additional unique regulations that apply if your company is involved in a merger or acquisition and the acquiring company treats your R&D spending as goodwill. If your company is part of a group or if you perform qualifying R&D as a subcontractor, the calculations grow more complicated. In situations like this, it can be advantageous to seek professional guidance to determine which technique is most beneficial to your company.
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