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When should you surrender losses for an R&D tax credit?

When should you surrender losses for an R&D tax credit?

When claiming R&D tax relief, companies can choose to use their qualifying R&D expenditure as a tax credit – or in other words a cash payment. This process of surrendering losses only applies if they are in a tax loss position as per the tax computation (and not necessarily the financial statement’s position).

Tax credits are available under both the SME and RDEC schemes, though the amount of cash benefit the company receives will depend on the R&D scheme the company is claiming under. As each company’s circumstances will be specific to them there is no one-size-fits-all solution for the right situation to surrender losses. The purpose of this overview is to provide additional detail into those important factors that should always be considered for each company’s individual circumstances.

Knowing when to surrender the loss for an R&D tax credit

Factors to consider to aid the decision process of when or if a tax credit is the appropriate decision for your company:

  • R&D tax credit scheme – The scheme you are claiming under RDEC or SME
  • Tax group considerations – Whether another company in your tax group is making profits chargeable to Corporation Tax
  • Future profits – When are you projected to move into profit – in the short, or medium term?
  • Past profits – Whether you have any profits in previous periods
  • Current value of cash – How much more valuable is that cash to the company today, rather than at some point in the future. What is the company paying for credit facilities for example?
  • Potential tax rate changes in the future – the CT rate is already set to increase for company’s generating more than £50,000 of profit from April 2023 – for company’s generating over £250,000 the top tier CT rate will be 25%. That is quite a difference from the 14.5% rate for expenditure incurred up to 31 March 2023. From 1 April 2023, the rate reduces to 10% (unless the SME qualifies as R&D intensive with 40% or more of the company’s costs incurred on qualifying R&D costs). 

If you surrender for a tax credit, if the company subsequently turns to profit and the benefit of hindsight says, “we would have been better to carry forwards.” This can be rectified by filing an amended tax return providing the tax return period is still open, the tax credit would be immediately due to be re-paid to HMRC with interest though.

If we first look at the specific options available under each scheme.

R&D tax credit options available under the SME scheme

When an SME company is in a tax loss position, they have 4 options as noted below:

  1. Carry back the loss. If the company made a taxable profit in previous periods the loss can be carried back to offset against previous taxable profits, this would provide a tax refund at the prevailing Corporation Tax rate of that period, currently 19%.
    Note previously this option was only available to the immediately preceding 12-month accounting period. Under new rules this has been temporarily extended to 3 prior accounting periods as an additional support to companies as a result of the pandemic. Further details can be found here.
  2. Immediate cash refund at 14.5% for expenditure incurred up to 31 March 2023, reducing to 10% for expenditure incurred from 1 April 2023 (unless the company qualifies as R&D intensive in which case the rate remains 14.5%)
    a. The total loss in the period (after the R&D claim) or
    b. the total enhanced R&D expenditure figure. Any surplus loss that is not related to the enhanced R&D expenditure can be carried forward and offset against future taxable profits.

    Note:
    At current SME rates, SME rates for expenditure incurred up to 31 March 2023:
    Enhanced R&D expenditure = Qualifying Expenditure *130% (Tax computation adjustment)
    Total Enhanced R&D expenditure = Qualifying Expenditure *230% (CT600 form)

    SME rates for expenditure incurred from 1 April 2023
    Enhanced R&D expenditure = Qualifying expenditure*86% (Tax computation adjustment)
    Total Enhanced R&D expenditure = Qualifying expenditure*186% (CT600 form)

  3. Group relief If the company is part of a group for tax purposes these losses can used to reduce the taxable profits of entities within the same tax group. This would provide a tax benefit at the prevailing Corporation Tax rate, which is currently between 19% and 25% depending on the taxable profit level of the other group entities.
  4. Carry forward the loss and use it to reduce future taxable profits. Whilst there is no immediate cash or tax benefit there will be a future tax benefit. Depending on the anticipated time frame for the company to become profitable the Corporation Tax rate may well be higher than the current rate between 19% and 25% depending on the taxable profit level of the other group entities.

The above are the 4 options available and whilst one company’s position may allow for just 1 of the options to be used, others may use a combination of methods according to their individual and specific circumstances.

R&D tax credit options available under the RDEC scheme

HM Treasury designed the RDEC scheme so that the RDEC adjustment is accounted for in the Income Statement (above the tax charge line) rather than as part of the tax adjustment in the corporation tax computation. That is why the best practice is to record the RDEC adjustment as a credit in other income. When a company is in a tax loss position and intends to claim a tax credit under the RDEC scheme this is based on the RDEC figure. This is calculated as a percentage of the qualifying R&D expenditure. The rate is 13% for expenditure incurred up to 31 March 2023 and increases to 20% for expenditure incurred from 1 April 2023. The tax credit amount is then calculated net of the Corporation Tax liability accrued on the RDEC income being recognised in the P&L. This is 19% up to 31 March 2023 and increases to 25% from 1 April 2023. A company has 3 options as noted below:
  1. Immediate cash refund: Up to 31 March 2023 at 81% of the RDEC value. A 19% Corporation Tax rate is applied when calculating an RDEC tax credit for expenditure incurred up to 31 March 2023, the 19% is then carried forwards, and offset against future periods profits or group relieved. From 1 April 2023 at 75% of the RDEC value. A 25% Corporation Tax rate is applied when calculating an RDEC tax credit for expenditure incurred from 1 April 2023, the 25% is then carried forwards and offset against future periods profits or group relieved.
    2. Where an entity’s Accounting Period straddles the 1 April 2023 the above rates are applied pre and post 1 April 2023
  2. Group relief offset your RDEC against the Corporation Tax payable in another company in your tax group, this would provide a benefit of 19% or 25% to the group company.
  3. Carry forward the RDEC to be offset against future Corporation Tax liabilities. This is calculated at 19% or 25% of the RDEC value, depending on when the expenditure was incurred and is carried forwards to be specifically offset against future Corporation Tax Liabilities (unlike the SME scheme carry forward where the company could benefit from an increase in the prevailing CT rate).
In order to surrender losses for a tax credit under the RDEC scheme, there are steps that must be followed in a specific order. Before you are able to claim the cash credit under the RDEC scheme there may be other tax obligations that you need to pay before HMRC will make the payment, again this is different from the SME scheme. For example:
    • Discharge the Corporation Tax liability for any other accounting period that was due and has not yet been paid.
    • Discharge any other liabilities of your company with HMRC e.g., overdue PAYE or VAT liabilities.

Are payable tax credits subject to a cap?

Yes, each scheme has its own specific requirements restricting the amount of a payable tax credit, the intention is to prevent companies taking more from the pot that they put in whilst still encouraging innovation. The differences between the caps are explained below:

The SME cap
For full accounting periods starting from 1 April 2021

The payable tax credit is capped at

3 x total PAYE
+

NIC (employers and employees) paid to HMRC for all employees within the company
+
£20,000.

If a company, therefore, has no employees, PAYE, or NIC contributions the maximum payable tax credit is £20,000.

The RDEC cap
The payable tax credit is capped at

total PAYE

+

NIC (employers and employees) paid to HMRC relating only to employees included in the RDEC claim

(i.e., not the entire company employees).

Amounts in excess of the cap can be carried forward for use in future periods.

In summary

These are the main points to take into consideration and often the decision involves an element of polishing the crystal ball to look into the future, hopefully, this overview allows you to make an informed decision as to the right course of action for your circumstances with the facts at hand overlayed against best predictions of future activity.

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