SME R&D Tax Relief is a government incentive scheme providing UK startups and scaleups with billions of funding. Here’s everything you need to know about the SME scheme, including how it works and how to apply.
Welcome to GrantTree’s guide to SME R&D Tax Relief, also known as SME R&D Tax Credits or simply, the SME scheme.
This blog covers the key things you need to know about SME R&D Tax Relief – what it is, how much funding’s available, how to apply, you name it.
Feel free to read straight through or use the contents below to jump ahead to the topic you are most interested in.
If you have any questions or would like some help on a claim you’re working on right now, my colleagues and I in GrantTree’s R&D Tax Relief team are happy to assist you.
Contents
What is SME R&D Tax Relief?
One half of the wider R&D Tax Relief scheme, SME R&D Tax Relief is a generous initiative that rewards small and medium-sized businesses for investing in innovation.
Through the SME scheme, your company can claim back up to 33p for every £1 it spends on engineers, software developers, subcontractors, and other development-related costs.
You will receive your funding as a cash credit, a tax reduction, or a combination of the two, depending on your financial position.
The SME scheme has provided billions of pounds to high-growth businesses since its launch in 2000. This has enabled them to hire new employees, invest in new equipment and products, and overcome periods of financial difficulty.
SME R&D Tax Relief is available to companies in a wide range of sectors, not just those in highly scientific fields like biotechnology and artificial intelligence.
This is thanks to the scheme’s inclusive, if confusing definition of “research and development”, which focus on the nature of an advancement, and not the field in which it takes place.
The SME scheme is changing
A number of important changes to the SME R&D Tax Relief scheme came into effect on 1 April 2023, impacting how much funding is available, and which costs are eligible for relief. For a complete breakdown of these changes, read our detailed blog.
How much will I receive from the SME scheme?
The SME R&D Tax Relief scheme lets you claim back between 8.6p and 33.35p for every £1 you invest in qualifying research and development projects.
Assuming you’re not impacted by the PAYE Cap.
How much you can claim within this range depends on your financial position and when you incurred your costs.
Loss-making companies receive the most relief, followed by profitable businesses and finally, because of a quirk in the scheme’s workings, firms breaking even.
In November 2022, the government announced it was reducing the amount of relief available through the SME scheme. This change affects qualifying costs incurred on or after 1 April 2023.
Below we can see two tables explaining the amount of relief available for expenditure made on either side of the 1 April change.
| Financial Position | Relief Before 1 April 2023 | Relief From 1 April 2023 |
|---|---|---|
|
Loss-Making |
33.35% |
18.6% to 27% |
|
Breaking Even |
18.85% |
8.6% |
|
Profitable |
24.7% |
16.34% to 21.5% |
As you can see, there’s a wide range of relief available. To understand why – and how much you’ll be able to claim – we need to look at how SME R&D Tax Relief works.
How does SME R&D Tax Relief work?
SME R&D Tax Relief works by artificially increasing your eligible expenditure. This is called the enhancement mechanism.
The enhancement rate is 130% for expenditures before 1 April 2023 and 86% for expenditures on or after this date.
So, if had £100,000 worth of eligible investment before 1 April, it would be like you had spent £230,000.
The purpose of enhancement is to reduce your company’s profitability or decrease its loss.
What impact this has depends on your financial position.
If you are a profitable SME
If your company is in the black, the enhancement mechanism will artificially reduce your profit by increasing your costs.
Less profit means a lower corporation tax bill.
Example (where all expenditure takes place before 1 April 2023)
| Profitable SME | Before Enhancement | After Enhancement |
|---|---|---|
|
Revenue |
£7,500,000 |
£7,500,000 |
|
Expenditure (incl. R&D) |
£2,500,000 |
£2,500,000 |
|
Qualifying R&D Expenditure |
£1,000,000 |
£1,000,000 |
|
130% Enhancement |
£0 |
£1,300,000 |
|
Net Profit Before Tax |
£5,000,000 |
£3,700,000 |
|
Corporation Tax Due |
£950,000 |
£703,000 |
|
R&D Tax Relief |
£0 |
£247,000 |
|
% of R&D Reclaimed |
0% |
24.7% |
In this example, we can see how the enhancement mechanism lowered this company’s profit from £5,000,000 to £3,700,000. This reduced it’s corporation tax liability from £950,000 to £703,000.
That’s a relief of £247,000, or 24.7% of its enhanced expenditure.
Loss-making SMEs
If you’re unprofitable, the enhancement mechanism will deepen your loss.
Then, through a mechanism called surrendering your loss, you effectively trade in your enhanced expenditure for a cash credit.
Your surrender rate – how much you’ll receive for exchanging your loss for a credit – depends on when your costs were incurred and how much of your total outgoings were spent on R&D.
The surrender rate is 14.5% on expenditures incurred before 1 April. I.e. you’ll receive 14.5p for every £1 you surrender.
From 1 April, it depends on how much you invested in R&D. If qualifying expenditure accounts for at least 40% of your company’s total outgoings, your surrender rate will be 14.5%.
If it’s less than 40%, your surrender rate falls to 10%.
Example (where all expenditure takes place before 1 April 2023)
| Unprofitable SME | Before Tax Relief | After Tax Relief |
|---|---|---|
|
Revenue |
£1,000,000 |
£1,000,000 |
|
Expenditure (incl. R&D) |
£2,400,000 |
£2,400,000 |
|
Qualifying R&D Expenditure |
£1,000,000 |
£1,000,000 |
|
130% Enhancement |
£0 |
£1,300,000 |
|
Net Profit Before Tax |
(£1,400,000) |
(£2,700,000) |
|
Corporation Tax Due |
£0 |
£0 |
|
Surrendered Loss |
£0 |
£2,300,000 |
|
R&D Tax Credit |
£0 |
£333,500 |
|
% of R&D Reclaimed |
0% |
33.35% |
In this example, we can see that loss-making companies can reclaim up to 33.35% of their development costs by surrendering their qualifying expenditure plus the enhancement for a cash credit.
Surrendering your loss is particularly useful if you are looking for new sources of investment capital or are trying to extend your cash runway.
However, it’s sometimes better to carry your loss forward than to surrender your loss.
Note
As of 1 April 2021, businesses can only claim tax credits worth up to 300% of their combined PAYE and NIC liability, plus a £20,000 buffer. You can read more about the PAYE Cap and how it will impact your claim here.
SMEs at break even
SME R&D Tax Relief is least generous if your company is at break-even.
This is because, having broken even, you will have no corporation tax to offset. And your genuine development spending will have been cancelled out by revenue.
While you will still be taken into an artificial loss by the enhancement mechanism, you will only be able to surrender the synthetic expenditure generated by enhancement.
In other words, you will be surrendering the 130% enhancement at a rate of 14.5%. This translates to a cash credit worth 18.85% of your eligible expenditure.
Example (where all expenditure takes place before 1 April 2023)
| SME at Breakeven | Before Tax Relief | After Tax Relief |
|---|---|---|
|
Revenue |
£1,500,000 |
£1,500,000 |
|
Expenditure (incl. R&D) |
£1,500,000 |
£1,500,000 |
|
Qualifying R&D Expenditure |
£1,000,000 |
£1,000,000 |
|
130% Enhancement |
£0 |
£1,300,000 |
|
Net Profit Before Tax |
£0 |
£1,300,000 |
|
Corporation Tax Due |
£0 |
£0 |
|
Surrendered Loss |
£0 |
£1,300,000 |
|
R&D Tax Credit |
£0 |
£188,500 |
|
% of R&D Reclaimed |
0% |
18.85% |
Clearly, this is much less relief than both profitable and loss-making companies receive.
We don’t know why companies are punished for reaching break-even. But we’ve come to refer to this rather odd situation as The Valley of Death.
How do I claim SME R&D Tax Relief?
Broadly speaking, there are six steps to filing a claim for SME R&D Tax Relief.
You can find more tips and information about filing for R&D Tax Relief in our comprehensive guide.
Step 1 - Select your projects
Choose the development work you’re going to claim for and assemble it into a series of projects.
Each project must be made up of eligible activities and meet HMRC’s definition of R&D.
Step 2 - Work out which scheme you're applying to
R&D Tax Relief is made up of two schemes: the SME R&D Tax Relief and the Research and Development expenditure credit (RDEC).
Whether you apply for the SME scheme or RDEC depends on your company’s size, its financial connection to other companies, and a few other factors.
Step 3 - Financial calculations
Identify all qualifying costs associated with your eligible projects and make sure they are correctly apportioned. Apply the enhancement mechanism.
Make sure you have correctly separated your expenditure according to the 1 April changes.
Decide whether you are surrendering your loss or carrying it forward.
Step 4 - Prepare the additional information form
From 8 August, you will need to file the additional information form to access R&D Tax Relief.
In this form, you need to enter a range of information about your development work and your company, including:
- What scientific and technical advances you were seeking
- What uncertainties you encountered
- Your project costs broken down by the nine categories of qualifying expenditure
- How much you spent on indirect qualifying activities
You don’t necessarily have to provide this information on all of your projects; it depends on how many projects you conducted during your claim period.
HMRC will not process your R&D Tax claim until they have received your additional information form, so make sure you file it before your Company Tax Return.
Step 5 - Complete your CT600
Next, plug your financial calculations into your CT600.
How you do this depends on whether you’re applying for the SME or RDEC scheme and whether you’re claiming corporate tax relief or the payable tax credit.
Step 6 - File
Finally, submit your claim to HMRC.
Remember, you will need to submit your additional information form before your corporation tax return, or HMRC will remove your R&D Tax claim from your Company Tax Return.
Which costs can I claim under SME R&D Tax Relief?
R&D Tax Relief claims are made up of a series of projects.
Each project – developing a new app or building a new piece of machinery, for example – incurs a range of costs. Some of these costs are eligible for relief.
The most common costs companies can claim for are staff, contractors and consumables.
However, in total, there are nine types of eligible costs under the SME scheme:
- Direct Staff costs
- Externally provided workers
- Subcontracted R&D
- R&D consumables
- Software
- Clinical trial volunteers
- Prototypes
- Cloud costs
- Data licenses
If you want to learn more about eligible costs, check out our comprehensive blog.
How long will it take to receive my relief?
In our experience, you will usually receive your funding in six to ten weeks.
HMRC aims to process 95% of claims within 28 days. But the truth is that processing times vary significantly throughout the year, depending on where we are in the financial year.
December to April is the time. So if your financial year ends between September and January, it’s a good idea to get your R&D Tax submission completed as soon as possible.
Should I use a specialist?
The truth is, it depends.
For small and straightforward claims, it’s usually cheaper to file yourself or with help from a traditional corporate accountant.
But for large or complex filings – any claim worth more than around £25,000 – it pays to get specialist help.
An R&D Tax Credits specialist will build your claim for you, saving your team hours of challenging and often tedious work. They will also maximise your windfall by making sure you’re claiming for every penny possible.
A specialist will also defend your claim by writing an airtight technical narrative, an important document that explains your development work to HMRC’s tax inspectors in a language they can understand.
Lastly, an R&D Tax Credits expert will ensure your claim is fully compliant and that there are no irregularities. Filing a compliant claim backed by a robust technical narrative is the best way to avoid a time-sucking HMRC enquiry.
Questions about SME R&D Tax Relief?
I hope this blog has given you a good, foundational understanding of the SME R&D Tax Relief scheme.
If you have any questions about SME R&D Tax Relief or would like to discuss filing a claim with one of our R&D Tax specialists, we’d be happy to help you.
Just drop us a line and we’ll be right with you.
