R&D Enhancement is an important aspect of the R&D Tax Credits scheme and of SME R&D Tax Relief in particular. If you’re looking to apply for the SME scheme, here are the key things you need to know about R&D enhancement and enhanced expenditure.
R&D enhancement is one of the most important aspects of R&D Tax Credits.
It is how SME R&D Tax Relief, the more generous of the two R&D Tax Credits schemes, generates funding for qualifying small and medium-sized enterprises.
In this blog, we’ll explain what R&D enhancement is, how it works and what impact it has on your R&D Tax Credits claim.
What is qualifying expenditure?
Before we talk about enhancement, we need to understand qualifying expenditure.
Qualifying expenditure means costs associated with eligible research and development projects that are claimable under the R&D Tax Relief scheme.
There are ten kinds of qualifying costs, including wages, subcontractor fees and consumables.
Total qualifying expenditure is the combined value of all of your qualifying costs once they have been accurately apportioned to your R&D projects.
Projects are packages of development work that meet the government’s definition of research and development for tax purposes.
What is R&D enhancement?
The R&D Tax Credits scheme works by allowing companies to claim back a percentage of their qualifying expenditure as a cash credit or corporation tax relief.
Under the SME R&D Tax Relief scheme, companies are allowed to artificially increase the value of their total qualifying expenditure by a fixed percentage in order to generate a larger relief.
The process of artificially increasing your expenditure is called R&D enhancement. Or, in tax law, the ‘additional deduction’.
The R&D enhancement is determined by the enhancement rate, which is 130% for qualifying expenditure before 1 April 2023 and 86% for expenditures after this date.
So, let’s say your company’s total qualifying expenditure (pre 1 April 2023) is £100,000. In that case, your enhancement would be £130,000.
What is enhanced expenditure?
Enhanced expenditure is your total qualifying expenditure plus the R&D enhancement.
As an example, let’s say your total qualifying expenditure was £50,000. In that case, your enhancement or additional deduction would be worth £65,000.
So your enhanced expenditure would be £115,000.
Another way of calculating enhanced expenditure is by multiplying your total qualifying expenditure by 230%.
Here is a recap of the three terms:
| Term | Calculation | Example Value |
|---|---|---|
|
Total Qualifying Expenditure |
Aggregated and Apportioned Qualifying Expenditure |
£50,000 |
|
R&D Enhancement |
Total Qualifying Expenditure x 130% |
£65,000 |
|
Enhanced Expenditure |
R&D Enhancement + Total Qualifying Expenditure |
£115,000 |
Again, these figures refer to expenditure that takes place before 1 April 2023.
What is the purpose of R&D Enhancement?
The purpose of R&D enhancement is to increase the amount of relief available to small and medium-sized businesses.
SMEs generally have fewer resources than larger businesses. So, they are given more financial support to encourage them to conduct research and development.
R&D enhancement is only available through the SME R&D Tax Relief scheme. The Research and Development expenditure credit (RDEC), the other scheme that makes up R&D Tax Credits, does not offer enhancement.
RDEC lets companies claim back up to 13% of their qualifying expenditure as a cash credit, while the far more generous SME scheme lets companies claim back up to 33%.
How does R&D enhancement affect my relief?
R&D enhancement artificially increases your company’s costs. Every £1 of qualifying expenditure becomes £2.3 on your balance sheet.
What impact this will have depends on your company’s financial situation.
Profitable companies
If your company is profitable, R&D enhancement artificially increases your costs. This reduces your company’s profitability, and therefore the amount of corporation tax you have to pay.
This is how the SME scheme delivers tax relief.
Here’s an example:
| Profitable Company | Before Enhancement | After Enhancement |
|---|---|---|
|
Revenue |
£7,500,000 |
£7,500,000 |
|
Expenditure (incl. R&D) |
£2,500,000 |
£2,500,000 |
|
Total Qualifying Expenditure |
£1,000,000 |
£1,000,000 |
|
R&D 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% |
Here, we can see how the enhancement mechanism creates a tax relief worth £247,000.
That is the equivalent of 24.7p for every £1 of qualifying expenditure.
Unprofitable companies
If your company is unprofitable, the enhancement will take it further into a loss.
Then your company can either carry its loss forward to surrender it for a cash credit worth up to 14.5p per £1 of enhanced expenditure.
This is how the SME scheme delivers a payable tax credit.
Here’s an example:
| Unprofitable Company | Before Enhancement | After Enhancement |
|---|---|---|
|
Revenue |
£1,000,000 |
£1,000,000 |
|
Expenditure (incl. R&D) |
£2,400,000 |
£2,400,000 |
|
Total Qualifying Expenditure |
£1,000,000 |
£1,000,000 |
|
R&D 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.
Companies breaking even
If your company is at break-even, the R&D enhancement will take you into a slight loss. The loss will be equal to the value of the enhancement.
You can then surrender the enhancement for a payable tax credit. However, you can only surrender the proportion of your enhanced expenditure that forms part of your company’s financial loss.
Here’s an example of this:
| Companies at Break Even | Before Enhancement | After Enhancement |
|---|---|---|
|
Revenue |
£1,500,000 |
£1,500,000 |
|
Expenditure (incl. R&D) |
£1,500,000 |
£1,500,000 |
|
Total R&D Expenditure |
£1,000,000 |
£1,000,000 |
|
R&D 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.
You can also read about how much your company should expect to claim in this article. Or by checking our easy-to-use R&D Tax Credits calculator.
Let GrantTree get the most out of your claim
We hope this clears up what R&D enhancement is. And how it impacts your R&D Tax Credits claim.
If you have any questions about enhancement, SME R&D Tax Relief, or the R&D Tax Credits scheme, our specialists are standing by to help.
Just drop us a line, and we’ll be right with you.
