R&D Tax Credits: Should You Surrender Your Losses?
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R&D Tax Credits: Should You Surrender Your Losses?

The SME R&D Tax Credits scheme lets you surrender your losses in exchange for a cash credit. But should you? In most cases, yes. But it depends on your company’s financial situation.

If you’re claiming SME R&D Tax Relief as an unprofitable company, you can use a mechanism called ‘surrendering your losses’ to produce a payable tax credit. 

In other words, cold hard cash!

But is it a good idea to surrender your losses for a cash credit? 

The short answer is: in most cases, yes. But not always. Sometimes, it’s better to carry your loss forward. 

It all depends on your company’s current financial situation. And on where you expect to be in a few years time.

What is surrendering a loss?

When you surrender your loss using the SME R&D Tax Relief scheme, you trade it in for a cash credit worth 14.5% of your enhanced expenditure. 

Your enhanced expenditure is your total qualifying expenditure plus your R&D enhancement. It is worth 230% of your total qualifying expenditure.

More on R&D enhancement and enhanced expenditure here

As a result, surrendering your loss yields a cash credit worth 33.35% of your qualifying expenditure.

So, if your total qualifying expenditure was £100,000, surrendering your losses would yield a cash credit worth £33,350. 

You can use this cash credit however you want. To hire new staff, buy new equipment, or even conduct more research and development work. 

A quick note: this calculation assumes that all of your total qualifying expenditure forms part of your company’s loss. 

More on that in this blog about how to claim R&D Tax Credits if your company is unprofitable

Now, let’s look at how surrendering a loss compares to carrying a loss forward.

What is carrying a loss forward?

Your other option is to carry your loss forward. By doing this, you can use your loss to offset future profits. 

Effectively, you are using historic losses to reduce the amount of profit your company makes. 

Of course, thanks to the SME R&D Tax Relief scheme, your losses have been enhanced. So you will be able to offset a higher proportion of your profits.

By offsetting your profits, you will be reducing the amount of corporation tax you have to pay.

In effect, you’ll be trading your enhanced expenditure for a tax reduction at a rate of 19p per £1. 

Factoring in R&D enhancement, the corporation tax offset would be worth 43.7% of your total qualifying expenditure, over 10% more than if you surrender your loss as a cash credit. 

Surrendering Your Loss Carrying Your Loss Forward
Effective Relief Rate
33.35%
43.7%

Should you surrender your loss?

Presented with these figures, you might think it is obviously better to carry your loss forward.

Unfortunately, it’s not that simple.

In order to carry a loss forward so you can offset it against future profits, your company actually needs to generate profit. 

The key concept is: if you are expecting continued tax losses in future years (and don’t forget to factor in future R&D claims in this!) then it’s probably a good idea to surrender your loss for cash.

Even if you are expecting profits sometime in the future (who doesn’t!) you may rather have the cash now. For example, so you can use it to extend your cash runway.

You should also consider how far, how certain, and how large those profits will be.

The formula for discounted cash flows is relevant here.

Discounted cash flows

Discounted cash flows allow you to represent the fact that cash in a year’s time is less valuable than cash in hand today. 

The way it works is by proposing that if you had the cash in hand today, you would be able to invest it wisely in productive projects within the company, that would provide a return on investment. 

So if you can only get the cash in a year’s time, that means it needs to provide at least as much of a return as it would have if you had been able to invest it.

Assuming your business is able to make use of funds to get a fairly reasonable 10% “internal rate of return” (IRR) on its own assets, then £100k today will be worth £110k in a year. 

Conversely, £100k received in a year is only worth £90.9k today. 

This means that at a 10% IRR, 14.5% today is worth:

  • 15.95% in 1 year
  • 17.54% in 2 years
  • 19.29% in 3 years
  • 21.22% in 4 years 

That means that, at a 10% IRR, it would be better to surrender your loss today and invest it in your company if you’re expecting to wait four or more years for your company to be profitable.

IRR for startups and scale-ups

Many pre-profit startups and scale-ups hope to generate a much higher IRR for their investments than 10%. 

At a still fairly reasonable 50% growth rate, a cash credit worth 14.5% of your total qualifying expenditure today would be worth 21.75% in a year’s time. 

So for a company with high growth potential, it is usually worth surrendering the loss today.

One exception to this is if your company has been investing heavily for several years but is about to stop spending aggressively and switch to ‘profitable’ mode. 

If you are convinced that you’re about to go from a £500k tax loss to a £1.5m profit, and you have plenty of cash in the bank to fund every project that has a return, then it will be better to keep the loss unsurrendered and exercise it the next year. 

This case is quite rare though, unfortunately.

Questions about surrendering your losses?

If you need guidance about anything written in this article, please get in touch

Surrendering losses and predicting profitability can be very nuanced. But GrantTree’s R&D Tax Credits specialists are here to help you make the most out of your funding.