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.
But is it a good idea to surrender your losses and receive your R&D Tax Relief as 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?
Surrendering your loss means exchanging it for a cash credit in return for not carrying it forward and using it to offset against a future corporation tax liability.
The surrender rate – the size of credit you get back relative to the loss you surrendered – is 14.5% for expenditures incurred before 1 April 2023.
This means you’ll receive 14.5p for every £1 surrendered.
If you invested at least 40% of your total company expenditure in qualifying R&D costs, your surrender rate for expenditure on or after 1 April 2023 will also be 14.5%.
If you invested less than this amount, your surrender rate will be 10%.
Taking the enhancement mechanism into account, your cash credit will be worth between 8.6p and 33.35p for every £1 you invest in qualifying projects.
Now, let’s look at how surrendering a loss compares to carrying a loss forward.
What is carrying a loss forward?
Rather than surrendering your loss, you can carry it forward and use it to reduce your corporation tax bill in future years.
Effectively, you are using a loss from the past or present to make your company less profitable in the future, reducing the amount of corporation tax you have to pay.
By doing this, you’ll be trading your £1 of loss for between 19p and 25p, depending on how profitable your company is, in reduced tax.
Factoring in enhancement, a carried loss can be worth between 57.5p and 16.34p for every £1 of qualifying expenditure – more than if you surrendered it for a cash credit.
| Surrendering Your Loss | Carrying Your Loss Forward | |
|---|---|---|
|
Effective Relief Rate |
Up to 33.35% |
Up to 57.5% |
Should you surrender your loss?
Presented with these figures, you might think it is 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 needs to generate profit.
Here’s the key. If you expect continued tax losses in future years (and don’t forget to factor in future R&D claims in this!), it’s probably a good idea to surrender your loss for cash.
Even if you expect profits sometime in the future (who doesn’t!), you may rather have the cash now.
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 is less valuable than cash in hand today.
It works by proposing that if you had the cash in hand today, you could 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, 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 can use funds to get a fairly reasonable 10% “internal rate of return” (IRR) on its 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 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.
So for a company with high growth potential, it’s often worth surrendering the loss today.
Naturally, this is more complicated when we factor in the new enhancement and surrender rates, and the higher corporate tax rate.
Another 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 not to surrender your loss and exercise it the following 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.
