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SME R&D Tax Relief: Everything You Need to Know

SME R&D Tax Relief is a government incentive scheme providing UK startups and scaleups with billions in growth 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 the SME scheme.

This blog covers a range of information about the SME scheme, so feel free to jump ahead to the topic you’re most interested in.

What is SME R&D Tax Relief?

SME R&D Tax Relief is one of the two schemes that make up R&D Tax Credits.

Available to small and medium-sized businesses, the SME scheme allows companies to recoup up to 33.35% of their development costs, either as a payable tax credit, a tax reduction, or a combination of the two.

The other scheme is the Research and Development Expenditure Credit, commonly known as RDEC.

RDEC is designed for larger businesses and companies that are ineligible for the SME scheme. It offers a cash credit worth 10.53% of your development expenditure.

Both schemes are available to companies in a wide range of industries, from software to manufacturing, fashion to food, brewing to biotechnology.

Launched in 2000, R&D Tax Credits are one of the UK’s most prolific sources of innovation funding.

In the 20 years the programme’s been running, it has paid out more than £33 billion in government aid, helping countless businesses to invest, invent and grow.

Should I file for SME R&D Tax Relief or RDEC? 

The main factor determining which scheme your company should apply to is its size.

Generally, companies that are considered SMEs should apply for the SME Tax Relief. Large companies should apply for RDEC.

Whether you’re an SME or a large company is determined by the size test.

The size test

If you have more than 500 employees, or both an annual turnover in excess of €100 million and a balance sheet worth over €86 million, then your business will be classed as a large company and must file for RDEC.

If your company falls below these limits, then you’re counted as an SME for the purposes of R&D Tax Credits. In which case, you may be eligible for the SME scheme.

The size test was set by the European Union, which is why its values are denominated in Euros.

But your company’s size isn’t the only thing deciding which scheme you need to apply to.

You may have to apply to the RDEC scheme if your business:

You may find that some projects qualify for the SME tax relief while others qualify for RDEC.

For example, if one of your projects received grant funding. In which case, you’ll have to split your application between the two schemes.

Dividing your claim up like this can be tricky.

If you want help splitting your claim between the two schemes without breaching HMRC rules, or working out which scheme you should apply to, then give us a call.

How much will I receive from the SME scheme?

SME R&D Tax Relief gives you back between 19% and 33% of your development spending.

Exactly much you receive depends on your financial situation and, of course, the size of your claim.

Loss-making companies receive up to 33.35% of their expenses back as a cash credit, while profitable companies receive up to 24.7% of their investment back as tax relief.

Companies at breakeven are given the least relief: just 18.85%.

We can explain this variation, and explore how much relief you’ll be able to claim, by looking at how the SME scheme works.

How does the SME scheme work?

SME R&D Tax Relief works by artificially increasing – or ‘enhancing’ – your eligible expenditure by 130%.

So if you had £100,000 of eligible investment, the enhancement mechanism would increase it to £230,000 on your balance sheet.

Enhancement has different implications for your business depending on whether you are profitable, unprofitable or breaking even.

Profitable SMEs

If your company is in the black, the enhancement mechanism will increase your costs, artificially reducing your profit.

A smaller profit means a lower corporation tax bill.

Example

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 reduced this profitable company’s corporation tax liability by £247,000, generating a 24.7% tax relief.

Loss-Making SMEs

Things are different for loss-making companies.

If you’re unprofitable, the enhancement mechanism will deepen your loss.

Then, by surrendering your loss, you can exchange your eligible expenditure, plus the enhancement, for a cash lump sum.

The lump sum will be worth 14.5% of the amount you surrender.

Example

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.

Note: As of 1 April 2021, businesses are only be able to 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, in our detailed blog.

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

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 file for SME R&D Tax Relief?

Broadly speaking, there are six steps to filing a claim for SME R&D Tax Relief.

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. 

R&D Tax Relief is made up of two schemes: the SME R&D Tax Relief and the Research and Development Expenditure Credit (RDEC).

 

Which scheme you apply to depends on your company’s size, its financial connection to other companies, and a few other factors.

 

You can read more about the two schemes here.

Add up all the eligible costs associated with the projects you’re claiming for. Then work out how much of each cost you can claim under the SME and RDEC schemes. 

 

Be sure to include every penny of eligible expenditure - that’s the key to maximising your claim size. And if you’re claiming for the SME scheme, make sure you enhance your total qualifying expenditure by 130%.  

The technical narrative is a 2-to-5 page document that explains your development work to HMRC. Technical narratives are not mandatory, but they will greatly increase the chances that your claim is accepted, and significantly reduce your chances of an enquiry.  

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. 

Finally, combine your updated CT600, technical narrative, and financial calculations into one document. Then send it off to HMRC. 

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 which are eligible for relief.

The largest costs most companies can claim for are staff, contractors and consumables.

But there are eight kinds of eligible costs in total:

  • Direct Staff costs
  • Externally provided workers
  • Subcontracted R&D
  • R&D consumables
  • Software
  • Clinical trial volunteers
  • Contributions to independent research
  • Prototypes

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, it usually takes 6 to 10 weeks for a company to receive their money. 

HMRC says it aims to process 95% of claims within 28 days. But the truth is that processing times vary significantly throughout the year, depending on how busy HMRC is. 

December to April is the busiest stretch. 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 for my SME claim?

The truth is, it depends.

For small and straightforward claims, it’s usually cheaper to file yourself or with your regular 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 will make sure 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.

Still have questions? 

If you want to know more about the SME scheme, then just drop us a line.

Our R&D Tax Credits experts would be happy to answer any questions you have about your claim, the SME R&D Tax Credits scheme, or our service.

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