Are you an SME or a large company? Your company’s size greatly impacts the amount of R&D Tax Credits you can claim. But working out how big you really are can be confusing, and HMRC could penalise you if you get it wrong. To help make it clearer, here are the main things you need to know about making the calculation, and what to do when your company changes size.
When it comes to distributing R&D Tax Credits, HMRC says companies come in two sizes: SME (small to medium enterprise) and large.
SMEs usually qualify for the SME Tax Credits (assuming they are not in receipt of grants), while large companies are only eligible for the RDEC (Research and Development Expenditure Credit) scheme. The SME scheme is much more generous, reimbursing businesses up to 33.35% of their R&D expenditure versus just 9.71% for the RDEC.
With so much money on the line, you need to know how big your company really is, and what to do when your business changes classification.
HMRC defines a large company (under R&D tax law) as a company with either:
>More than 500 employees,
>An annual turnover over €100 million AND/OR a balance sheet over €86 million
A business with lower values for any of these criteria is considered an SME.
However, this calculation isn’t as simple as it looks. There are a few extra variables you need to consider when working out your company’s classification.
How many employees do I really have?
Calculating the number of employees isn’t as straightforward as looking at how many people are on your payroll. There are two main kinds of employees which don’t contribute to your employee headcount:
1. Employees on maternity or paternity leave
It’s important to account for these omissions when calculating your employee total. With apprentices now comprising a significant part of the workforce, it could have a significant impact on your calculation and the amount you can claim.
What if I change size during my financial year?
There are two ways your business can change size:
1. Your company is bought or sold by a larger enterprise, or group of businesses, which qualify as a large company
2. Your company changes size organically
What happens to your classification is different in each scenario. Here’s a breakdown of what happens:
If you’re acquired by another company
Here, it all depends on whether your company, and the purchasing company, are ‘linked’. In other words, whether you’ve transferred control of your business to the company that buys you. If so, HMRC’s calculation relates to the overall size of the combined entity. I.e. your company + the company that bought you. If you retain control, the calculation relates only to your business. Here you’ll find more on calculating whether your business is linked.
SMEs with venture capital investment, or that have surrendered equity by other means, may find that the finances and employee headcounts of their equity holders also have to be included in their calculation. This often tips them into the ‘large company’ bracket. Click here for more information on how company ownership can affect the size calculation.
According to HMRC rules, if the combined entity exceeds the SME criteria, then it will be considered a large company for the whole of the accounting period in which the acquisition took place. In other words, your company will be considered a large business for the whole of the financial year and you won’t qualify for the more generous R&D Tax Credits given to SMEs.
Here’s an example:
Company A has a financial year spanning January to December. It has 480 employees and a turnover of £30m in year one. If Company B, which has 1000 employees, buys 80% of the shares and thereby takes over control of company A in October of year 1, Company A will have to consider company B’s staff headcount. So, it will be considered a large company for the purposes of Tax Credits. This applies to the whole period and they must therefore claim under the RDEC scheme, despite having been an SME for the majority of the time.
Note: this is not true if the process happens in reverse; if your company becomes ‘unlinked’ from a parent business. More on that below.
You change size organically
Companies that change size organically don’t instantly become reclassified as either an SME or a large company. There is a two-year ‘transition period’, during which a company’s classification won’t change. That means if your company changes organically from an SME to a large company, or vice versa, you company will only officially change size, and therefore the tax credits scheme it qualifies for, at the beginning of the third financial year. In other words, your company needs to have remained eligible for its new classification for two consecutive financial years in to qualify for a change in status. Here are two examples:
Example one: SME to large company
If company A has 480 employees in year one but goes up to 510 employees in year 2 it will remain a SME for year 2. If however it still has at least 500 employees in year 3 it will be classified large company for year 3.
Example two: Large company to SME
If company A has 520 employees in year one, but goes to 450 employees in year 2, it will remain a large company in year 2. If it still has under 500 employees in year 3, it will be then qualify as an SME and have access to SME Tax Credits.
Your company is sold by a large business
If your company is sold by a large business, and the spun-out entity is autonomous, then HMRC’s transition period takes effect. So, if the new entity was part of a large company, but now qualifies for SME status via the the calculation, then it will only receive SME status, and become eligible for the SME Tax Credits, in the third financial year (assuming it doesn’t change size in its second financial year).
Here’s an example:
In year one company A is part of a group of companies which, when considered together, qualifies as a large company. In year two company A leaves the group and then meets all the criteria to be considered an SME. However, it will still be considered a large company for that year. Company A will be only be considered an SME for the purpose of R&D Tax Credits in year three if it meets the SME threshold tests for a second year in succession.
Getting Expert Help
It’s a complicated calculation. But knowing what your company qualifies as can have a major impact on the amount of R&D Tax Credits your recieve. Making sure you are claiming the right amount of Tax Credits, and under the correct scheme, greatly speeds up the claims process, meaning you get your tax refund quicker. Moreover, incorrectly calculating company size and eligibility for the SME tax credit has seen a number of UK companies over-claiming, leading to substantial HMRC fines and repayment demands.
If you’re unsure about how to classify your company, or how much you should be claiming for, don’t hesitate to get in touch, and one of our tax experts will be happy to help.
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