Despite a mixed picture for R&D in the UK, engineering and technology companies can still use mechanisms to strengthen and protect claims for R&D tax relief and help avoid HMRC R&D enquiries.
The world of research and development (R&D) tax relief has recently been overshadowed by a combination of stricter HMRC policies, increased compliance requirements and bad press, which is largely down to rogue specialist R&D boutique firms offering flawed advice.
Despite this challenging environment, R&D remains crucial for innovation-driven industries, particularly in engineering and technology. These sectors are among the most active in pursuing R&D, and they continue to benefit from the government’s R&D tax relief schemes, which reduce the financial risks and costs associated with innovation, fostering further growth and investment.
HMRC’s latest R&D tax credit statistics highlight the central role that engineering and technology firms play in driving R&D claims in the UK. However, the data also reveals that many companies are still not fully capitalising on this valuable tax relief, leaving potential growth opportunities untapped.
An overcast view of UK R&D
R&D tax relief has long been a powerful tool for businesses, enabling them to reduce costs, mitigate risk, attract top talent and drive industry-wide innovation through new processes and technologies. For engineering and technology small and medium-sized enterprises (SMEs) in particular, R&D is essential. These businesses are the engine of innovation in the UK, often taking the biggest risks and generating breakthrough ideas that push industries forward.
However, recent data from HMRC paints a concerning picture for SMEs. In September, the latest figures revealed that claims under the more generous R&D SME scheme fell by 3% from 2021/22 to 2022/23. Even more alarming is the fact that the total number of SME scheme R&D claims dropped by 23% – marking the third consecutive year of decline.
While large companies and non-eligible SMEs saw a 7% rise in claims under the R&D expenditure credit scheme, the outlook for smaller firms remains bleak. And this is likely just the tip of the iceberg, as the most recent data only captures trends through 2022/23. With the landscape becoming increasingly challenging, SMEs are facing even greater obstacles than the statistics suggest.
HMRC’s new approach: a barrier to R&D
Recent changes in HMRC’s approach to R&D enquiries have made the process more difficult for many engineering and technology firms, with some companies even abandoning their claims altogether due to lengthy, drawn-out enquiries and a rigid ‘computer says no’ HMRC mentality. The full impact of these changes has yet to be reflected in HMRC’s latest statistics, suggesting that the situation may be worse than it appears.
SMEs have been hit particularly hard by:
- A surge in HMRC R&D enquiries: this has led to increased professional and management costs, along with the rejection or reduction of some companies’ claims.
- Increased documentation requirements: HMRC now demands more detailed evidence to support claims, creating additional administrative burdens and increasing the costs of submitting claims for R&D tax relief.
- Reduced rates of relief: the rates for SME scheme R&D relief have already been cut and will drop even further under the new merged scheme for accounting periods starting on or after 1 April 2024.
These three factors have made claiming R&D relief more expensive, time-consuming and less attractive for smaller companies.
Yet, despite these challenges, R&D tax relief remains a valuable tool for engineering and technology firms. With proper planning, companies can still benefit from R&D relief to significantly reduce the financial risks of innovation and help fuel future business growth.
Strengthening and protecting R&D claims
To maximise the benefits available from R&D tax relief, engineering and technology companies must plan in advance and proactively identify and document qualifying R&D projects. This requires refining their R&D strategies to ensure that activities are well-documented and align with HMRC’s requirements. It’s essential for both the R&D project leaders and financial teams to stay up-to-date with the latest changes and complexities in the R&D tax relief schemes.
In addition to R&D tax relief, engineering and technology businesses can also leverage other valuable, yet often overlooked, tax incentives:
- Patent Box Relief: this relief offers companies selling patented products or processes a reduced 10% corporation tax rate on eligible profits. With the main rate of corporation tax now at 25%, Patent Box relief has become even more valuable for companies with qualifying intellectual property profits. Crucially, this relief can often be claimed alongside R&D tax credits, potentially increasing the overall tax benefits for innovation-driven companies.
- Enterprise Investment Scheme and Seed Enterprise Investment Scheme: these schemes offer significant tax incentives to investors in early-stage companies that meet specific qualifying conditions, such as a ‘risk to capital’ requirement – often applicable to R&D-focused firms. Investors can benefit from a range of tax reliefs, including income tax, capital gains tax (CGT) and inheritance tax relief, which can dramatically lower the cost and risk of investment. These schemes also make R&D-intensive businesses more attractive to potential investors, unlocking crucial funding for growth.
- Enterprise Management Incentive (EMI) Scheme: Retaining top talent is critical for R&D-intensive engineering and technology firms, yet it remains one of their greatest challenges. In fact, a recent Deloitte survey found that 90% of leaders view recruiting and retaining tech talent as a significant hurdle. With the UK engineering sector projected to face a shortfall of one million engineers by 2030, keeping skilled employees onboard is more important than ever.
The EMI scheme is a powerful, yet underutilised, tool for retaining talent. It allows businesses to grant share options to key employees, providing them with a long-term incentive to stay and contribute to the company’s growth. This is particularly valuable for firms engaged in complex R&D, where highly specialised employees play a crucial role.
Under the EMI scheme, employees can benefit from a reduced 10% CGT rate on gains from share sales, compared to the much higher rates of income tax and national insurance – up to 47% – often associated with receiving shares as part of employment remuneration.
Beyond cutting-edge innovation
Engineering and technology R&D extends far beyond cutting-edge inventions. It encompasses areas such as software development, product design, manufacturing processes and advancements in electronics, AI, automation and robotics. While these activities are often eligible for R&D tax relief, they are frequently overlooked by companies.
Many engineers or tech professionals mistakenly believe that the relief is only available for groundbreaking projects that ultimately succeed. In reality though, R&D tax relief can also be claimed for projects that fail or are abandoned due to technological uncertainties that cannot be overcome.
This misunderstanding, combined with recent changes to R&D relief, negative press and the rise in HMRC enquiries, has caused many businesses to hesitate when it comes to claiming R&D tax relief. However, by working with trusted tax advisors that specialise in R&D and other complementary tax reliefs, companies can effectively navigate the complex landscape of the R&D schemes and ensure they identify and access all available tax reliefs.
If a company can qualify for R&D or other complementary tax reliefs, the financial benefits can be transformative, helping to fuel further innovation, reduce risks and drive growth.
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