Grants, such as those from Innovate UK, can be an excellent way to raise finance for R&D projects. However, Small/Medium Enterprises (SME) need to be aware that grants can also severely restrict how much Research and Development (R&D) Tax Relief can be claimed. This is because when a project receives notifiable state aid grant funding, all of its costs must be claimed under the Large Company, R&D Expenditure Credit (RDEC) scheme, which is much less beneficial than the SME version.
This is because when a project receives notifiable state aid grant funding, all of its costs must be claimed under the Large Company, R&D Expenditure Credit (RDEC) scheme, which is much less beneficial than the SME version.
Consider the following example: a loss-making SME spends £100,000 on an eligible R&D project but hasn't received any grant funding. They can expect to receive 33% or £33,350 back in a payable tax credit under the SME R&D Tax Relief scheme.
If instead, the company receives just £10,000 in notified state aid grant funding for the same project, all of the £100,000 must be claimed under the RDEC scheme. In this case, the company could expect to receive only £10,530 back in payable tax credit under RDEC . The end result would see the company receive £22,820 less than if they had received no state aid grant funding. And even taking into consideration the grant funding, the total benefit would be lower than had they not received a grant.
One point to carefully consider then is the company's cash flow. Does the business need the money now or later? R&D credits are in retrospect (although it is possible to get loans against your R&D claims), while grants are often ahead of expenditure.
We often see investors, that are backing low revenue or pre-revenue businesses, pushing these companies to apply for grants. Does the investor fully understand the implications of this grant funding and has the Finance Director modelled the impact on any future R&D tax claims to ensure the maximum benefit is received overall?
It is extremely important to understand therefore, the implications that any grant funding will have on how a project can be claimed under the SME R&D Tax Relief Scheme for the current and any future years on the same project.
Below we provide four important questions to consider before applying for a grant.
Is the grant notifiable state aid?
- Not all grants are considered state aid. If it isn't, then the funded amount of the project must be claimed under the less-generous RDEC scheme.
- This means that if a loss-making SME receives £25,000 of non-state aid grant funding on a £100,000 eligible R&D project then this amount must be claimed under the RDEC scheme. However, £75,000 can still be claimed under the SME R&D Tax Relief scheme. In summary, that amounts to £27,645 in tax credits across the two schemes in addition to the £25,000 of non-state aid grant funding.
How do you define the scope of the project?
- When writing a grant proposal, care needs to be taken over how the project is scoped in the grant application. We have seen many cases where a company has been so eager to receive grant funding on a project, that they will try to describe all of their interesting R&D in an attempt to bolster their grant application. A company may also seek to include the development of their main product/service line within the scope of the grant. Tread carefully here.
- A grant may only cover a short period of time, say 12 months, but the R&D project may go on for much longer, potentially years.
- For example, a loss-making SME receives £100,000 of state aid grant funding for the first year of development on its new product line. The company will be entitled to £10,530 in tax credit under the RDEC scheme on this first year expenditure.
- However, the project continues for another three years, during which the company doesn't receive any more grant funding. Because the scope of the grant proposal covered the same, ongoing project, it must continue to be claimed under the less generous RDEC scheme. The company spends a further £300,000 on the project over the next three years, for which it only receives £31,590 in payable tax credit.
- Instead, consider if the company had been more careful, and made the scope of the grant proposal narrower so it only covered a one-year project. Then, when a new project was started, the future three years could be claimed under the SME R&D Tax Relief scheme instead. The company would receive £100,050 of payable tax credit under the SME R&D Tax Relief scheme. It amounts to £68,460 more compared to having to claim under the RDEC scheme for all four years.
Are Innovation Loans and Innovation Continuity Loans state aid?
- Short answer, yes. These Innovation Loans have favourable terms (particularly a below-market rate of interest) and the value of this benefit over the life of the loan is deemed equivalent to a grant. They are therefore considered a form of state aid. This means that R&D projects which receive Innovation Loan funding must be claimed under the RDEC scheme.
- Rules regarding state-aid funding are currently being reviewed following the UK leaving the EU. Therefore, these rules and their impact on the R&D Tax Relief/Credit may change over time but there are no current plans published.
Is the R&D subcontracted to the company or is the client purchasing a fully developed product?
- It is important to carefully determine which case applies because the implications for each differ considerably. Key areas to consider here relate to where the risk lies and what the contract and invoices say.
There are many factors that can impact on a company's R&D tax relief claim. Be careful, and ensure you speak to an expert before you submit any applications which could negatively impact your R&D Tax Relief claims.
If you have any questions on Grant funding and R&D Tax Relief, please get in touch or to speak to one of our team
David and Alexis are the founding Directors of MMP Tax.
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