Lighting up Innovation – UK Tax Incentives

published on 4 August 2020 | reading time approx. 3 minutes

In light of the economic impact of covid-19, UK companies should be considering ways of maximising tax efficiency. Let us focus on the area of innovation and explore a couple of tax options available to UK companies.

The current pandemic has put the spotlight very much so on the finance and tax policies of UK companies.

Many UK companies are revisiting existing tax policies and considering new avenues in the pursuit of reducing their overall tax burden.

This article will touch upon two reliefs available to UK companies who are engaged in Research and Development (R&D) activities or have income derived from the exploitation of Patents.

1. Research and Development`

The UK operates a fairly generous, and easy to apply, R&D relief regime, in comparison to other counties worldwide.

R&D – UK system

R&D reliefs support companies that work on innovative projects. It can be claimed by a range of companies that seek to research or develop an advance in their field. It can even be claimed on unsuccessful projects.

For R&D expenditure to be applicable for the R&D relief, the R&D activities should be those that directly contribute to achieving an advancement through the resolution of a scientific or technological uncertainty on the worldwide market as a whole.

Projects that count as R&D

The project must relate to the company’s trade; either an existing one, or one that the company intends to start up based on the results of the R&D.

To obtain R&D relief the company should explain how a project:

1. Looked for an advance in science and technology
2. Had to overcome uncertainty
3. Tried to overcome this uncertainty
4. Could not be easily worked out by a professional in the field

The project may research or develop a new process, product or service or improve on an existing one.

Size of entity and relief types

There are two types of R&D reliefs; “Research and Development Expenditure Credit” (RDEC) for “Large” companies and “SME Relief” for small and medium sized companies. An entity will be considered an SME for R&D purposes if the following apply on a worldwide group basis:

Less than 500 staff AND either

1. Less than EUR 100 million turnover, or
2. Less than EUR 86 million gross assets.

• SME companies claim R&D relief as an enhanced deduction of 230 percent of the qualifying costs, so for every £100 of R&D costs, the company claims £230 as a deduction to the calculation of taxable profits. If the company is loss making, claiming a tax credit worth up to 14.5 percent of the surrenderable loss is possible. Where the SME Company undertakes R&D work as a subcontractor to a large company, it can claim R&D tax relief using the RDEC method.
• Large companies claim R&D relief as an above the line expenditure credit (RDEC). The rate of the RDEC increased from 12 percent to 13 percent for expenditure incurred on and after 1 April 2020.

Qualifying R&D expenditure

Once it has been established that there is qualifying R&D activity in the UK entity, and which relief is applicable, the qualifying expenditure will need to be identified. Examples of qualifying expenditure include:

1. Staff costs, including salaries, employer’s NIC and pension contributions, as well as some reimbursed business expenses.
2. Money spent on Externally Provided Workers (EPWs) and some very limited subcontractor costs.
3. Expenditure on consumables and materials like light, power and heat that are used up or transformed in the R&D process.
4. Some types of software costs.
5. Money paid to clinical trial volunteers.
6. Contributions to independent research.

R&D Capital allowances

In addition to RDEC or R&D SME relief, R&D capital expenditure can potentially qualify for 100 percent relief.

Making a claim to UK tax authority (HMRC)

A report detailing the evidence that the activities are qualifying and supporting calculations on qualifying expenditure will need to be submitted to HMRC. The report will be submitted with the Corporation Tax return (CT600) and computation.

Many people will be surprised at how broad R&D claims can be in the UK. In the age of globalisation and digitalisation, it is not just the traditional lab coat R&D that qualifies. It is worth exploring the feasibility of an R&D claim with a tax expert if UK companies feel that there have been significant process, product, technology or software developments.

2. Patent Box

As with several other countries, the UK also offers tax incentives for certain profits generated from the exploitation of Patents.

What is the UK Patent Box Regime?

The aim of the UK patent box regime is to provide an incentive for companies to develop and retain patents and other qualifying Intellectual Property (IP) within the UK as part of the Government’s growth agenda.

The regime is available for accounting periods commencing on or after 1 April 2013. It applies to companies within the charge to corporation tax that actively hold qualifying patents. Qualifying companies can elect for a reduced rate of corporation tax to apply to the income generated from the relevant patents. Companies that elect to be within the patent box regime can claim an additional deduction in calculating taxable profits, with the effect that the relevant profits are taxed at a reduced rate of 10 percent.

Qualifying IP

The types of qualifying intellectual property that the patent box applies to include patents granted by the UK Intellectual Property Office (IPO) and the European Patent Office (EPO), certain rights granted under the law of specified EEA states, UK and EU supplementary protection certificates, regulatory data protection, and certain plant variety rights.

Profits derived from the following activities will qualify for the reduced rate:
1. Licensing or sale of the patent rights
2. Sales of the patented invention or products incorporating the invention
3. Use of the invention in the company’s trade
4. Infringement of the patent rights

Qualifying companies

Only those companies that meet the qualifying company conditions are able to benefit from the reduced rate of Corporation Tax which can be applied to patent box profits.

 
Companies must satisfy the following conditions:

• Condition A – During the accounting period, the company holds qualifying IP rights, or holds an exclusive licence in respect of any such rights.
• Condition B –

1. The company has held a qualifying IP right or exclusive licence in respect of a right (Right in this context can be seen as making a significant contribution to the creation/development of the patent).
2. The company has received income in respect of an event which occurred in relation to the right or licence when:

 
a) The company was a qualifying company, and
b) The company had made a patent box election, and

 
3. The income falls to be taxed in the accounting period.

• Condition C (applies to companies that are members of a group) – The company meets the ‘active ownership’ condition for the accounting period where they undertake a significant amount of the management of the IP portfolio.

Election into the Patent Box Regime

An election is required to benefit from the reduced rate of Corporation Tax that applies to the Patent Box. This must be done within 2 years after the end of the accounting period in which the relevant profits and income arose.

 
The election can be made in the Corporation Tax computation accompanying the Corporation Tax return.
Non-qualifying profits generated by a company, which has elected in to the regime, will continue to be taxed at the main rate of Corporation Tax.