A company which is an SME will cease to be one
only if it fails to meet the qualifying conditions over two consecutive
years. Similarly, a company that is not a SME will become one
only if it satisfies the criteria for SMEs over two consecutive
financial years.
Sub-paragraph (2) provides that the Treasury
may substitute another definition of SME if necessary. This will
allow the definition to be updated if there are any changes to
the EC definition or rules.
Paragraph 3 defines "qualifying R&D
expenditure". The paragraph sets out the overarching conditions
that must be satisfied for expenditure to be qualifying R&D
expenditure on which a company may claim R&D Tax Relief.
Sub-paragraph (1) provides that "qualifying
R&D expenditure" means expenditure that meets the conditions
set out in paragraph 3.
Sub-paragraph (2) provides that the expenditure
must not be of a capital nature.
Sub-paragraph (3) provides that the expenditure
must be attributable to "relevant research and development"
directly undertaken by the company or on its behalf.
Sub-paragraph (4) provides that the expenditure
must be on "staffing costs", "consumable stores",
or be "qualifying expenditure on sub-contracted research
and development". The purpose of this rule is to provide
a simple and consistent measure of R&D activity. The R&D
tax credit is then given by reference to this measure.
Sub-paragraph (5) requires that any "intellectual
property" created as a result of the R&D is, or will
be, vested in the company. The purpose of this test is to identify
the person who has the ownership rights to any fruits of the R&D.
A person must have such ownership rights to claim R&D Tax
Relief. It prevents people who are carrying on R&D activities
on behalf of another person ("sub-contractors") from
claiming R&D Tax Relief for that work.
Sub-paragraph (6) requires that the expenditure
is not incurred by a company in carrying out activities contracted
to it by another person. This complements the rules relating to
sub-contracted R&D in paragraphs 9 to 12, which allow the
principal to claim R&D Tax Relief where R&D is contracted
out, and prevents double relief for the same R&D.
Sub-paragraph (7) provides that the expenditure
must not be "subsidised". This stops a company claiming
R&D Tax Relief on R&D paid for by someone else.
Paragraph 4 defines "relevant research
and development". This matches the present rules for allowable
expenditure on scientific research, and covers both trading and
pre-trading expenditure.
Sub-paragraph (1) provides that "relevant
research and development" is R&D related to a trade carried
on by the company, or from which the company intends to derive
and carry on a trade.
Sub-paragraph (2) provides that "related
to a trade carried on by a company" includes R&D which
may lead to or facilitate an extension of that trade, and R&D
of a medical nature which has a special relation to the welfare
of workers employed in that trade.
Paragraph 5 sets out the "staffing
costs" that can qualify for R&D Tax Relief.
Sub-paragraph (1) provides that the qualifying
staffing costs are the emoluments paid to directors and employees
(excluding benefits in kind), the secondary Class NIC 1 paid by
the company (this excludes NIC on benefits in kind are excluded)
and payments made by the company into a pension fund operated
for the benefit of the directors of employees.
Sub-paragraph (2) provides that the qualifying
staffing costs attributable to relevant R&D are those paid
to or in respect of directors or employees directly and actively
engaged in such R&D. Together with sub-paragraphs (3)
and (4), this focuses R&D Tax Relief on actual R&D
activity and excludes activities which are peripheral or remote,
such as consideration of R&D by the main Board.
Sub-paragraph (3) provides that, where
a person does not spend all his or her time on R&D, an appropriate
proportion of his or her staffing costs are treated as attributable
to relevant R&D. However, if a person spends more than 80%,
or less than 20% of their time on the R&D their staffing costs
are included, or excluded in full. This rule simplifies the computation,
by removing the need to adjust for minor amounts of qualifying
or non-qualifying activities.
Sub-paragraph (4) specifically excludes
from the staff whose costs can qualify for R&D Tax Relief
persons who provide services in support of the R&D activities,
such as clerical or administrative services. This excludes staff
peripheral to or remote from the R&D activity such as central
pay-roll, clerical and administrative services of the company.
It does not exclude staff directly engaged in carrying on the
R&D, including ancillary staff employed in a dedicated R&D
facility such as technicians, maintenance, clerical and security
staff.
Paragraph 6 sets out the expenditure on
"consumable stores" that can qualify for R&D Tax
Relief. They are the consumable stores employed directly in carrying
out the R&D. Consumable stores has the same meaning as in
normal accounting practice.
Paragraph 7 defines "intellectual
property" for the purposes of R&D Tax Relief. It comprises
industrial know-how, patents and other rights in information recognised
under UK law, and their overseas equivalents.
Paragraph 8 defines the "subsidised
expenditure" that does not qualify for R&D Tax Relief.
Sub-paragraph (1) treats expenditure as
subsidised expenditure if a notified State aid has been obtained
in respect the expenditure or of any expenditure on the same R&D
project, whenever incurred. In such a case, no expenditure on
the R&D project can qualify for R&D Tax Relief. This is
to ensure that the European Commission rules against the accumulation
of State aid are not breached.
Expenditure is also subsidised expenditure to
the extent that a grant or subsidy has been obtained in respect
of it, or it has otherwise been met directly or indirectly by
another person. In such a case, any unsubsidised expenditure on
the R&D project can qualify for R&D Tax Relief.
Sub-paragraph (2) defines a notified State
aid as a State aid notified and approved by the European Commission
(other than R&D Tax Relief or R&D tax credit). Any grant
towards an R&D project out of Government or public funds,
or from the Commission itself, would normally fall into this category.
Sub-paragraph (3) provides for an apportionment
of any notified State aid, grant, subsidy or payment that is not
allocated to particular expenditure. The apportionment is made
in such a manner that is just and reasonable. The purpose of this
rule is to identify the proportion of the moneys receivable that
is referable to the R&D expenditure.
Sub-contracted Research and Development
Paragraph 9 contains rules that enable
a company to claim R&D Tax Relief on R&D which it sub-contracts
to another person. This is a normal incidence of R&D activity.
The treatment depends on whether or not the parties are connected.
Sub-paragraph (1) provides that the special
rules in paragraphs 10 to 12 have effect to determine the
amount of the "qualifying expenditure on sub-contracted research
and development".
Sub-paragraph (2) defines what is meant
by expenditure on subcontracted R&D. A company incurs expenditure
on subcontracted R&D if it makes a payment (a "sub-contractor
payment") to another person (the "sub-contractor")
in respect of "relevant R&D" contracted out to that
person.
Paragraph 10 contains the rules that apply
where the company and the sub-contractor are "connected persons"
(as defined in Section 839 ICTA 1988). The purpose of these rules
is to look through to the actual expenditure incurred by the sub-contractor
in carrying out the sub-contracted R&D.
Sub-paragraph (1) provides that, where
the company and sub-contractor are connected persons, the amount
of the company’s qualifying expenditure on subcontracted
R&D is the lower of the amount of the particular sub-contractor
payment in question and the sub-contractor’s "relevant
expenditure".
Sub-paragraph (2) defines "relevant
expenditure" and "relevant period" for the purposes
of sub-paragraph (1).
The "relevant expenditure" is defined
as the revenue expenditure, not being subsidised expenditure,
incurred by the sub-contractor on staffing costs and consumable
stores in carrying out the work sub-contracted by the company
that is represented by the company’s sub-contractor payment.
The "relevant period" is defined as
a period for which the sub-contractor draws up accounts that ends
not more than 12 months after the end of the accounting period
of the company in which the company recognises the sub-contractor
payment as a deduction in accordance with normal accounting principles.
Sub-paragraph (3) applies the definitions
of staffing costs and subsidised expenditure in the schedule,
with any necessary adaptations, for the purposes of sub-paragraph
(2).
Sub-paragraph (4) provides for all necessary
apportionments to be made for the purposes of paragraph 10.
Paragraph 11 allows a company and sub-contractor
who are not connected to jointly elect for the connected persons’
treatment in sub-paragraph (10) to apply.
The election covers all payments made under the
same contract or arrangement and is irrevocable.
Paragraph 12 contains the rules for sub-contractor
payments in other cases, i.e where the parties are not connected
and have not elected into the connected person’s treatment.
In such cases, 65% of each sub-contractor payment is treated as
qualifying expenditure on R&D. This is a broad measure of
the sub-contractor’s revenue costs of staff and consumable
stores employed to fulfil its contractual obligations. It allows
the company to claim R&D Tax Relief without requiring an unconnected
sub-contractor to divulge information about its own costs.
Part II: Manner of Giving Effect
to the Relief
Part II contains the rules that determine how
the amounts of R&D Tax Relief and the R&D tax credit are
calculated and how they are given.
Paragraph 13 contains the provisions for
a claim to R&D Tax Relief in cases where the qualifying R&D
expenditure is given as a deduction in computing the profits of
a trade. It increases the relief for qualifying R&D expenditure
by 150%.
A company which is entitled to R&D Tax Relief
for an accounting period (i.e it satisfies the conditions in paragraph
1) and which has qualifying R&D expenditure deductible in
computing for tax purposes the profit or loss of a trade carried
on in the accounting period may claim R&D Tax Relief. Where
these conditions are met, it can treat that qualifying expenditure
as if it were an amount equal to 150% of the amount.
Paragraph 14 contains the special rules
that enable companies that are carrying on R&D, but not as
part of a taxable trade, to gain the immediate benefit of R&D
Tax Relief, by treating 150% of the deductible qualifying R&D
expenditure as if it were a trading loss of the period. The loss
can then be used under the existing provisions for trading losses;
for example, they could be set against investment income the company
may be earning on its capital.
The purpose of this rule is to provide assistance
to start-up companies that are carrying on R&D. These companies
may incur significant R&D expenditure for a number of years
before they are in the position to begin trading for tax purposes.
Under the existing rules, they could not obtain any relief until
they started to trade, at which point the pre-trading expenditure
would be treated as incurred under the rules in Section 401 ICTA
1988. Paragraph 14 allows immediate relief, but only for
qualifying R&D expenditure.
Sub-paragraph (1) applies the provisions
of paragraph 14 to pre-trading qualifying R&D expenditure.
Paragraph 14 applies where a company incurs
qualifying R&D expenditure in an accounting period that is
not deductible in computing for tax purposes the profits of a
trade carried on in that period. It applies to the qualifying
R&D expenditure which would have been deductible in the accounting
period had the company been carrying on such a trade. Where the
company is not within the charge to tax, paragraph 25(3)
deems there to be an accounting period. The effect of these rules
is to apply paragraph 14 to the qualifying R&D expenditure
deducted, in accordance with normal accounting practice, in the
P&L account for the period.
Sub-paragraph (2) allows the company, on
an election, to be treated as if it had incurred a trading loss
in that accounting period equal to 150% of the amount of that
qualifying expenditure. This allows the company to have the benefit
of the general provisions relating to the set-off of trading losses
for these deemed losses.
Sub-paragraph (3) prevents qualifying R&D
expenditure that is treated as a trading loss during a pre-trading
period from also being treated as incurred on the first day of
trading under the existing rules in Section 401 ICTA 1988.
Sub-paragraphs (4) to (6) contain provisions
regarding the form of the election.
Paragraph 15 contains the rules that determine
the amount of a trading loss that a company can surrender in return
for payment of the R&D tax credit.
Sub-paragraph (1) provides that the company
may claim the R&D tax credit for an accounting period in which
it has a "surrenderable loss".
Sub-paragraph (2) provides that a company
has a "surrenderable loss" in an accounting period if
it has claimed R&D Tax Relief and has incurred a trading loss
in the period, or is treated as having incurred a trading loss
under the special pre-trading provisions.
Sub-paragraph (3) defines the amount of
the "surrenderable loss". It is the lower of the "unrelieved
trading loss" and 150% of the qualifying R&D expenditure.
Sub-paragraph (4) defines the "unrelieved
trading loss" as the trading loss of the accounting period
less any amount that could be set against other income of the
same period (whether or not the company makes a claim), and less
any losses that are relieved in any other way, including by being
carried back and set against profits of an earlier accounting
period. Amounts surrendered as group relief are also excluded.
Sub-paragraph (5) prevents any losses brought
forwards from earlier accounting periods, or carried back from
later accounting periods being taken into account when computing
the surrenderable amount.
Paragraph 16 determines the amount of the
R&D tax credit payable in relation to a surrenderable loss.
The purpose of the R&D tax credit provisions is to allow a
company that makes a trading loss for an accounting period, to
surrender the part of the loss attributable to the 150% deduction
for qualifying R&D expenditure in return for a cash payment
equal to 16% of that amount (that is 24% of the corresponding
R&D expenditure), provided the payment does not exceed the
"total amount of the companies PAYE and NICs liabilities".
The effect of this rule is to allow companies
that are carrying out R&D, but which are not in profit to
receive the benefit of R&D Tax Relief earlier than would otherwise
be the case.
Sub-paragraph (1) provides that a company
is entitled to an R&D tax credit for an accounting period
equal to the lower of 16% of the surrenderable loss of the period
and the "total amount of the company’s PAYE and NICs
liabilities" for "payment periods" ending in the
period.
Sub-paragraphs (2) and (3) give the Treasury
the authority to change the amount of the percentage in paragraph
(1) and to make any necessary further or transitional arrangements
as they see fit. The 16% rate for R&D tax credits represents
the existing small companies rate of tax (20%), subject to a 20%
discount, reflecting the greater value of money immediately, against
the prospect of a reduction in tax liabilities in the future.
But 16% could become unduly generous or mean if the tax rates
were to change.
Paragraph 17 defines the "total amount
of the company’s PAYE and NICs liabilities" for the
relevant "payment period".
Sub-paragraph (1) defines the amounts of
PAYE and NICs that are taken into account. They are for the whole
company, and are not limited to the liabilities in relation to
the staff directly carrying on the R&D.
Sub-paragraph (2) defines a "payment
period" as a period which ends on the 5th day
of a month for which the company is liable to account for income
tax and NIC to the Inland Revenue. This avoids the need to make
any apportionments, since few company accounting periods end on
the 5th of the month.
Paragraph 18 contains rules concerning
the payment of the R&D tax credit.
Sub-paragraph (1) provides that the Inland
Revenue will pay to the company the R&D tax credit where the
company is entitled to, and makes a claim for it.
Sub-paragraph (2) permits the Inland Revenue
to use the R&D tax credit to discharge any outstanding corporation
tax liabilities of the company. It treats an R&D tax credit,
or any interest payable under Section 826 ICTA 1988 on the credit,
as paid to the extent it is applied in discharging the liability.
Sub-paragraph (3) allows the Inland Revenue
to withhold payment of the R&D tax credit if there is an enquiry
into the company’s tax return for the accounting period for
which the R&D tax credit is claimed. Payment may be withheld
until the enquiry is completed, or the Inland Revenue may make
provisional payments.
Sub-paragraph (4) provides that no payment
of the R&D tax credit need be made until the company has paid
the PAYE and Class 1 NICs liabilities of payment periods ending
in the accounting period of the claim.
Paragraph 19 restricts the loss that can
be carried forwards where there is a claim for the R&D tax
credit. The purpose of this rule is to ensure that the company
cannot both claim an R&D tax credit and carry forward the
surrendered loss against future profits of the trade.
Sub-paragraph (1) treats the trading losses
of an accounting period that can be carried forwards under Section
393 ICTA 1988 to be reduced by the actual amount of the loss that
is surrendered.
Sub-paragraph (2) defines the amount of
the loss surrendered. It is the amount that is finally used for
a claim to the credit for the accounting period. It is the whole
surrenderable loss if the claim were for the maximum possible,
or a corresponding proportion of the surrenderable loss if the
claim is less than the maximum.
Paragraph 20 confirms that a payment of
the R&D tax credit will not be treated as income of the company
for any tax purpose. This means it is exempt from tax.
Part III: Supplementary Provisions
Paragraph 21 contains anti-avoidance provisions
that apply where there are artificially inflated claims for R&D
relief or the R&D tax credit.
Sub-paragraph (1) applies where there are
arrangements entered into wholly or mainly for a "disqualifying
purpose". No R&D relief, pre-trading R&D loss or
R&D tax credit is available for an accounting period to the
extent that it attributed to transactions forming part of such
arrangements.
Sub-paragraph (2) defines the arrangements
that are entered into wholly or mainly for a disqualifying purpose.
They are arrangements of which the main object, or one of the
main objects, is to enable the company to obtain a greater amount
of R&D Tax Relief, pre-trading R&D loss or R&D tax
credit than that to which it would otherwise be entitled.
Sub-paragraph (3) defines ‘arrangements’
widely, to include any scheme, agreement or understanding, whether
or not legally enforceable.
Paragraph 22 imposes restrictions on the
amounts that can be surrendered as group relief. They apply where
a company claims R&D Tax Relief, a pre-trading R&D loss
or an R&D tax credit for any accounting period during which
it is owned at any time by a consortium of companies. The company
is prevented from surrendering any amounts as group relief to
any member of the consortium which is not a small or medium-sized
company.
Paragraph 23 contains rules concerning
the use of the deemed trading loss created where a company that
is not carrying on R&D as part of a trade claims R&D Tax
Relief.
Sub-paragraph (1) applies the provisions
of paragraph 23 where a company that is not trading for
tax purposes has claimed the special pre-trading treatment under
paragraph 14 for 150% of its qualifying R&D expenditure
to be treated as a trading loss an accounting period.
Sub-paragraph (2) prevents the deemed trading
loss from being carried back and set against profits of a preceding
accounting period under Section 393A(1)(b) ICTA 1988, unless the
company would have been entitled to R&D Tax Relief under the
pre-trading rules in paragraph 14 for that earlier period.
This rule mirrors the existing provisions for loss-making companies
that are carrying on a trade.
Sub-paragraph (3) provides that any unrelieved
deemed trading losses are carried forward. They are then treated
as losses of the trade brought forward when the actual trade derived
from the R&D commences. This means they cannot be treated
as losses arising in the accounting period during which the trade
commences, so they cannot be set sideways against other income
or surrendered for group relief.
Paragraph 24 provides that Section 10 of
the Exchequer and Audit Departments Act 1866 shall be construed
as allowing payments of the R&D tax credit to be made out
of the gross tax revenues collected by the Inland Revenue. This
provision is required because the payment of the R&D tax credit
is not a repayment of tax already paid; the R&D tax credit
is public expenditure payable out of tax receipts.
Paragraph 25 contains interpretation provisions.
Sub-paragraph (1) contains the interpretation
of various words and phrase used in Schedule 20.
Sub-paragraph (2) applies the connected
persons’ provisions in Section 839 ICTA 1988 to Schedule
20.
Sub-paragraph (3) contains provisions to
establish the accounting period of a company that is not in the
charge to tax, but which incurs qualifying expenditure on R&D.
It is treated as having an accounting period that begins when
it starts to carry on the relevant R&D activities, with the
accounting periods then computed as if it were carrying on a business
consisting of the R&D activities on which the expenditure
is incurred. This rule is needed for those rare cases where a
company does not have an established accounting period for tax
purposes, but is incurring qualifying R&D expenditure on which
it wishes to claim the R&D tax credit.
Paragraph 26 contains transitional provisions
for the commencement of R&D tax credits.
Sub-paragraph (1) prevents Schedule 20
from applying to expenditure incurred before 1 April 2000.
Sub-paragraph (2) prevents the pre-trading
rules in Section 401 ICTA 1988 from treating expenditure made
before 1 April 2000 as qualifying R&D expenditure if the trade
in relation to which the R&D is carried out commences after
that date.
Schedule 21: R&D Tax Credits:
Consequential Amendments
Schedule 21 contains consequential amendments
relating to the interest, claims and penalties. They aim, as far
as possible to incorporate R&D tax credits into the existing
compliance structure for corporation tax self assessment.
Paragraph 1 contains provision relating
to interest payable on the R&D tax credit.
Sub-paragraph (1) provides for amendments
to be made to Section 826 ICTA 1988. This section deals with payments
of interest on tax overpaid.
Sub-paragraph (2) includes within the categories
of payments to which Section 826 applies, payments of the R&D
tax credit.
Sub-paragraph (3) inserts a new subsection
(3A) into Section 826. This gives the material date from which
interest is payable on the R&D tax credit. It is the later
of the first anniversary of the filing date of the company’s
return for the accounting period of the claim and the date on
which the return or amended return containing the claim is delivered
to the Inland Revenue. This is also normally the latest date on
which the company can deliver its tax return without incurring
a penalty.
Sub-paragraphs (4) and (5) make provisions
for the recovery of interest paid on a claim to the R&D tax
credit, if the claim is reduced and all or part of the tax credit
becomes recoverable. This is built onto the existing provisions
in Section 826A ICTA 1988, which provide for the recovery of excessive
interest paid on repayments of corporation tax.
Paragraph 2 requires the claim for the
R&D tax credit to be made in the company’s tax return
or amended return. This is done in a new sub-paragraph (2) of
Paragraph 10 of Schedule 18 Finance Act 1998 (FA 1998). The detailed
rules are contained in a new Part IXA to Schedule 15 FA 1998.
Paragraph 3 provides a mechanism to recover
excessive payments of the R&D tax credit. This is done by
adding the R&D tax credit to the existing rules in Schedule
18 FA 1998 that deal with recoveries of excessive repayments of
tax and interest.
Paragraph 4 inserts into Schedule 18 FA
1998 a new Part IXA, comprising Paragraphs 83A to 83F.
This contains the provisions relating to claims for R&D tax
credits.
Paragraph 83A applies Part IXA of Schedule 18
FA 1998 to claims by companies for R&D tax credits.
Paragraph 83B requires claims for the R&D
tax credit to be made in the companies tax return or amended return
for the accounting period of the claim.
Paragraph 83C requires the claim to specify the
amount of the R&D tax credit being claimed, and for that amount
to be quantified at the time the claim is made.
Paragraph 83D provides that a claim can only be
amended or withdrawn by the company by amending its company tax
return.
Paragraph 83E contains the time limit for making,
amending or withdrawing a claim for R&D tax credits. This
is the first anniversary of the filing date for the company tax
return for the accounting period of the claim. The Inland Revenue
may allow the time limit to be extended.
Paragraph 83F provides for penalties to be charged
relating to claims for R&D tax credits in certain circumstances.
Paragraph 83F(1) provides that a company
is liable to a penalty if a claim for R&D tax credits is made
negligently or fraudulently, or if the company discovers that
a claim for R&D tax credits is incorrect and does not remedy
the error without unreasonable delay.
Paragraph 83F(2) provides that the maximum
penalty is an amount not exceeding the difference between the
R&D tax credit to which the company is entitled for the accounting
period to which the claim relates and the amount of the R&D
tax credit actually claimed by the company for that period.
______________________
BACKGROUND
The Government announced its intention to investigate
ways in which the UK R&D base could be improved in Budget
1998. At the same time HMT and DTI jointly published a consultation
document "Innovating for the Future". This explored
how best to remove barriers to R&D investment. It was followed
in July 1998 by "The Report of the Williams Group on the
Financing of High Technology Businesses".
The Inland Revenue then issued two technical notes.
"Research and Development: Definition and Appeals" (January
1999) sought comments on a new definition of R&D to underpin
a transfer of jurisdiction of appeals on R&D matters to the
tax Commissioners and courts in line with other tax appeals. The
technical note also included draft Guidelines on the meaning of
R&D.
The second technical note, "Research and
Development: New tax incentives for small and medium-sized companies"
(March 1999), sought comments on proposals for a possible scheme
of R&D tax credits. The measures in Clause 68 and Schedules
20 and 21 reflect the scheme outlines in the technical note,
but with modifications made in the light of the responses to the
technical note.
The scheme has been notified to and approved by
the European Commission. The EC Treaty contains rules dealing
with aid granted by Member States of the European Union which
might otherwise distort or threaten to distort competition. One
aspect of those rules is that the UK has to notify the European
Commission of plans to grant aid so the Commission can ensure
that the aid is not incompatible with the common market.
