Research and Development (‘R&D’) relief provides invaluable support and incentives for companies undertaking scientific and technological innovation.
In 2018 R&D expenditure totalled £37.1bn, which amounts to 1.71% of total GDP within the UK.
With the Government seeking to push the UK towards an innovative and technologically driven economy, investment within R&D businesses is an attractive prospect for many investors.
However, where this does happen, it is important that business owners and investors are cautious in ensuring that they understand how their existing investments and interests may impact upon the treatment of R&D relief for existing and future investments.
R&D relief overview
There are primarily two versions of the scheme, which are:
- SME scheme; and,
- Research and Development Expenditure Credit (‘RDEC’).
The SME regime allows small and medium sized companies to obtain a deduction of up to 230% of qualifying expenditure. If a company is loss-making, it is possible for the company to ‘sell’ the loss attributable to R&D expenditure to HMRC for 14.5%.
Under the RDEC scheme, non-SME and large companies can get a tax credit of up to 13% of the qualifying expenditure after 31 March 2020 and 12% before that date.
A company will fall within the SME definition provided it meets the following conditions:
- Fewer than 500 employees; and
- Either annual turnover not exceeding €100m or an annual balance sheet figure not exceeding €86m.
For the purpose of categorising whether a company falls within the SME or RDEC regime, the company seeking to claim R&D relief is not assessed in isolation. As such, where there are ‘linked’ enterprises or ‘partner’ enterprises involved, this can make things complex as set out below.
Two enterprises are linked if one can exercise control over the other, or if both are under common control of another person (either a company or an individual). This control can be either direct or indirect and can take many forms including shareholding, voting rights and contractual rights. An enterprise is ‘linked’ with another if it has:
- A majority of the shareholders’ or members’ voting rights in that enterprise;
- The right to appoint or remove a majority of the members of the administrative, management or supervisory body of another enterprise;
- The right to exercise a dominant influence over another enterprise;
- Controls a majority of shareholders’ or members’ voting rights in that enterprise.
If a company is deemed to be linked to another, the combined turnover, assets and staff count of both must be applied to the SME threshold tests. Importantly, it is worth noting here that, despite the fact that only companies are entitled to R&D relief, ‘enterprise’ is far broader than that and will extend to individuals, partnerships and trusts.
The test for a ‘partner’ enterprise will be satisfied where one enterprise holds 25% or more of the capital or voting rights in the other but they are not linked enterprises. If a company making an R&D claim has a partner enterprise, a proportion of the data from that enterprise must be aggregated with that of the company when considering the qualifying SME criteria. The data to be aggregated will be proportional to the percentage interest of the company in the enterprise.
An autonomous enterprise is a company that is not a linked enterprise or a partner enterprise.
In addition to this, despite satisfying the definition of a partner enterprise, an exception applies where the investor is:
- A venture capital company;
- A public investment company;
- Individual(s) with regular venture capital investment (i.e. business angels), as long as the collective investment does not exceed €1.25m.
Notably, this exception does not apply where the definition of a linked enterprise is satisfied.
We have recently seen an example whereby HMRC had enquired into a sizeable SME R&D Tax Credit claim, on the basis that the relevant company was a linked enterprise.
The company carrying on the trade worked within the automotive and aerospace industry, producing specialist composite materials. In isolation, the company would have met the criteria for a small and medium sized enterprise. However, the company was controlled (51%+) by a corporate finance house, which also owned a number of similar businesses within the same industry. Consequently, this resulted in the company not qualifying for an SME R&D Tax Credit claim. Instead, the company could only qualify for a lower RDEC claim. Had the corporate finance house been aware of this at the time of investment, a consideration of the entitlement to SME R&D Tax Credit would have been central to an investment decision.
Where an investment or takeover decision is being considered, it is important to assess how the impact of such an investment may affect SME R&D tax relief, as an investment or takeover could potentially mean that the company no longer qualifies as an SME.
At ETC Tax, we have assisted a number of clients in relation to structuring corporate transactions and investments and claiming R&D tax relief. Our knowledge and experience provides us with the ability to advise on effective structuring transactions to maximise efficiency, whilst also ensuring that key entitlements to investors, existing linked or partnership enterprises or future linked or partnership enterprises can maintain maximum relief, where eligible.
If you have any queries about R&D, structuring investments and corporate transactions, or tax in general, then please do get in touch.