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and the importance of understanding and using R&D Tax Credits.
Grants vs R&D Tax Credits
I'm often asked by my clients whether they should consider applying for innovation grants to fund R&D projects. Alternatively, when I sit down to do an annual R&D review, some clients tell me "oh, we received a six figure grant last year - is that going to affect our R&D claim?".
As with most tax related questions, the answer is a definite "maybe"!
This article will try to explain the issues around the interaction of grants and R&D tax incentives, and provide some guidance for those considering applying for grants, or for those who have already been awarded a grant and want to claim R&D tax credits. Note that I'm going to focus on grants awarded by InnovateUK, but many of the factors are also relevant to other types of grant.
What is the complication?
There is often a misconception that receiving a grant means that you cannot also claim R&D tax credits, but the actual situation is not quite so straightforward. The main problem is that both R&D tax credits and InnovateUK grants are forms of notified state aid, so only one or the other can be received at the same time for a given project.
Fortunately, if you receive a grant you are still allowed to claim R&D Expenditure Credits (RDEC), the scheme usually applicable to large companies. This is worth just under 10% of qualifying spending, compared to about 25% for the SME R&D tax credit. The blow is softened somewhat because the grant money received can also be included in the claim, so for a grant with a 50% match funding requirement the gap as a percentage of your own money spent is narrowed considerably.
Let's take a look at some of the pros and cons in relation to R&D and tax.
Advantages of grants
Grants are only awarded to genuinely innovative projects. The very fact a grant has been awarded is strong evidence to HMRC that a projects will qualify as R&D. There can also be PR benefits associated with winning a grant competition.
Cash flow improvement. R&D tax credits are only realised after the end of a financial year, so with the typical time taken to finalise accounts and prepare tax returns the benefits can take up to 18 months from the point the money was spent. Grants are typically paid every three months in arrears.
Speed of development. A grant, particularly a large one (say over £100k) can allow you to accelerate projects you might not have been able to undertake at all with internal resources alone. There is the caveat that you can't start spending until the grant is applied for and awarded, which is itself a time consuming and uncertain process.
Advantages of R&D tax credits
Greater cash value - as described above, even though it may take longer to arrive, you will usually see a bigger tax benefit without a grant.
More allowable costs. If you receive a grant and therefore need to claim RDEC, it is easy to overlook the fact that certain costs that are allowable for an SME claim are excluded. The most significant of these is the costs for activities subcontracted to other organisations. Under the SME scheme these can be included, albeit at a reduced rate of 65%. This can make a huge difference if you're planning to use the grant to pay subcontractors such as software developers or specialist analysis services. In addition, grants can sometimes be used to fund costs that are never eligible for R&D tax credits, the most common being IP and patent related spending.
Tax credits are retrospective, in other words you don't need to wait for a grant to be awarded before starting work. Most grant applications are over-subscribed, with only something like 1 in 4 or 5 applications succeeding. On the other hand, if your project qualifies, you will definitely be able to claim R&D tax credits, giving a degree of certainty to the process.
Application costs are easier to manage, as most specialist R&D tax advisers will only charge once an R&D credit is actually received. For grants, because of the competitive nature, specialists tend to charge some point of their fee up-front (although using some of the grant advisers I've met will significantly sway the odds in your favour). There are also quarterly costs associated with auditing and applying for payments.
Tips for combining grants and tax credits
Bearing the above in mind and assuming you find yourself in the position of needing to make the most of both schemes, what should you be considering?
- Good project management. Both grants and R&D tax credits work on a project by project basis. Make sure you are clear about what is being done and spent on each project. You don't want to "contaminate" your other projects with the grant money. If you can demonstrate good documentation and cost management (for example with distinct project accounting cost codes) you can simultaneously claim SME R&D tax credits and RDEC.
- Look carefully at external activities. It is often possible to arrange work with third party specialists in a manner that allows them to be treated as "externally provided workers" and thus allowable under RDEC, instead of R&D subcontractors, which are not allowable. Get this right before you start, as there is definitely the opportunity to act in haste and repent at leisure!
- Choose grants carefully. Is there really a good match between the grant criteria and what you plan to do? Don't chase after grants for the sake of it, particularly when the amounts of funding are relatively small compared to the project. There is no point wasting time and money applying for a £40k grant if you plan to spend £100k with a subcontractor, but a £200k grant that will fund a new, internal project is likely to be well worth the hassle!
I hope we've been able to show you a balanced view, as this is an area that is often misunderstood. I also hope you can also see the value of getting advice early, and because we only charge our clients when an R&D claim is successful (which is 100% of the time so far!) it is completely free to get in touch at email@example.com or call 07752 057553 at any time to run your ideas and plans past us.