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R&D Tax Credits and Corporate Transactions
If you are involved in buying or selling companies (or are planning to), then this article is aimed at you. You may not think R&D tax credits are a factor in your transaction, but read on, as you might be surprised!
Amongst all the complex processes and agreements involved in a typical corporate deal, this small area of the tax rules is often overlooked until it is too late. This can have the consequence of tens of thousands of pounds of tax credit entitlements being lost!
What are R&D tax credits?
Briefly, companies carrying out projects that try to make an advance as a result of applying science or technology are entitled to a generous tax reductions, or in certain circumstances a cash payment from HMRC. This applies to a broad range of companies who have created new products and services, and is a frequently missed by companies not recognising that it might apply to them.
The credits are worth approximately 25% of the money spent on qualifying projects by small companies, and about half that for large (more than 500 employees) companies. Unlike most tax reliefs, loss making companies can actually generate a payment of up to 33% of that spending. Without going into detail about all the rules and regulations, there are a few key ones that can have a major impact during and after a corporate sale.
- Time limits - You can make a claim up to 2 years after the end of an "accounting period", usually a financial year. This means that you can claim for spending that could date back nearly 3 years.
- The claiming company must be a "going concern" in order to claim. This is an accounting definition that is technically assessed at the end of the accounting period in question, but it is unlikely that HMRC will consider any company in administration or liquidation, for example as part of a pre-pack deal.
- Only the company that carried out the R&D can actually make the claim. A significant potential issue for companies undergoing restructuring as part of a deal.
- The size of company making the claim is important. SMEs get the best deal, and the assessment of size includes both parent and subsidiary companies. Whilst technically you can still claim for a previous period if a company has become "large" as a result of being acquired, but the process of merging and aligning business can make this much more complex after a deal.
However, the biggest issue we've come across is of both buyers and sellers simply not spotting a potential claim at all! The remainder of this article will focus on specific advice for people on both sides of a transaction, but if you're unsure whether a particular type of work or project might qualify in the first place, feel free to get in touch with us here.
Advice when selling a company
- If you think that you might have a claim, get it done! Most corporate transactions involve a "cash sweep" at completion, in other words any extra cash in the business resulting from a successful R&D claim is yours to keep. Don't be put off by the process of making the claim - specialists like WOCO can move very quickly to conduct and analysis and produce a report (our record was one done in less than a week!). HMRC will generally process returns and make payments in around 3-6 weeks.
- R&D adds significantly to your valuation. Claims are usually a reflection of ongoing activity, rather than a one-off. If you have successfully claimed R&D credits worth (say) £50k in the year prior to the sale, make sure that future claims are factored into the valuation, as R&D tax credits represent a direct contribution to the balance sheet. Using the £50k example (which could result from annual R&D spending of £200k, or £100k per year over 2 years), there would not only be the immediate cash benefit, but it could add a multiple of that onto the company valuation, and that's before you even consider the additional value the fruits of that R&D itself will bring!
- Show your company in the best light. The process of making a claim and producing the associated report can help you to clarify exactly what parts of your business do. Often R&D work is under-appreciated, we often hear the phrase "it's just what we do", and the R&D analysis can show just how impressive your company really is. Making claims will also help to show that a company is well organised and has been efficiently run.
Advice when buying a company
- See the first point for sellers above! If you spot a claim in a company you just acquired, this can generate an immediate and easy cash benefit to offset the price paid in acquiring the business.
- Make sure you buy the right thing! If you only want to acquire part of a business, it is essential to retain the original corporate entity that carried out the R&D. Just acquiring the assets & staff, creating a new company or starting a joint venture can wipe out potential benefits.
- Watch for crossing the SME threshold. This applies to both the company being acquired and the acquirer. A company of 450 employees acquiring a smaller one with 100 staff will mean that future claims for both companies will no longer be eligible for the SME scheme. Whilst this may not be enough to derail a transaction, it is worth understanding the potential impact on both sides when looking to value the deal.
- Don't lose critical information. In all the excitement of merging 2 companies, vital information about R&D projects can go astray. In smaller companies this can also happen when key staff (such as owner-managers) leave as part of the deal.
The above point should also be taken into account during the negotiations for sale. Whilst is may be tempting to "get one over" the previous owners by keeping quiet about a claim until after an acquisition, if you have to keep some kind of relationship with them (either due to an earn-out, or by requiring their help to make the claim) it might be in everyone's best interests to be completely open!
I hope we've been able to give some useful examples and pointers in an area that sometimes seem complex and daunting. I also hope you can see the benefits of getting expert advice as early in the process as possible!
If you are in the process of preparing to sell your company, or are advising clients in either selling or buying, get in touch with us. We work on a "no claim no fee" type arrangement, so any up-front advice is free of charge. We also offer a generous fee sharing scheme for advisers who introduce us to their clients.