An indepth look at how companies can make the most of R & D credits
For a company to maximise the benefits of tax breaks designed to encourage innovation, they first must convince the tax man of the value of their work.
But due to the highly specialised nature of innovation in life sciences, this isn’t always the easiest task.
While companies in possession of a patent may fully understand the Patent Box scheme, where profits from patented items attract a lower rate of corporation tax – 10 per cent instead of 20 per cent – the same cannot be said for the other major tax benefit for innovative companies, the research and development (R&D) tax credit scheme.
More companies than ever are looking to leverage the credit, provided as a rebate from HMRC, to stimulate cash flow as they look to grow their businesses.
The scheme was introduced by the Treasury in 2000 to help those companies engaged in R&D and to keep such work viable and in the UK.
The rise in its use, however, has brought into sharp focus the quality of claim justification with companies tasked with providing evidence to support their claims and to explain their work to tax inspectors whose expertise lies in accountancy, rather than scientific innovation.
With claims from a multitude of sectors including software, pharmaceuticals and engineering, the depth of knowledge required to manage the process is profound.
Leyton is a management consultancy whose area of expertise is auditing and identifying innovation in order to allow companies engaged in R&D to maximise their tax arrangements. Its team of experts’ task is to translate projects into the HMRC framework.
Dr Tony Huynh, a senior R&D consultant with Leyton, says: “My role is to understand our clients’ business activities and align that with the R&D tax relief scheme.
“HMRC is a financial organisation so it predominantly employs people with tax backgrounds, who go on to assess the technical aspect of a claim.
“So when we are talking about high-end research, it can be difficult to synthesise that information in a way for a tax inspector to understand and be in line with the legislation, so that is where Leyton comes in.”
Huynh has a PhD in paediatric oncology but is also an expert in tax legislation and understanding financially qualifiable areas of R&D in the life sciences sector.
He says the explanation goes both ways: “Clients won’t necessarily understand the tax laws or how the calculations of savings have been arrived at, so it is a two-way translation.
“Our task is to explain the tech to HMRC, while explaining the financial aspect to the client and how it is applicable to them.”
David Kent, Leyton’s head of Scotland, says that the figures involved can be significant.
“There are two forms of relief, one targeted on small and medium companies and one intended for large companies.
“A small company can still get quite a lot back as it gets a higher level of relief than a large company.
“Companies are sometimes reluctant to claim for something like R&D tax relief because they don’t want to raise their profile with HMRC and open themselves up to risk of inquiry.
“If a company were to claim for more than it was entitled HMRC would ask for it back, perhaps with interest and perhaps with penalties as well. But that is one of the risks we mitigate.
“We have never had a claim denied by HMRC and part of the reason is that we don’t overstep the rules. We endeavour to get clients what they are entitled to, based on the correct interpretation of legislation.
“Because of our experience we know what HMRC would be comfortable paying for and what is allowable.”
The national average of further inquiry into reports is 16 per cent (one in six). Leyton UK’s record is 0.7 per cent (less than one in 100).
Huynh says that while most companies in the life sciences sector will already be aware of the tax relief, they still may not be claiming all that they are entitled to.
“We find that when we are talking to the company whose sole purpose is high-end research, they will only claim for that very high level element.
“But the criteria that HMRC has established is often too complex for most to understand and regularly leads to companies missing out on their full tax savings.
“Particularly in the biology sector, the client will recognise the high-end R&D area, but there are other aspects to their work, such as engineering or software aspects for instance.
“Quite often a great deal of time goes into developing facilities or coming up with better equipment and repairing that equipment.
“These developments might seem at quite a low level but if they feed into the high-end R&D they are allowable as qualifying indirect activities. It’s not directly R&D but it is activity essential for the R&D to occur.”
He says other companies don’t realise that what they do is applicable for this tax relief.
“There are some small life science companies who provide one specific service, for instance they are subcontracted to run tests for a larger pharmaceutical company.
“The smaller companies are quite likely to think that they can’t claim because everything is provided to them and so all of the intellectual property (IP) will belong to the larger company.
“We find in a lot of cases that there are various angles that we can approach where the subcontracting company can make a claim.”
Kent agrees that most companies they audit are not making the most of the scheme.
He says: “The expense you have incurred carrying out R&D is eligible for tax relief, but the expertise is in knowing where to find all aspects of qualifying R&D within the company.
“There are certain things from a checklist that you know you can include in a claim: for instance, salary costs, subcontracting expenses, external testing, software licensing, consumable materials and some utility costs.
“But where we can really add value is recognising costs that can be justified as part of the claim where others might overlook it.
“Where companies believe that IP belongs to the third party, they often think they can’t claim for any of that research, whereas, in fact, that is something we can help them work on.
“They might not be able to claim all of it but there may be parts of the work that should be considered their own R&D and therefore can be included in their own claim.”
He also says that a frequent example of companies not making a claim when they can, is if they have been in receipt of a grant. “They believe that that excludes them from claiming at all, but it isn’t entirely true.”
Leyton takes its fee from the tax relief that it finds, so companies may choose to prepare their own in-house claim, and then call in Leyton’s experts to see what extra benefits can be found. The R&D tax relief scheme also allows companies to claim for two prior complete financial periods, so Kent says: “For a company with a December year end, for example, we could currently go back to the 2015 and 2016 financial years.
“It may be that they have claimed previously but we would reassess those claims with a deadline of 31 December this year to adjust the 2015 claim.
“We would submit a recalculated claim to HMRC for the difference.
“Typically clients don’t pay us until they receive their benefit from HMRC, so even from a cash flow viewpoint it is very easy.”
Savings can be significant and fundamental to a company’s growth, according to Kent. “For a company that is doing pure research, it consumes its own resources until it can commercialise what it is doing.
“Fortunately a loss-making small company has the highest rate of return. It can get almost a third of its expenditure back as cash which will stretch a research programme much further.”
The money is usually spent on additional research, paying better salaries or buying new hardware or software.
Leyton didn’t have a base in Scotland until June 2015 and now employs 45 staff based in Glasgow.
Kent says: “We have grown very quickly with lots of new clients coming on board in a very short timeframe.
“When we first speak to a company if they are not already claiming we can educate them in what it is and the benefits.
“If they are already claiming, then one of the things we can do is to review their existing claims for optimisation opportunities and we will only charge them on the additional value that we can recognise.
“It is a good way for us to demonstrate how much additional value we can add to their existing process, whether that is them doing it themselves or [employing] an accountant who perhaps isn’t a specialist.”
For Huynh, the company’s unique selling point is the huge pool of knowledge it can offer each client.
“As a global company, we can put together a team with a full spectrum of technical expertise.
“In life sciences, for instance, you may need to call on an engineering specialist for their equipment, software experts and a broad range of scientific knowledge to understand their work.
“We offer that malleability to find the right team of people who can really bring benefits to a company.”
For more information on Leyton Life Sciences, visit http://www.leyton.com/en/united-kingdom/home