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Research and Development - Don't forget the capital

30th Oct 2009
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By Emily Martin

There has been a great deal of focus over recent years on the availability of Research and Development (R&D) tax incentives to invest in innovation in the UK. For companies developing new products, processes, materials or services, it is likely that R&D will be carried out and tax incentives will be available.

Enhanced relief is available for revenue expenditure incurred on research and development incurred by small and medium enterprises (available at 175%) and large enterprises (available at 130%). However, it is important not to overlook the fact that Research and Development Allowances (RDAs) are still available for capital expenditure for which a 100% first year allowance is available. This is often overlooked with other capital allowances such as plant and machinery or industrial building allowances being claimed or being treated as non-qualifying expenditure.

What is qualifying R&D?

Qualifying R&D for the purposes of revenue and capital expenditure is defined by reference to DTI Guidelines (issued by the Secretary of State for the Department of Trade and Industry for the purposes of Section 837A Income and Corporation Taxes Act 1988). Broadly, these guidelines provide that a project which, for example, seeks to:

(a) extend overall knowledge or capability in a field of science or technology; or

(b) create a process, material, device, product or service which incorporates or represents an increase in overall knowledge or capability in a field of science or technology; or

(c) make an appreciable improvement to an existing process, material, device, product or service through scientific or technological changes; or

(d) use science or technology to duplicate the effect of an existing process, material, device, product or service in a new or appreciably improved way, (e.g. a product which has exactly the same performance characteristics as existing models, but is built in a fundamentally different manner),

will be qualifying R&D for tax purposes. The activities that directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are qualifying R&D, along with certain qualifying indirect activities related to the project.

Examples of qualifying R&D

An advance in science or technology may have tangible consequences (such as a new or more efficient cleaning product, or a process which generates less waste) or more intangible outcomes, (e.g. new knowledge or cost improvements), and the key aspect is whether there is an appreciable element of innovation.

However, the relief is by no means restricted to pharmaceutical and other high-end technology industries, but also can apply to activities in such industries as manufacturing, software, financial services, consumer business and energy and utilities.

Research & Development Allowances

For capital expenditure to qualify for relief, the expenditure must be for the purposes of R&D that is related to a trade that the trader carries on, or a trade that the trader sets up and commences.

This means that where a company (or other trader) acquires or builds property with the intention of using the property for the purposes of carrying on qualifying research and development, then most, if not all, of the expenditure involved will qualify for a 100% allowance in the accounting period in which the expenditure is incurred. This can apply to laboratories, as well as other research facilities, including office space, research equipment, company cars or capitalised expenditure associated with the development of a new information technology system for internal use.

With the reduction in rates of capital allowances available for expenditure on plant and machinery, and the phased abolition of IBAs, the additional benefit in claiming RDAs is greatly increased. This is particularly the case where other capital allowances are not available, for example on the "building costs" associated with an office development used for R&D.

Where a building is only used (or to be used) partly for the purposes of qualifying R&D, the maximum benefit can be obtained by the detailed segregation of all costs that are associated with the relevant areas in qualifying use. These identified costs will qualify for the 100% FYA, with the balance qualifying for other capital allowances where available. A detailed specialist review is often required to ensure the most beneficial tax allowances are obtained.

Specific points to note:

  • There is no alternative to the 100% FYA. Therefore, if the full amount is not claimed in the first year, there are no provisions in the legislation to claim further allowances relating to that expenditure, and the potential allowances are lost.
  • If RDAs are claimed in relation to a property used for qualifying R&D, and the property then begins to be used for another purpose, then there are no provisions to claw back the allowances relating to that property.
  • If, however, the property is disposed of and the disposal value is more than any unclaimed RDA, there is a balancing charge. An unclaimed RDA is the part of the 100% FYA that was not claimed. The amount of the balancing charge is the smaller of:
  • - the amount by which the disposal value exceeds any unclaimed RDA; and
    - the RDA made.

    Therefore, with the enhanced and accelerated tax reliefs that are available for R&D expenditure, don't forget to consider any capital expenditure when making claims for revenue items.

    www.bournebc.com

    Emily is a manager at Bourne Business Consulting LLP with over four years of experience working as a specialist in tax depreciation on diverse projects such as maximising claims for land remediation relief and maximising research and development expenditure on the purchase of R&D facilities.

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