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How should accountants treat R&D Tax Credits?

20th Sep 2019
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If one or more of your clients has undergone any research and development work recently then they may well be able to receive R&D Tax Credits to help with the cost.

In a nutshell, R&D Tax Credits are a UK-government backed tax incentive that allows companies to claim back some of the costs they have incurred on research, development and innovation. This is achieved either via a reduction in their Corporation Tax or as a cash lump sum.

The scheme is incredibly broad, both in terms of the sectors it covers and the types of R&D expenditure it allows. It was launched in the early 2000s in recognition of the fact that investment in innovation is not just beneficial to companies individually but to the wider economy as a whole. Depending on the size of the company, the claim will come under the SME (for SMEs and start-ups) or the RDEC (Research and Development Expenditure Credit) scheme for larger companies.

How should R&D Tax Credits be accounted for?

The way in which research and development (R&D) Tax Credits in the SME scheme is accounted for is relatively straightforward. As R&D Tax Credits are non-taxable they will only affect a company’s tax charge. For claims under the RDEC scheme, the relief can be recognised above the line in the accounts, which has a positive effect on company’s pre-tax profit.

In terms of accounting, the way R&D tax credits should be treated depends on whether the company qualifies under the SME scheme or the RDEC scheme.

What’s the difference between the SME and RDEC schemes?

To apply under the SME scheme a company must:

  • Have 500 employees or less
  • Have a turnover which is less than €100 million or a balance sheet less than €86 million

To apply under the RDEC scheme a company must:

  • Have more than 500 employees
  • Have a turnover which is more than €100 million or a balance sheet of over €86 million

How should R&D Tax Credits under the SME programme be treated in accounting?

For SMEs and start-ups claiming the relief, the way it is treated in their accounts is pretty easy as the tax credit is not classed as taxable income. It is a below-the-line benefit and will be shown in the company’s profit-and-loss statement, either as a reduction in its Corporation Tax liability or as a credit.

If a company has calculated its R&D tax credit before it has finalised its accounts, the Corporation Tax will need to be adjusted to include the actual figures in relation to the R&D tax relief benefit. Alternatively, you are able to give an estimate instead. Finally, if a company doesn’t know what its R&D tax relief is worth until after the finalisation of its accounts, a prior year adjustment can be included once the claim has been processed. This is because R&D Tax Credit claims are filed retrospectively after company accounts are finalised, and the deadline for Corporation Tax return filing is generally later than the deadline for filing statutory company accounts.

What is the double entry accounting for SME R&D Tax Credits?

As mentioned, R&D Tax Credits under the SME scheme count as a below-the-line benefit. If a company’s claim reduces its tax liability, this should be reflected in the tax line of its profit-and-loss statement and in its Corporation Tax creditor.

To post a company’s tax (pre-R&D):

  • Dr Corporation tax charge (profit-and-loss statement)
  • Cr Corporation Tax (balance sheet)

To reduce a company’s tax charge to reflect its R&D claim:

  • Dr Corporation Tax (balance sheet)
  • Cr Corporation tax charge (profit-and-loss statement)

Then, when a company receives a tax refund:

  • Dr Bank (balance sheet)
  • Cr Corporation Tax (balance sheet)

Alternatively, if a tax credit is expected:

  • Dr Corporation Tax (balance sheet)
  • Cr Corporation tax charge (profit-and-loss statement)

Then, when the credit is received from HMRC:

  • Dr Bank (balance sheet)
  • Cr Corporation Tax (balance sheet)

Accounting for the RDEC scheme

Unlike the SME R&D Tax Credit scheme, the credit a company receives under an RDEC scheme claim is classed as taxable income. RDEC was originally set up as an above-the-line credit, meaning that companies should show the credit as income when calculating pre-tax profit.

In terms of accounting, a company’s gross credit is above-the-line in its profit-and-loss statement – usually it’s shown as ‘other income’. However, it’s important to note that it’s not compulsory for the credit to be treated in this way, so it’s well worth making sure you fully understand all the options. This is when speaking to us at Myriad Associates would be highly beneficial as we can guide you through the different scenarios.

As with the SME credit, a company can finalise its R&D claim calculation early enough to show an accurate figure in its accounts (or a reliable estimate) or it can wait to make an adjustment.

If the R&D expenditure is deferred until the balance sheet, the accounting treatment will be slightly different. Again, please do get in touch with our team if you would like to discuss this.

Double entry accounting under the RDEC scheme

A company’s RDEC receipt is taxable income and, as mentioned, is shown above-the-line in its accounts. The double entry accounting for this is therefore different to an R&D Tax Credit claim made under the SME criteria. Companies will need to decide on the most appropriate disclosure for the RDEC relief in its profit-and-loss statement, as it could also be shown as other income, or taken off the R&D expenditure amount.

For instance, to post the RDEC:

  • Dr Corporation Tax (balance sheet)
  • Dr Corporation tax charge (profit-and-loss statement)
  • Cr Other income (profit-and-loss statement)

A company must post the RDEC relief’s gross value above-the-line (other income), and the tax which needs to be paid on this in the tax line of the profit-and-loss statement.

And if a cash payment is received via the RDEC scheme:

  • Dr Bank (balance sheet)
  • Cr Corporation Tax (balance sheet)

As noted, if a company capitalises its R&D costs, the accounting will be different from that shown above.

Have a question or need further advice? We can help

Myriad Associates is a firm of R&D tax advisors and technical specialists who solely deal with applications for R&D tax reliefs. If you believe that your client’s company could benefit from R&D Tax Credits, and you would like to make sure you’re in the best place to advise them accurately, please feel free to call the team on 0207 118 6045 or use our contact page.