What is RDEC and what's it got to do with R&D Tax Credits?
Throughout your accountancy career, it’s highly likely that Research and Development (R&D) tax reliefs will feature prominently. There are a number of different reliefs available and obviously it’s important to become proficient in them as soon as possible in order to advise business owners correctly.
RDEC (Research and Development Expenditure Credit) is one of these reliefs. It’s essentially a UK government-backed tax incentive scheme designed to encourage businesses to invest in innovative processes, solutions and technology via R&D activities. Although mostly used by larger, well established companies, SMEs are also able to access it under certain circumstances.
Here we will look at some of the key features of RDEC as well as discuss some of the important questions that clients are likely to ask.
What is RDEC?
RDEC is one of a couple of R&D Tax Credit incentive schemes provided by the UK government to boost innovation investment within the private sector. It’s designed to give a much-needed financial windfall to larger sized UK companies that pay Corporation Tax in the UK so that they can undergo qualifying R&D activities. For smaller companies there’s the R&D Tax Credits scheme instead, which is slightly different from RDEC in that it offers a better, more generous tax credit rate. Having said that, there are some circumstances when an SME isn’t eligible for R&D Tax Credits, and so it is able to use the RDEC scheme instead.
- An RDEC tax credit is worth 12% of a company’s eligible R&D expenditure.
- The credit is taxable at 19% (the usual Corporation Tax rate) which in effect means it’s worth 10 pence for every £1 a company spends on eligible R&D.
- The benefit can be considered as ‘above the line’ (ATL) as it’s visible income in a company’s accounts.
- The credit is offset against a company’s tax liability or alternatively it can be paid in cash under some circumstances.
What are the benefits of RDEC?
As mentioned, RDEC can be ‘above the line’ in accountancy terms in a company’s profit-and-loss account, as long as visible profit is present. This is also useful for a company in that this clarity can have a positive impact on the decisions made around R&D investment.
As RDEC depends largely on a company’s tax position, the benefit it receives is far more straightforward to forecast. This means improved stability and makes it simpler for large companies to factor the relief into their decisions around investment in innovation. The good news too is that unlike the RDEC scheme’s predecessor that ceased to function in April 2016, RDEC money is not only available to profit-making companies but loss-making ones too.
What is the current RDEC rate?
The current RDEC rate stands at 12%. However, because this rate is applied net of Corporation Tax, the effective RDEC rate a company receives is worth 10 pence for every £1 spent.
The 12% rate that it is today came about in the Autumn Budget of 2017 and has remained unchanged since. It was only the second rate increase since the scheme was launched in April 2013. A popular and successful scheme for a huge number of companies that use it, businesses have recently gained even more when the Corporation Tax rate was reduced to 19% on 1 April 2017.
What qualifies as an RDEC activity?
In order to qualify for RDEC tax relief certain eligibility criteria must be met. These guidelines are published by the Department for Business, Innovation and Skills which also sets out the activities constituting R&D. Sometimes called the ‘BIS guidelines’, they apply to both the SME R&D Tax Credit scheme and the RDEC scheme alike.
For tax purposes, what defines R&D is purposefully very broad and can apply to all companies regardless of their sector or size. Companies that are specifically looking to address a technological uncertainty or resolve a technological or scientific problem are more than likely to be embarking on an eligible R&D activity. If a company builds new products or designs new services or processes (or modifies existing ones) then again it’s likely to qualify for R&D.
What is RDEC qualifying expenditure?
Once a company has identified its qualifying activities, it needs to thoroughly examine the R&D expenditure that goes along with them. There are certain set categories of R&D expenditure that are permitted for inclusion on an RDEC claim.
Qualifying expenditure includes:
- Staffing costs, such as pension contributions, salaries and employer’s NICs, in addition to some business expenses.
- Money that was spent on temporary or external workers, such as advisors, contractors and subcontractors.
- Certain software costs.
- Money paid out for independent research.
- Expenditure on materials and consumables, such as power, heat and light that are transformed or used up during the R&D process.
- Payments to volunteers for taking part in clinical trials.
What do larger companies usually want to know?
Sometimes larger companies that are already claiming R&D Tax Credits come to an accountancy firm to ask for a review of its claims process and identify any discrepancies. They also often want to understand the risks and opportunities available to them, as well as how to increase efficiency and maximise value.
Accountants should feel confident in carrying out this analysis, particularly with regard to a company’s record-keeping processes, in order to make recommendations for improvement.
How to treat RDEC in accounting
Legislation for the RDEC scheme stipulates that it can be included in profit before tax (PBT) instead of being part of the tax charge/(credit) on the taxation line, making it much more visible. Additionally, many companies use PBT to monitor performance, so including RDEC in this way can help to influence company decisions. The credit itself is treated as taxable income no matter where it is displayed in the accounts.
When it comes to accounting, a company’s gross credit can be included in its above-the-line income statement (usually shown as ‘other income’). It isn’t compulsory to treat it like this though, and the accounting method you choose will depend on a variety of factors. For example, when a company has prepared its RDEC claim compared to when it files its accounts and how reliably it has measured its RDEC figures. These decisions may well involve not just yourself as their accountant but also an R&D tax advisor and an auditor.
Talk to us at Myriad
If you have any questions about the issues raised in this article or need further R&D tax credit advice, please feel free to contact Myriad Associates on 0207 118 6045 or use our contact page.