Calculating RDEC
As you will see from the length of this article RDEC is relatively complicated. We would recommend not filing an RDEC claim without the support of someone experienced in the area. We have that experience and have seen errors in RDEC claims we have not worked on but have been asked to assist with the HMRC enquiries errors generate.
If you have enquiries about RDEC claims, contact RAndD Tax today.
Background.
The Research and Development Expenditure Credit (RDEC) was introduced in 2013 and completely replaced old Large Company scheme in 2016.
It is important to realize that while the old Large Company scheme had similarities to the SME scheme in terms of calculations, the RDEC scheme is completely different. RDEC is above the line, taxed as income, while the SME is below the line, purely a tax adjustment. RDEC does not involve enhanced expenditure or tax relief through an additional deduction, in terms of the credit it does not involve surrendering losses as RDEC does not create losses.
This is a key point to get across as the fact that both schemes relate to R&D activity, and both potentially lead to tax credits, RDEC and the SME R&D Tax Credit, the potential to confuse them exists especially when selecting options in tax software. It is crucial to understand that they are different in terms of the way they are claimed through the company accounts and tax returns.
The current RDEC rate (2020) is 12%. As this is above the line the net benefit is 9.72%.
Who claims RDEC?
- Large companies. The definition test is relatively straightforward. But it is also crucial to correctly handle linked and partner enterprises when gathering the numbers for those tests. A company may be small in itself but ownership of 25% or more by other entities may make it a large company for R&D claim purposes. The guidelines in this area are relatively complex.
- Grant recipient SMEs. Grant funding can throw either an entire project into the RDEC regime or part of a project into RDEC. This assessment depends on the nature of the grant. Again, it is an area which requires the correct understanding of the guidelines.
- SMEs subcontracted to do R&D by Large Companies. A special rule exists allowing this. It is important to understand this means the SME must claim under the rules of the RDEC scheme which differ for example under the eligibility of subcontractor costs.
Example RDEC calculation.
RDEC calculations are governed by a 7 Step process. This process should be replicated as a note in the tax computation.
Profitable Company, RDEC delivered at Step 1.
PDF of spreadsheet showing the example below.
Ace Example PLC makes a £3,000,000 profit
CT is due at 19% of £570,000.
They have £2,000,000 of qualifying R&D expenditure.
The year end is December 2019 & the RDEC rate is 12% for that year.
The RDEC is £2,000,000*12%=£240,000 shown in Box 530 CT600.
Firstly, if the accounts have not been published add this as income into the accounts. If they have, add the RDEC into the trading result in the tax computation (An adjustment will be required in the following year’s accounts). This process has the impact of increasing the profit by £240,000.
With RDEC, Ace Example PLC makes a profit of £3,240,000
CT is due at 19% which equals £615,600. At this point RDEC has increased tax by £45,600 (£240,000 @ 19%)
We now need to look at the seven RDEC steps and see how the RDEC benefit will be delivered.
Step 1 the credit discharges any corporation tax liability for the claimant in the accounting period.
CT due of £615,600 prior to use of RDEC
£615,600-£240,000 (RDEC)= £375,600
CT is now due of £375,600
We do not need to go to Step 2 as the RDEC has been fully discharged.
The Ace Example PLC after R&D should be an accounting profit of £3,240,000 with CT due of £375,600.
The net benefit to the company is the pre RDEC CT due less the post RDEC CT due.
£570,000-£375,600=£194,400
A useful crosscheck, when all the RDEC is discharged at Step 1, is to look at the net RDEC.
£240,000-19%=£194,400
Because these numbers match up the RDEC has been added correctly. This is a straightforward RDEC example as it only involves Step 1. It also does not involve a payable RDEC, available at Step 7 so Box 880 should be blank.
Profitable Company where RDEC is larger than the CT liability with all 7 Steps.
Beta Example PLC makes a £3,000,000 profit
CT is due at 19% of £570,000.
They have £20,000,000 of qualifying expenditure.
The year end is December 2019 & the RDEC rate is 12% for that year.
The RDEC is £20,000,000*12%=£2,400,000.
Firstly, we add the RDEC in the accounts.
Profit with RDEC £5,400,000
CT due at 19% of £1,026,000
Secondly, we work through the RDEC steps.
Step 1 discharge the CT liability.
RDEC £2,400,000 less £1,026,000 = £1,374,000
The CT liability is now zero and £1,374,000 is taken to Step 2.
Step 2 Notional Tax adjustment and potential carry forward or Group relief.
Carry forward the lesser of the amount remaining after step 1 and the Net RDEC.
£1,374,000 remaining after step 1
Net RDEC £2,400,000-19%= £1,944,000
Because the amount after step 1 is lesser that is taken to step 3. Had it been capped the excess would have been carried forward (or used as Group relief) but can only be set against CT due (step 1 before next year’s RDEC) and cannot be used for a payable RDEC.
Step 3 Restriction to R&D Workers PAYE & NIC.
R&D Workers PAYE & NIC £1,000,000
Caps the amount taken to Step 4 to £1,000,000
£374,000 is carried forward and added to any expenditure credit for the following accounting period but is not subject to any restriction at step 2 having already been taxed.
Step 4 Discharge any corporation tax liabilities for any other accounting period that are due but not settled.
Beta Example PLC has a CT liability of £100,000 not paid. £100,000 is used to settle this.
This reduces the RDEC taken to Step 5 to £900,000.
Step 5 Group Surrender of RDEC.
b/fwd. Step 4 £900,000
The company is part of a Group. CT liabilities of the Group £300,000 settled with £300,000 RDEC
c/fwd. Step 6 £600,000
Step 6 Discharge any other liabilities owed to HMRC e.g. VAT, PAYE/NIC.
b/fwd. step 5 £600,000
VAT liability £200,000 settled with £200,000 RDEC.
c/fwd. step 7 £400,000
Step 7 Payable RDEC providing the company is a going concern.
Payable RDEC £400,000 Box 880 CT600. Box 880 only contains an entry if a payable RDEC is claimed. The total RDEC amount should be entered in Box 530.
In this example the company has the following benefits.
- CT saving/repayment £1,026,000 (Step1)
- Carried Forward RDEC due to PAYE/Nic Cap (Step3) £374,000
- Discharge of other period CT liability (Step4) £100,000
- Group Surrender (Step5) £300,000
- Discharge of other tax liability (Step6) £200,000
- Payable RDEC (Step7) £400,000
These add up to £2,400,000 which is the gross RDEC.
Summary
We have not produced a loss-making example. But the process would start at Step 2 as shown above.
It is important to understand that for a loss-making company it is possible that the carry forward of the notional tax (Step2) and PAYE/NIC cap (Step3) that the amount of cash available at Step 7 can be restricted and that any other liabilities to HMRC are discharged first.
When RDEC was introduced it was described as a simplification. That is not really the case. I could explain the old Large Company to someone with knowledge of the SME scheme in one sentence. The rates are different, 130% enhanced expenditure and 30% additional deduction, and no payable R&D tax credit is claimable. RDEC is somewhat more complex. Not every tax software package handles RDEC correctly and the risk of confusing RDEC and SME claim related options in tax software exists. But at least loss-making companies can almost always get a payable credit or at least settle liabilities.
Contact RAndD Tax to ensure your RDEC claim is processed correctly.
Chris Toms – Director RandDTax