Most governments recognise that innovation drives economic growth. That’s why they offer targeted tax incentives, such as R&D tax credits, to support innovative businesses like yours.
Maybe you’re already managing significant investments in research and development (R&D). Let’s see if you qualify for tax relief on that basis.
This article takes you through the essentials of applying for R&D tax credits, showing you how they work and how you can qualify for them.
Here’s what we cover:
R&D tax credits explained
R&D tax credits are the result of a UK government initiative to reward companies that invest in innovation. If you’re developing new products, processes, or services—or improving existing ones—you could be eligible.
If you have to rely solely on your own revenue or profits to fund R&D, this could severely affect your growth prospects.
As a result, you’re likely to develop a risk averse mindset, which could significantly limit innovation—especially if yours is a small or medium-sized enterprise (SME) with little financial flexibility.
The other main funding alternative is to turn to venture capital, private equity, or bank loans. However, these are highly sought after, lowering your chances of qualifying.
Also, they often come with strings attached, diluting your ownership, for example.
R&D tax credits can alleviate that pressure by offering a potential reimbursement or tax reduction after eligible R&D activities have been completed. While not guaranteed, they can provide a valuable cash flow benefit for many companies. They serve as a safety net so you’re free to explore ideas and push boundaries.
All in all, they’re an important option not only for your own growth, but also for the general development of the niche in which you operate.
That said, most companies finance R&D with a mixture of these sources, and it’s hard to say how heavily they depend on tax credits. The figure varies significantly by industry, company size, and economic conditions.
However, these credits can represent a significant portion of the R&D budget for small companies.
How do R&D tax credits work?
Already jotting down beer-mat ideas for innovating in your area? It’s not that simple, unfortunately.
You apply for R&D tax credits as part of your corporation tax return (CT600), typically at the end of your financial year. If eligible, you can either reduce your corporation tax bill or, in some cases, receive a cash payment if your business is loss-making.
Some common questions relating to the overall model are:
- How far back can you claim R&D tax credits? You can make a claim for R&D tax relief up to two years after the end of the accounting period during which you incurred the R&D costs. Don’t forget, there are deadlines for submitting claims, so keep an eye on those dates.
- Are R&D tax credits taxable? In most cases, no. The great majority of R&D tax credits are awarded to SMEs and are not taxable because they aren’t considered part of your income. They simply reduce the amount of tax you owe. They can also function as a cash credit because HMRC will transfer the appropriate amount to your bank if it upholds your claim.
HMRC will apply strict criteria to determine whether your work constituted “advancement in science or technology”.
If your projects qualify, HMRC will provide tax relief, effectively reducing the tax you’d pay if you hadn’t undertaken suitable R&D activities.
Transition to new R&D claim model
In April 2024, HMRC significantly restructured the R&D tax credit landscape. It introduced the Enhanced R&D Intensive Support (ERIS) scheme, providing enhanced support for loss-making, R&D-intensive SMEs.
Not only is the portion of R&D expenditure eligible for credit greater, but ERIS also offers tailored benefits, including potential cash credits.
At the same time, HMRC merged the previous SME scheme with the claim system for large companies, the Research and Development Expenditure Credit (RDEC) scheme.
This new, single system effectively brings profit-making SMEs under the RDEC tax treatment.
Here’s how the coverage now breaks down:
Percentage of R&D expenditure eligible for tax relief
| Previous rules | 2024 rules | |
| Loss-making and R&D-intensive SMEs | up to 18.6% | up to 27% (ERIS scheme) |
| General and profitable SMEs | up to 24.7% | up to 21.5% (new merged scheme) |
| Large companies | 13% (RDEC) | 20% (new merged scheme) |
Unfortunately for ERIS qualifiers, these new credits are taxable. You read that right—you’ll be paying tax on your tax relief.
The logic is that taxing these credits:
- Balances this support with fiscal responsibility, ensuring that the scheme remains sustainable in the long term
- Incentivises SMEs to become profitable
- Maintains consistency and fairness across different company sizes (many of which are already taxed on their R&D credits).
The point to remember is that profit-making and loss-making SMEs are treated differently, with varying rates and benefits.
The merged system for profitable SMEs and large companies
The merged system aligns the tax treatment for profitable SMEs with the original RDEC scheme, meaning the credit is treated as taxable income before reducing corporation tax liability. This increases transparency by making the credit visible in financial statements. While it may seem convoluted, it still results in a net tax reduction.
Profitable SMEs can also claim enhanced deductions on corporation tax for eligible R&D costs, such as those that resolve uncertainties, demonstrate innovation, and are well-documented.
Retroactive claims
Profitable SMEs can still make retroactive claims for R&D projects carried out before April 2024. These claims will be processed under the previous, non-taxable rules.
Eligibility criteria for R&D tax credits
However big your company is, HMRC will scrutinise your R&D credit application (often referred to simply as an R&D claim) to ensure you have sufficient grounds for qualifying.
The project must aim to achieve an advance in science or technology through the resolution of scientific or technological uncertainty. And the work must be undertaken by competent professionals.
Which projects qualify for R&D tax credits?
HMRC’s criteria for approving R&D tax credits are the same for SMEs and large companies alike—both must prove that their projects:
- Seek an advance in a field of science or technology
- Seek to overcome scientific or technological uncertainty in the company’s area of expertise.
So, you must show that the goal of your projects is to develop new knowledge or capabilities, not just making routine improvements.
Qualifying activities can range from developing new software or hardware to creating innovative manufacturing processes. Industries such as software development, engineering, and manufacturing often have projects that fit the bill.
Qualifying expenditures
You can claim for a range of expenses, including:
- Staffing costs (salaries, wages, National Insurance contributions)
- Software costs
- Materials used in R&D
- Certain subcontracted R&D costs or services (note: general overheads—such as rent, marketing or general admin—are no longer eligible unless they directly support R&D activities).
And you can even claim indirect expenses, such as:
- Information services—such as preparing the original R&D findings report
- Maintenance—of systems, equipment, or software used in your R&D activities, for example
- Security—protecting research personnel, data, and assets; handling dangerous chemicals, ensuring lab and equipment safety
- Administration—record-keeping, and compliance with regulatory requirements
- Finance and personnel—running your team
- Research—data collection, testing or acquiring papers from universities
- Feasibility studies—needed to decide the strategic direction of your R&D activities, for example.
Basically, if it’s directly related to your R&D, it’s probably claimable. It’s essential to keep detailed records of all these expenses, as you’ll need to provide evidence to HMRC.
One important point is that if you are an SME and you received research grants, under ERIS you can still apply for R&D tax relief on items not covered by the grants.
If your application refers to projects started before the ERIS programme, HMRC’s original SME tax relief and RDEC pages detail the elements that are considered valid.
Examples of successful R&D tax credit claims
Take a software development SME as an example, creating a new data processing system for handling large-scale datasets in real time.
Its project has significant technical challenges, including the issue of optimising algorithms for speed and accuracy.
In this case, it can qualify for R&D credit. Specific costs addressed would include staff and third-party developers, software licences, and cloud computing services.
Another example is a small manufacturing company developing a new production technique to improve efficiency and reduce waste.
This type of project falls under the category of “technological uncertainties” because it involves experimenting with novel materials and processes, which qualifies it for R&D tax credits.
Claimable costs in this case would be staff, automation of manufacturing processes, raw materials, and testing—including software development costs for running simulations.
Company size eligibility
For SMEs, you need to have fewer than 500 employees and fall within a certain revenue threshold.
Even after Brexit, the UK still uses the European Union (EU) definition of an SME. And in keeping with that, HMRC states SME revenue thresholds in euros.
So, to qualify for R&D claims, SMEs must register either a turnover of under €100 million (£85 million) or a balance sheet total of under €86 million (£73 million).
Any company that exceeds these SME requirements is by default a large company and can be considered for the RDEC scheme.
It’s also worth noting that you might be excluded from the SME scheme if your company is part of a larger group.
Check HMRC’s guidelines to make sure you fit the criteria.
How to claim R&D tax credits
The obvious place to claim R&D tax credits is through your corporation tax return. And that’s the approach taken by HMRC.
First, you need to identify all your eligible R&D projects and the associated expenditures specific to each one. This means costs such as staff salaries, materials, and software used uniquely for those projects.
Then, gather your more general R&D costs. These are things like overhead costs associated with running an R&D department, or software subscriptions that are used across multiple R&D projects.
Apportion those general costs across all projects to reflect how much each one relied on those resources. For example, you’ll have to calculate the percentage of total time your staff spent on each project.
Finally, write a technical report for each project, explaining the scientific or technological advancements you’ve made. This is what HMRC will use to judge project eligibility, so make it as detailed and accurate as possible.
This means you should outline all the scientific or technological uncertainties you addressed. The more thorough this report is, the sooner HMRC will conclude that it requires no more supporting information.
Upcoming changes to the system
HMRC continuously reviews its R&D tax relief schemes to ensure they are effective and fit for purpose. This includes monitoring claim trends, identifying areas of potential abuse, and gathering feedback from stakeholders.
In announcing the transition to ERIS, HMRC stressed that it would further refine the R&D tax credit schemes to target abuse and support genuine innovation.
It hasn’t announced a specific timeline for these changes, but has hinted that the changes will include:
- More rigorous checks: potentially including interviews with claimants and site visits to verify R&D activities.
- Tighter definitions of qualifying activities: such as, greater clarity on what constitutes an “advance in science or technology”.
- New reporting requirements: such as, more detailed or additional evidence to support claims.
- A larger compliance team: enhancing its capacity to review claims, conduct investigations, and identify potential abuse of the system.
R&D relief starts with excellent tax management
Let’s recap.
Claiming R&D tax credits is quite a complex process. You’ll need to identify eligible expenses, list them accurately in your claim, and ensure you meet criteria that at times are a little subjective.
The last section of this article showed that HMRC is stepping up its scrutiny—and you’re under greater risk of investigation if you fail to follow their criteria to the letter.
For the best chance of meeting HMRC’s regulations, you need easy access to detailed records of your R&D costs and activities.
A good tax management system will automate collection and storage of much of that information, saving you potential headaches in the long run.
The post What are R&D tax credits and how do you claim them? appeared first on Sage Advice UK.