Although you may well have come across the term “R&D Tax Credits” before in your business life, it’s not always clear exactly what they are, who can claim, and how to claim them. And surely you have to be a large, highly profitable business to get them, right? Wrong.
Launched for smaller businesses in the year 2000 before being offered to larger organisations in 2002, Research and Development (R&D) Tax Credits refer to a UK government-funded initiative designed to incentivise businesses to invest in innovation. Offering a vital stream of cash for businesses across the country, they’re essential for hiring new staff, embarking on new development opportunities and ultimately allowing companies to move forward.
There are several pieces of criteria that businesses applying for R&D Tax Credits must meet in order to be successful, but essentially any company that spends money on the development of new products, services or processes (or enhances existing ones) can be eligible for R&D tax relief.
Companies can be either short or long-term unprofitable for a huge number of reasons, particularly if the business is very new or has had to adapt to a substantial change in the market. For organisations that aren’t turning a profit, a mechanism will kick in called “surrendering your losses” which will then allow you to receive some cash out of R&D Tax Credits despite the fact that there are no profits to offset. But is this the best course of action? Yes, is the short answer - but tread carefully and do your homework.
At the current rate of 19%, it might seem better to carry the loss forward and offset it against profits made in the future, rather than opt to surrender it straight away at a rate of 14.5%. But, so that it can be offset successfully in the years to come, there must be actual profit made in those years that continues going forward. The main thing to take away from this is, if the loss your business is currently making carries on into future years ahead - even with future R&D claims - then it would be very wise to surrender the loss as it is at the moment.
Of course, businesses all aim to make profit in future and will draw up plans to instigate this, but even so it’s well worth considering carefully just how large (and how reliable) these projected profits will really be. This is where the theme of discounted cash flows becomes highly relevant.
Discounted cash flows represent the fact that the cash of the future is worth less than the cash your business readily has available right now. It works by suggesting that if you had access to money today, it would be prudently invested back into the company in order to give a return. In essence, if cash is only forthcoming in twelve months’ time, then it must bring with it at least as big a return as it would have done if you had invested it.
On the assumption that your company can put the funds to work and achieve a fairly decent “internal rate of return” (IRR) of around 10% on its own assets, then £100k today will be worth £110k in a year’s time. The flip side of course is that £100k received in twelve months’ time is presently only worth £90.9k. So, with a 10% IRR, 14.5% today is worth 15.95% next year, 17.54% in two years, 19.29% in three years and 21.22% in four years. Yes, it takes 4 years in order to fully exercise your loss in which case it’s definitely better to surrender it today. After all, it’s more beneficial to take the money at today’s rate and invest it immediately in your business.
Many loss-making start-up technology companies (and established businesses too) choose to spend money on R&D as they tend to look at either a much higher growth rate than 10%, or expect to make no profit at all. A growth rate of 50% is a reasonable one, so 14.5% today is worth 21.75% in twelve months’ time. This means that for a company which potentially will enjoy very fast growth might well surrender its losses today, regardless of what might occur next year.
It’s worth remembering though that the calculation we’ve set out above does not take into account the element of uncertainty. A business may well be profitable next year – and let’s hope so – but things can happen, life is unpredictable and a loss may still be on the cards. When considering risk, the surrender of any amount of loss ought to really be made in favour of cash in your pocket today.
Like most rules there is an exception to this though - although rare - and that is in the case of a high-value, high-growth start-up that’s literally on the cusp of being very profitable. If this sounds like your company and you’re absolutely sure as far as you can be that a £600k tax loss will soon be a £2.5m profit (and there’s plenty of resource available to fund projects yielding a strong return), then listen up; it may well be better for the loss to remain unsurrendered and to exercise it the following year instead. Yes it’s an unusual case but not unheard of.
If you would like to speak to us about any issues raised in this article or you need some tailored advice regarding R&D tax relief in general, Myriad Associates is here to help. We are a highly experienced team of business analysts, technical experts, cost accountants and R&D tax experts based in the UK.
We deliver intelligent and maximised R&D Tax Credit claims, R&D Grant Application services, Video Games Tax Relief claims, and Research and Development Capital Allowances claims.
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