17 July 2015    |    Taxation

R&D tax deductions for capital costs

R&D tax deductions for capital costs

SMEs can claim enhanced tax relief for research and development (R&D) costs. The bad news is that this doesn’t apply to the equipment used for the project. However, you can make use of a different tax break. What is it?

Tax relief

Research and development (R&D) tax breaks for SMEs which develop new technology (anything from scaffolding systems to software) have gradually increased since they were introduced around ten years ago. Currently, you can claim nearly two and a half times the usual tax relief for expenses incurred on an R&D project. This level of generosity doesn’t extend to capital expenditure, but there’s an alternative tax break for that.

Capital expenditure – equipment

The cost of equipment for R&D qualifies for a 100% rate of capital allowances (CAs) – HMRC’s version of depreciation costs. This means your company receives a tax deduction for the full cost of equipment in the accounting period in which it incurs the expenditure instead of it being spread over decades. And there’s more good news.

 Other capital expenditure

Certain types of capital cost don’t usually qualify for CAs, namely buildings, but under the R&D rules they do. However, there are exclusions you need to watch out for.

Trap: you can’t claim 100% R&D CAs for the cost of land or a dwelling. However, if the dwelling is part of a larger building used for R&D and costs no more than 25% of the whole building, 100% CAs are allowed.

Example. A Ltd incurs the following costs on a qualifying research project:

 

land costing £500,000a building costing £800,000 that includes a workshop dedicated to R&D (its apportioned cost is £610,000) and an apartment for the on-site caretaker at £190,000three cars used by employees in their job in the R&D part of your business.

 

The building qualifies for 100% R&D CAs, including the living accommodation because it cost less than 25% of the whole building. We added the cars to our example because these qualify for 100% CAs regardless of their CO2 emissions.

 

Trap. If you sell assets for which you’ve claimed the 100% CAs, your company must pay tax on whatever it receives for the accounting period in which the sale takes place.

End of the line

If your company stops using the equipment etc. for R&D purposes, there’s no clawback of the 100% allowance. A tax charge only arises when the asset is sold. There’s also no clawback if an asset becomes worthless and you scrap it.

Tip: Claiming the 100% CAs for expensive capital purchases, e.g. a building, might result in your business showing a loss for tax purposes. However, you shouldn’t restrict your claim for two reasons.

The 100% deduction can’t be claimed in a later year. You might be able to exchange some of the loss relating to your general R&D costs for an R&D tax credit (see The next step ). This is a cash payment from HMRC.

The next step

If your company makes a loss you can choose to receive your R&D relief as a tax credit. This is a cash sum paid to you by HMRC where your company has PAYE and National Insurance contributions liabilities for that period. The maximum amount of tax credit is 14.5% of your R&D expenditure, but capped to the total of your PAYE and National Insurance contribution liabilities for the period.

Example for 2015/16

 

Amount
R&D expenditure£20,000
R&D tax relief enhancement£20,000 × 130% = £26,000
Normal taxable profit£6,000
Trading loss (after R&D Relief)£20,000
R&D expenditure qualifying for conversion to credits£20,000
Potential tax credit£20,000 × 14.5% = £2900
Payable tax credit£2,900

 

Money spent on buildings and equipment used for R&D qualifies for a 100% capital allowances tax deduction for the accounting year when the purchase took place. This applies to cars regardless of their emissions. If this results in a loss you can claim a cash payment from HMRC relating to your general R&D costs.

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