15 Aug 2013

Research and development expenditure and tax incentives

This year’s Finance Act introduces an ‘above the line tax credit’ (ATL) for certain expenditure on R&D.

We thought it was therefore a good time to remind companies of the beneficial tax incentive offered by the ‘tax credit’ or enhanced deduction for certain expenditure on R&D  particularly as our experience shows that many oil companies are not taking up the benefit in respect of their Upstream activities.

There are two broadly equivalent incentives available.

For large companies since April 2008 an additional deduction is given equal to 30% of the expenditure.  CT relief via the enhanced expenditure alternative is therefore at 80.6%, i.e. £100 of spend will generate a tax benefit of £80.6 (130 at 62%) for a company carrying on a ring fence trade.

As an alternative the ‘above the line tax credit’ (ATL) was introduced in this year’s Finance Act 2013.

The ATL credit will be available on a claim at a rate of 10% of the qualifying expenditure for non-Ring Fence trading activities and 49% for ring fence activities.  The ATL credit acts as income that is taxable in the computation of trade profits and also as an amount of tax credit that is set off against the corporation tax liability.  So in respect of ring fence qualifying expenditure of 100 a credit of 49% on a £100 spend the overall effect is tax relief is £80.6 as illustrated below:

 

 

Without R&D With R&D and ATL Effective relief
Income 300.0 300.0
R&D (100.0)
ATL income 49.0
Profit 300.0 249.0  
Tax at 62% 186.0 154.4
ATL credit (49.0)
Net Tax 186.0 105.4 80.6

 

Many upstream companies have not been claiming relief

The rules allow that where R&D meets certain criteria, some of the relevant R&D cost qualifies for the ATL or uplift.  Aside from certain pharmaceutical related expenditure, there are 3 types of qualifying expenditure; staff costs, costs of externally provided workers and consumable items.  Separately, contributions by large companies to independent R&D for the purpose of funding research and development carried on by the recipient qualify for the ATL credit or enhanced deduction if they are made to a qualifying body, an individual, or a partnership each member of which is an individual.

The R&D that qualifies excludes oil and gas exploration and appraisal, and the qualifying expenditure excludes amounts which are capital. The R&D work must also be seeking to make an advance in science or technology. The combination of these restrictions has deterred many companies from considering whether they have an entitlement to the ATL or uplift. However, whilst the type of costs potentially eligible may be routinely capitalised, a careful examination of the activities of staff may be worthwhile.  Where technical staff are working outside of individual capital projects to develop solutions and advance understanding it may be that the work should not be allocated to any particular capital project, and instead may qualify for the ATL or enhanced deduction. For example projects that seek to find new E&A techniques and new ways of enhancing recovery but which are not themselves part of any specific E&A activity could qualify.  Typically companies may not have identified scientific activities as separate from their E&A projects masking the opportunities afforded by the tax incentives.

Re-examining the possibilities

We can assist with any review of the possibilities; in the identification of areas where eligible costs may exist, advising on how to plan for the future to maximise the benefits, and how to handle the issue with HMRC. We have experience of a number of these claims and the legislative and practical requirements that must be met.

ATL compared to the enhanced deduction

For companies that have identified their qualifying expenditure there is a choice as to whether to claim the ATL credit or the enhanced expenditure deduction.  The ATL is first set against the corporation tax liability of the company for the period. An excess ATL credit not used against the company’s corporation tax liability in the period may be surrendered to other group companies, carried forward or repaid.  However there is a limit on the amount of credit that may be surrendered or repaid; only the amount of the PAYE and NIC included in the staff costs that made up the claim can be reclaimed or surrendered such that the excess must be carried forward.  The effect of these rules is that ATL is likely to be the most beneficial route where the company is fully tax paying.  In a case where there are losses in place the enhanced expenditure deduction is likely to be beneficial (particularly for a ring fence company which has losses that can be enhanced with ring fence expenditure supplement).

Please get in touch if you wish to discuss whether there are likely to be benefits for your company.


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