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Investing in Innovation - how R&D tax credits release extra funding for SMEs

Author: 
Alistair Aird, Head of Partnerships at EasyR&D

When looking to invest, there is no doubt that evidence of innovation is attractive in a business. Innovation demonstrates to current and future investors that your company is committed to staying one step ahead of its competitors.

From a returns point of view, McKinsey & Co have quantified the benefit of innovation throughout the cycle, and their research has shown that innovators consistently outperform the S&P500 – in both bear and bull markets. But corporate innovation can be expensive and risky.  The UK Government is aware of the importance, none more so than in the present circumstances, of the need for such innovation within UK enterprise, but appreciates the risk can be off-putting, so in 2000 they introduced the R&D Tax Relief to support innovation.

What is R&D Tax Relief?

Firstly, a recap on what R&D Tax Relief is. R&D (or Research and Development) tax relief is a government State Aid incentive which rewards companies for spending money on innovation and research within the UK in scientific and technical areas. The support works as a tax relief, reducing a company’s tax bill by a certain percentage of qualifying R&D expenditure, or by a repayment in cash, again linked to qualifying R&D spend. It can be retrospectively claimed over the two previous accounting periods. For a profitable small business, the relief can be up to 25% of the qualifying expenditure, so not to be sniffed at. For a loss-making SME it is even higher, at 33%.

The definition of what activity can qualify for R&D Tax Relief is deliberately wide, much wider than most presume. It can of course support totally new innovation, but also applies to incremental improvements in processes or products. The improvement can be for internal purposes - a bespoke warehousing system for example; or external - an improved product for sale.  All too often we find that companies are conducting qualifying R&D without realising it meets the definitions of the relief. Many times, the R&D activity is simply viewed as “business as usual”. And for the best firms, that will be the case – their innovation is constant, but that does not mean that it is not qualifying activity.

Over £20bn has been claimed since 2000, in the form of 240,000 claims. An average claim for UK SMEs for R&D tax relief is over £45,000. The cashflow benefits, especially in the current climate, are immediately obvious, but the real benefits come as companies start to factor in the R&D relief into innovation decisions, allowing for the de-risking to encourage investment that might not have otherwise been approved, creating a virtuous circle and a corporate culture of innovation. This extra cash can be invested as you wish across your company, such as staff, technology, machinery, and training.

Why don’t more qualifying companies claim?

There are of course some issues with R&D Tax Credits that are preventing them reaching everyone they are intended to reach, but these are ones that can be solved through better education. All too often companies either do not know about it, or, more likely, believe that it would not be relevant to them. Firstly the phrase “Research and Development” conjures up images of white lab coats and pipettes, not a farmer trying new ways to increase yields or an architect using materials in a new way to build structures in a more efficient energy saving way, or an engineer improving safety features.

Secondly, by delivering this innovation support through the tax system, there is all too often an assumption that this is a financial issue, one best left to the accountants and finance departments, but this is often far from the best way of really appreciating the innovation that is occurring. Specialist R&D Tax consultancies such as Easy R&D typically lead with technical consultants, often former engineers, IT consultants, and other technical disciplines, to uncover the true R&D occurring. Once properly identified and defined, the costs can more accurately be allocated, ensuring a maximised claim.

What is the process?

As a source of funding, R&D tax Reliefs can be in your company’s bank much quicker than borrowing from the banks. The average length, from start to finish, for a R&D tax claim is 4-6 weeks working with specialist advisors, and then a further 4-6 weeks with HMRC once it has been accepted. This means you could have cash in your bank within two months.

The claims process, if done in conjunction with specialist consultants, typically starts with a 15-minute no-obligation call to establish the likelihood of there being any qualifying activity. Thereafter, once engagement letters are signed, it takes no more than about 4-5 hours of committed company time, not a bad investment when the average claim is around £45k.

The use of R&D tax credits is an increasingly prominent question on an investor’s checklist and financial due diligence scope. Their use not only signals innovation, but strength in cash management and control. A growing number of professional equity investors are also appreciating the value R&D tax relief can bring to their portfolios, marking them as an important part of both investment readiness and value creation.

Alistair Aird previously spent 15 years in lead advisory M&A before joining Easy R&D, a specialist in R&D tax credits for SMEs

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