If your business claims Research and Development (R&D) tax credits under the SME scheme, it’s vital to understand two key developments: how recent rate changes affect future claims, and the impact of the cap on payable credits. These updates, effective from 2023 and 2024, have significant implications for both cash flow and compliance.
Why These Changes Matter for Small Businesses
The net benefit available under the SME R&D scheme remains substantially higher than that under the Research and Development Expenditure Credit (RDEC) regime. For qualifying small and medium-sized enterprises, the difference can almost double the cash benefit, providing a valuable source of funding to support innovation and growth. Ensuring your business remains eligible for SME treatment, and understands how the evolving framework applies, is therefore essential.
Determining SME Status
The SME R&D scheme has been in place for many years, supporting businesses that undertake R&D for their own purposes. Whether your company qualifies as an SME for tax credit purposes depends on several EU-derived criteria assessed over the relevant accounting period: An SME is a company that has:
- Up to 499 employees;
- Annual turnover not exceeding €100 million; and
- Gross assets not exceeding €86 million.
If your company is part of a group or is 51% owned or controlled by another business, these tests must be applied at group level. Additional rules apply where companies have between 25% and 50% ownership linkages with other entities.
However, SME relief is not available in all circumstances. If your R&D is externally funded for example, through government grants or when work is carried out for another party you will not qualify for SME relief on that project. Instead, you may be able to claim under the RDEC scheme. Importantly, this assessment is project specific, meaning that an SME could have some projects qualifying under SME rules and others under RDEC.
1. Evolution of the SME Scheme
Historically, SME relief has been provided as a payable tax credit effectively a cash payment from HMRC. For loss-making companies, this represented an important source of liquidity. However, HMRC became increasingly concerned that the payable element of the scheme was susceptible to error and fraud.
In response, the government reduced relief rates for claims relating to expenditure from 1 April 2023 and later announced a broader reform to merge the SME scheme for profit making businesses with the RDEC regime. This merged scheme applies to accounting periods beginning on or after 1 April 2024.
2. R&D Relief for Loss-Making SMEs
The rate reductions raised concerns about the ongoing support available to start-ups and early stage innovators. To address this, the government introduced the Enhanced R&D Intensive Scheme (ERIS) a more generous regime for loss making SMEs where R&D expenditure represents a significant portion of total costs.
Under ERIS, qualifying loss making SMEs those with R&D costs making up at least 40% of total expenditure can claim relief at an effective rate of 27% on allowable R&D costs for expenditure incurred on or after 1 April 2023.
From 1 April 2024, two key adjustments have made the scheme more accessible:
- The R&D intensity threshold has been reduced from 40% to 30% of total expenditure; and
- A one-year “grace period” applies if a company’s intensity temporarily falls below 30%.
This grace period provides stability for businesses whose R&D spending fluctuates year on year, helping them avoid switching repeatedly between ERIS and the merged RDEC regime.
ERIS will continue to operate alongside the merged scheme, retaining similar rules on qualifying costs and the PAYE/NIC cap on repayable credits. However, ERIS relief will remain reported within the tax line of company accounts, while the merged scheme follows an “above the line” presentation similar to RDEC.
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3. How the Cap on Payable Credits Works
To limit abuse, the government introduced a cap on the amount of payable R&D tax credit an SME can receive. The maximum payable credit is restricted to £20,000 plus 300% of the company’s total Pay As You Earn (PAYE) and National Insurance Contributions (NIC) liability. This cap ensures the relief remains linked to genuine employment and UK based activity.
Your SME can, however, be exempt from this restriction if:
- Employees are directly involved in creating, managing, or preparing to create Intellectual Property (IP); and
- Less than 15% of qualifying R&D expenditure is spent on subcontracting to connected parties or on externally provided workers (EPWs) supplied by connected parties.
Where accounting periods are shorter or longer than 12 months, the cap is applied on a time apportioned basis.
To protect smaller and genuine claimants, a £20,000 de minimis allowance was introduced. This ensures that SMEs claiming payable credits up to £20,000 are unaffected by the cap. In addition, companies may include the PAYE and NIC liabilities of UK employees of connected entities that participate in R&D through subcontracted arrangements or the provision of externally provided workers (EPWs), further widening the base for legitimate claims.
Heightened HMRC Scrutiny
HMRC has significantly increased its focus on R&D tax relief compliance. The department has expanded its team of specialist R&D caseworkers and launched targeted campaigns, writing to thousands of businesses to verify the validity of their claims.
The message is clear: HMRC expects companies to demonstrate that claims are accurate, supported by evidence, and within the spirit of the legislation. Errors or unjustified submissions can lead to repayment demands, penalties, and reputational damage.
Ultimately, responsibility for the accuracy of an R&D tax relief claim lies with the claimant company. Engaging external advisers does not transfer liability. If HMRC deems a claim incorrect or misleading, your business will be accountable for repaying reliefs and any associated penalties.
Safeguarding Your Business
Given the changing legislative landscape and the tightening of HMRC’s review process, it is crucial to ensure your claims are fully compliant. Businesses should maintain detailed documentation of their R&D activities, cost allocations, and project justifications. Regular reviews and the use of qualified tax specialists can help mitigate the risk of disputes or disallowances.
Get Expert Help with Your R&D Tax Credits
Whether you want to confirm you’re claiming the correct relief, explore additional opportunities, or ensure your business is protected from HMRC challenge, professional advice is essential.
Our team of R&D tax specialists can help you maximise available incentives while ensuring compliance with current legislation. Contact us today to discuss your circumstances and secure the right support for your R&D claims.
FAQs
What is the enhanced R&D intensive support (ERIS)?
ERIS was introduced to give extra relief to loss making SMEs that invest heavily in Research and Development. It is a clear sign that the government wants to prioritise genuine, research driven businesses.
How can my loss making business continue to claim R&D tax relief confidently?
If your company is investing in research and development whether through new technology, software, or process development R&D tax relief can provide a substantial return. While it’s particularly beneficial for R&D intensive and early stage businesses, many organizations still find it a valuable source of support.
How do i prepare the documentation for my R&D tax credits claim?
Accurate documentation is key to a successful R&D tax relief claim. With HMRC’s reviews becoming more rigorous, strong records help prove both the technical and financial aspects of your work. Keeping real-time records of your R&D activities and costs not only supports compliance but also reduces the risk of delays or enquiries.
What happens when HMRC opens enquiry into my R&D tax claim?
If HMRC opens an enquiry into your R&D tax relief claim, it means they want to take a closer look at part of your submission. This doesn’t necessarily mean something’s wrong, HMRC is simply applying more scrutiny as part of their standard compliance process.
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