Up to 90% of innovative pharmaceutical companies in the UK could be missing out on the chance to receive significant tax relief either because they're unaware of the UK's R&D tax credit scheme or don't believe it applies to them, while others are under-claiming significantly as they don't understand its ins and outs.
What qualifies as R&D? Which team or teams in the business should be involved in making a claim? How much can we claim for our consumables costs? These are just a few of the questions many companies are struggling to find the answers to, while those that have done their research are benefiting either from substantially reduced tax or, for loss-making companies, a generous cash payment. Some companies are receiving both.
"The idea is to provide cash to companies that are undertaking R&D to incentivise them to reinvest that cash and do more R&D, which is good for the economy," explains Jennifer Tragner, a director at R&D tax credit consultancy ForrestBrown and a member of HMRC's R&D Consultative Committee.
Elly Earls sat down with Tragner to find out more about the sorts of companies that are eligible for the scheme, what they can claim for, and where to start.
Elly Earls: How much could innovative companies in the pharmaceutical industry benefit from the R&D tax credit scheme?
Jennifer Tragner: The cash benefit of an R&D claim can be up to 33% of the R&D expenditure identified - if you spend £100 on R&D, you could potentially receive £33 from HMRC. It's hugely generous for a tax incentive and can provide immediate cash for companies during their early start-up period when they are cash poor. It's specifically designed to get cash in the door quickly.
The key challenge is to maximise the activities and expenditure identified; there are still many misconceptions about what does and does not constitute R&D for the purposes of the relief - the definition is quite specific and it is worth a look even if you don't initially think it will apply.
EE: In a nutshell, how does the scheme define R&D and therefore who is eligible for it?
JT: R&D takes place when a project seeks to achieve an advance in science or technology through the resolution of scientific or technological uncertainty.
Although this language seems inaccessible, the definition is designed to apply to any sector and equally to products, processes, materials, devices and services. It also applies to either new inventions or appreciable improvements to existing things, and even to the generation of new knowledge where there is no tangible product, process or service generated.
It is important to remember that your advance needs to be in science or technology (often a clever business idea triggers an R&D project, but the business idea is not an advance in itself) and that you need to be pushing the boundaries of the scientific or technological baseline in your field, and not just in your own knowledge (ignorance is not an excuse for overstating your R&D). However, if R&D is carried out by others in secret, your R&D is still valid provided the work of others is not in the public domain.
EE: What sorts of companies in the pharmaceutical industry are likely to qualify for the scheme?
JT: The obvious example is drug development companies, but there are many less obvious ones too. For example, manufacturers who develop innovative, cost-effective ways to produce products, suppliers of equipment and specialist testing companies could also qualify.
If you think of the lifecycle of a drug, it starts at drug development and goes all the way through to a cost-effective commercialised product - R&D takes place along that entire supply chain.
EE: How many innovative companies in the UK are thought to be missing out on the benefits of the scheme and why?
JT: It is difficult to quantify, but overall it is widely accepted that up to 90% of potential R&D claimants do not claim. In addition, a growing number make modest claims and miss much of their eligible cost base due to the perceived complexity of the claim rules.
The reasons many companies don't claim are that they are either not aware of the relief or don't realise they are eligible. Within a company, it is the finance staff who are tasked with tax compliance, however the technical staff are needed to identify the R&D activities, so a common reason for missing out is that the relief slips between the two sets of stakeholders and never gets the combined consideration and focus required to maximise the opportunity.
Moreover, it's becoming more common due to recent publicity that claiming the R&D incentives is in some way 'exploiting a tax loophole', similar to a planning scheme, which is not true. R&D tax relief is a genuine government incentive, which HMRC are actively working to raise awareness of.
EE: What are the main complexities that companies perceive in the claim rules?
JT: There are two aspects to consider: what the scheme says R&D is, and what costs can be claimed and how to attribute these to the R&D activities identified.
The definition of R&D can cause confusion due to its generic wording - it is essential that time is taken to understand how the definition applies to your business and to ensure that the right people in the business are given the task of identifying R&D projects and activities. This will not typically be tax or finance staff.
However, the greatest level of complexity is probably around identifying and attributing costs to those R&D projects and activities. The eligible cost categories are defined in legislation and HMRC publishes guidance on how to identify these, however there is very little guidance on how to accurately quantify R&D activities.
Not all companies have a timesheet system and of those that do, they will never be perfectly calibrated to identify R&D vs non-R&D activities, so some level of pragmatism is necessary; and what that level is, or what methodology will prove robust to HMRC scrutiny, is an eternal challenge for companies.
EE: Since it was first introduced in 2000, the scheme has evolved quite a lot. Have these evolutions overall been positive or negative for companies?
JT: The trend is definitely positive. Notable changes include various increases to relief rates, the doubling of the threshold limit for the more generous SME scheme (bringing more companies into the higher rate scheme), the introduction of the R&D Expenditure Credit (RDEC) scheme to increase the benefit to large companies, and various tweaks to cost categories to correct previously complex provisions.
Alongside an overwhelming number of examples of positive changes, there have been a few restrictive changes though, including the new rule on consumables.
EE: Can you explain the changes to the consumables rule - what was it before, what is it now and who will these changes most impact?
JT: The changes restrict R&D relief where materials costs are used for R&D purposes, but are also part of an end product sold to a customer. Prior to this, there was no formal exclusion for these costs, although large claims have been subject to intense scrutiny by HMRC over the years. The new rules mean any costs relating to materials or components, which form part of an item sold in the ordinary course of business won't be eligible for R&D relief.
The changes are likely to impact one group of claimants (large manufacturers) quite significantly. However, there is a much wider impact of introducing a new complexity to the claim preparation, as the application of the new provisions will need to be considered for every claim in which materials are used in R&D activities. When faced with complicated provisions, many companies may opt to leave materials costs out in their entirety.
EE: Finally, if a pharmaceutical company was to think about applying for the scheme, where should they start?
JT: Do some research - there is some guidance via the gov.uk website and the BIS Guidelines are also available online. There is also an Advance Assurance scheme for smaller, first time claimants, run by HMRC and designed to help support you through your first three R&D claims.
There are a number of advisers who can also help, from your accountant to specialist firms, but it's important to remember that although the services offered by each can look comparable on the face of it, there is a huge variation in scope, expertise, approach, experience and fee structure. It pays to take time to understand what you are getting and find an adviser who is the right fit for your business.