Clients often ask about machinery purchased for use in R&D qualifying projects and whether the costs can be recovered through the R&D tax credit scheme. Unfortunately, ‘capital expenditure’ doesn’t attract the higher level of enhanced relief for your R&D efforts in the same way as ‘revenue expenditure’ i.e. costs incurred for employees, subcontractors, agency staff, raw materials, software licenses and utilities.
For expenditure on machinery and buildings, Capital Allowances are available to reduce taxable profits or to create trading losses, which can then either be surrendered for tax credits, carried back against taxable profits in the previous period or carried forward to shelter future profits.
In the year of purchase, accelerated capital allowances are available in the form of the Annual Investment Allowance (AIA), the limit for which was increased to £1m from January 2019 and is shared between groups of companies under common control.
Where a company has exhausted its AIA allowance (or where there is scope to re-allocate it within a common control group), an additional scheme for companies undertaking qualifying R&D activity could offer further relief; Research and Development Capital Allowances (RDA’s)
RDA’s offer 100% write off for tax purposes in the year of purchase on capital equipment and facility build costs used for qualifying R&D projects. For companies where no Annual Allowance is available, this provides a timing advantage over routinely claiming capital allowances at 18% or 8%, in addition to which, allowances for build costs related to an R&D facility – which generally fall outside the scope of AIA’s – do qualify for RDA’s.
We also come across many cases where ‘revenue expenditure’ has been capitalised to the balance sheet as an Intangible Fixed Asset (IFA) and there is a common misconception that, since these items are now considered capital in nature, the R&D enhancement no longer applies. However, this is not the case and a specialist in this area such as Innovation Tax should be consulted to ensure any benefits available to the claimant company are fully maximised.
R&D development costs reported as IFA’s and which include items of a revenue nature can still be included in the R&D claim by taking the following important steps;
- As IFA’s are not deducted from profits for tax purposes, the value of any addition in the year needs to be fully amortised in the tax computation to bring the expenditure into scope for enhanced R&D relief
- The rationale is that although the costs have been capitalised in the financial statements, this has been unwound in the tax computation and CT600 and, as the decision to capitalise was a conscious one, the costs were eligible to be written off to the P+L. Furthermore, there’s no reason why amortisation cannot be claimed at 100% in the tax computation.
- The capitalised expenditure needs to be clearly outlined to HMRC in the R&D report
The decision to capitalise costs in the first instance generally arises as they relate to a longer-term objective and therefore it doesn’t seem appropriate to offset them against profits in the current accounting period. Furthermore, capitalisation will both strengthen the balance sheet and increase trading profit, which can be desirable when assessing the financial performance of a company or where there are financial covenants in place.
This is a niche area of Corporation Tax where specialist advice from Innovation Tax could increase the benefit of any R&D claim being considered. Call us today on 0203 813 4603.