Research and development (R&D) is fundamental to preserving and nurturing the innovative core of the UK’s high-tech economy.

As such, the state sees fit to incentivise R&D activity in the form of tax credits, which subsidise spend on building new products, technologies and processes.

In April 2024, the R&D environment changed abruptly when a new tax credit regime was rolled out. Adjusting to a new scheme may seem like an unwanted complication for certain businesses, but it’s still vital to ensure that your company can make the most out of the R&D taking place.

In late 2023, HMRC (the UK’s tax authority) set out new guidance for R&D tax credits.

Starting in the April 2024-2025 tax year, the government established a ‘merged’ RDEC (R&D Expenditure Credit) scheme. The headline benefit for companies is a 20% credit on R&D activities, which after tax translates to a credit of between 15% and 16.2%.

“This represents a less generous subsidy compared to the previous tax credit structure. That’s not great news for businesses, but HMRC is aiming to simplify things by having one flagship scheme which works for a few people in a garage, right up to the largest corporates,” says Benjamin Craig, Associate Director for R&D Incentives at consultancy Ayming.

Alongside RDEC is a more generous scheme designed for loss-making SMEs making significant investments in R&D. ERIS (which stands for Enhanced R&D Intensive Scheme) allows companies that fit this profile to claim higher subsidies of around 27% post tax.

“The threshold for ERIS qualification is based on R&D spend as a percentage of total operational expenditure,” says Ben. “The scheme was originally only available to companies spending 40% of their opex on R&D, but that’s now been broadened out slightly: any loss-making SME (Small to Medium Enterprise) can claim under the ERIS scheme if they spend 30% or more of their opex on R&D.”

SME, in this context, means a company with fewer than 500 employees and either turnover under €100 million or a balance sheet under €86 million.

At the time of publishing, HMRC has stated that “to qualify for R&D relief, a project must seek an advance in a field of science or technology.”

So what does an “advance” mean?

Well, HMRC defines it as an “appreciable improvement”, either with physical consequences (such as designing and manufacturing a new hardware product) or as an increase in overall knowledge (such as improving a process or a service).

“Because the HMRC definition has many potential interpretations, companies are sometimes lured into thinking that almost all software development is eligible for R&D tax credits, because it’s aimed at appreciably improving something to do with the business,” says Ben. “But in reality, it’s a little stricter than that – HMRC don’t want companies to be claiming for building their website, as an example. It’s meant to be reserved for your core technical work.”

Companies filing R&D tax credit claims usually do so alongside their corporation tax return. But companies should keep in mind that filing a claim – even if it’s approved – may well be scrutinised by HMRC.

“HMRC has tightened up its approach to R&D tax claims in recent years,” says fractional CFO and former auditor Luke Jahn. “They may judge that a claim isn’t viable and refuse to accept it. And even if they accept a claim and pay out, they could later judge that all or part of the claim is invalid and attempt to claw back some or all of the credit.”

Are some businesses more vulnerable to clawbacks or rejections than others? “Well, life sciences and fintech are two sectors where early-stage companies can have reasonably high odds of hitting the 30% R&D intensity threshold to qualify for ERIS support,” says Ben. “Generally, HMRC is likely to understand fintech propositions in more depth than they do life sciences.”

This doesn’t add up to a rationale or an excuse for anyone to take shortcuts in what they deem to be R&D, or to make excessively broad claims. Rather, it’s especially important for early-stage companies in highly technical and scientific fields to understand where they may need to simplify language and make complex concepts especially clear when they come to file their claims.

An early-stage startup might not automatically look to large corporates for guidance, given the differing scales of operation and the rate of growth in the typical startup. But, Ben thinks, certain best practices ingrained in large enterprises that may be useful in early-stage environments too.

“We often see early-stage companies make a big annual effort in the lead-up to their R&D tax credit claim, going back and reconciling a year’s worth of work in a few weeks, which is very stressful. In larger corporates, R&D evaluation is a natural part of the software development process and is a year-round consideration,” he says.

This has a big impact on reporting, logs and other documentation.

“Keeping your R&D records up to date in real time always helps. HMRC will comb through that documentation in evaluating your R&D claim, so having contemporaneous records is hugely helpful,” says Ben.

In Luke’s view, this starts with your bookkeeping: “Whether it’s the Financial Controller or the Finance Manager, it’s crucial that your books establish what the company intends to classify as R&D.”

As with so much compliance and reporting activity, it’s crucial to track and stick to reporting deadlines. HMRC now requires companies to submit an advance notice of their intent to file a claim for R&D tax relief, if they are submitting their first such claim or if they haven’t submitted a claim for three years. Filing a Claim Notification Form has to be carried out by six months after the end of the relevant tax year.

What else can early-stage companies miss? There are many different costs that can contribute to an R&D filing. For instance, “payroll can often be the single biggest line item in an R&D claim,” says Luke. “In lots of larger tech companies, 100% of certain engineers’ time (and therefore salary cost) can be allocated to R&D.”

It’s also worth thinking about your relationship with third parties. “It’s perfectly possible for companies to claim for R&D even if the work is being carried out by a contractor or agency. But it has to be made crystal clear what the intention of the work is. It’s essential to set out in writing at the start of a project the nature of your expectations for the work, so you can show HMRC that you purposely commissioned R&D activity,” says Ben.

While tax claims would appear to be the domain of the finance department, Ben emphasises that the bulk of the value in a company’s R&D claim tends to sit with the engineering team.

There will normally be a senior individual in that function who is the main point of contact for the rest of the business as the R&D tax claim is prepared and filed. “That person is normally the CTO, VP of Engineering or perhaps the Chief Product Officer,” says Ben.

But that individual doesn’t have to shoulder all the burden. In Luke’s opinion, “early-stage startups will almost always need some sort of advisor or experienced third party to help guide them through the process.”

For any companies thinking about going it alone with an R&D tax credit claim, dividing up a lengthy process into manageable tasks is always helpful.

Building on SeedLegals’ R&D tax credits checklist for companies, the main steps are:

• Find out if you’re eligible
• Understand which expenses you can claim for
• Learn which scheme you’re a fit for (RDEC or ERIS)
• Have your tax return and company accounts to hand
• Summarise your R&D projects and effort
• Identify your claimable expenses for each project
• Submit your claim and await review

Finally, companies may also wish to think ahead about how they’ll utilise the funds released through a successful R&D tax claim.

Ben says: “It can be helpful for the engineering and finance departments to think about ways to make the benefits of R&D credits really clear to the wider team. Distributing some of the cash realised through the claim back to the team in some way can make the business impact of your year-round effort to codify R&D activity much clearer.”

Although there have been significant changes to the R&D tax regime in recent years, these tax credits offer UK companies the potential for meaningful non-dilutive capital – vital to any scaling company. They also function as a reward for developing innovative new technological and scientific solutions.

But all too often, startups find themselves in a rush to prepare for a tax credit filing deadline, having to retread through 12 months of technical documentation to establish what R&D work happened, when.

Some simple areas of focus can make claims easier for early-stage companies, like regularly documenting R&D-eligible work, and preparing for interim deadlines like the advance notice of an intent to claim R&D tax credits.

These initiatives can significantly ease the compliance burden for early-stage companies. Along the way, R&D tax credits can even help improve collaboration and cohesion across teams – as Ben says.

Startups are eager to capture the potential rewards of more efficient R&D tax credit claims.

And if more startups successfully claim for the research and development they undertake, the UK’s tech ecosystem will be better rewarded and better funded: a win-win scenario for all parties.