The R&D tax incentive that rewards innovation
By Dan Thomson and Emma Walsh, Ernst & Young LLP
Published: 13 April 2017
The value of R&D to the UK economy
With Brexit on the horizon and global markets continuing to evolve, retaining and attracting organisations that undertake R&D activities is a crucial part of the UK Government’s economic growth strategy.
R&D tax credits are a well-established, effective way of incentivising companies performing R&D. The UK boasts one of the more generous R&D regimes, seen as strategically vital to maintaining Britain’s position at the cutting edge of science and technology. A recent announcement by Theresa May boosted the
Government’s commitment to transforming Britain into the ’global go-to place for scientists, innovators and tech investors’, with the Prime Minister pledging a further £2bn of Government investment into R&D by the end of the current Parliament.
Awareness of the regime is growing in the financial services (FS) sector: in recently published HMRC statistics, R&D tax claims made by FS organisations increased more than 10% over the previous year, a trend which looks set to continue. Significant potential benefits are available to alternative asset managers under the regime, although uptake in the sector is lower than other areas of the FS sector.
Some common misperceptions about R&D tax relief
Many alternative asset managers who look into HMRC’s definition of ’R&D’ conclude that they do not undertake activities which qualify for R&D tax relief. Interpreting qualification under the regime can often be confusing, given that the definition and guidelines run to more than 140 pages!
In practice, alternative asset managers need to extend continually their technological knowledge and capabilities to retain their competitive edge in pursuit of profitable returns. As this typically involves a broad range of technologically advanced activities, there is frequently significant scope for tax relief qualification. Some examples of potentially qualifying activities are as follows:
- Development or enhancement of core, unique IT platforms to support trading strategies, requiring a combination of a multitude of technologies not achieved previously
- Research and modelling to inform signal generation, where undertaken as part of a project to extend technological capability
- Development and enhancement of data frameworks and distributed computing capabilities, enabling low-latency trade processing and risk calculation
- Creation of tools to scrape and collate market data from a variety of structured and unstructured data sources
Qualifying activities like these occur across the whole spectrum of management strategies, from fully discretionary to quantitative funds. Qualifying spend on R&D-eligible activities by both types of fund frequently runs into the millions, which can lead to significant and material tax benefits.
However, many firms are not yet claiming tax relief for activities which would qualify. One motive for this, which we have encountered a number of times, is that sensitive information critical to competitive advantage could be revealed. This is not the case. First, HMRC requires a narrative that they and their inspectors can understand to support a claim, and this does not include detailed confidential technical aspects. Second, if you choose to use an advisor to support your claim, their commitment to maintaining the confidentiality of your data should be paramount in their working approach.
After confidentiality concerns, another frequently asked question is: ’our competitors are all doing similar things: will we be eligible for tax relief?’ Under the UK regime, where details of the technological advances competitors have achieved are not publicly available (which is almost always the case), work by a firm to develop its own solution can still qualify.
Projects do not need to develop completely new technology to qualify; materially extending technological knowledge (both within the firm and publicly) can also qualify for tax relief.
A final myth is that projects must be successful to qualify for R&D tax relief. Even the most experienced technologists take wrong turns when the path to the end result is unclear. HMRC recognises that experimentation is at the core of innovation and advance, and unsuccessful projects still receive tax relief if their activities qualify.
Where there is R&D, there is reward
An enhanced deduction of 230% on qualifying R&D expenditure is available to companies qualifying as Small and Medium Enterprises (SMEs) under HMRC rules. This translates to a 26% tax benefit where a company pays corporation tax at 20%, and can result in a cash refund for loss-making companies. Large companies can also claim, at a reduced (but still substantial) rate.
Companies can make a claim up to two years after the end of a corporation tax accounting period, meaning an R&D eligibility conversation can consider all recent activity and unlock more funding for further projects.
Fundamentals for claiming
The legal entity structure of your firm is a significant determinant of how much tax relief you can receive.
A partnership structure is often the primary choice for many alternative asset managers. Partnerships may not make direct R&D claims themselves but corporate members of partnerships may, in accordance with their profit share. Further, corporate members of partnerships that provide services to the partnership (or other group entities) under a services contract, and are paid a fee for those services, can make an independent claim on the basis of their own profits rather than their share of the partnership profit only.
Staff costs, including bonuses, are usually the most significant expense qualifying for the relief. Costs incurred for external staff, subcontracted work and software licences used on a project can also be taken into account, depending on exact circumstances.
An examination of organisational structure, and a survey of the major technological activities taking place, can enable experienced R&D advisors to give an indicative view of potential benefits, subject to more detailed review.
The right conversation gets the right result
IT professionals can quickly differentiate between those technological activities on projects which meet the R&D criteria, and those undertaken using available and existing knowledge. Developing a good understanding of the HMRC definition of R&D for tax purposes, and discussing its application to technological projects, is crucial to organisations making an informed assessment of R&D tax relief eligibility.
Making your claim
For alternative asset managers, turnaround time can be swift, and the time impact on important technologists minimal. For firms which have not yet claimed R&D tax relief, now is the time to look closely at the benefit it can provide.
 Her Majesty’s Revenue and Customs (2016) “Research and Development Tax Credit Statistics” https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/577859/160914_R_D_publication_commentary_v1-1.pdf
To contact the authors:
Dan Thompson – Partner, Wealth & Asset Management, Ernst & Young LLP: firstname.lastname@example.org
Emma Walsh – Director, Head of UK Financial Services Innovation Incentives, Ernst & Young LLP: email@example.com