Why are so many SMEs still hesitant to apply for R&D tax credits?

In particular, when it comes to research and development work HMRC wants to be generous in the form of giving companies tax credits on work carried out. But, while many have heard of the scheme, uptake continues to be poor among SMEs as many fear the paperwork and bureaucratic process will far outweigh any potential benefit. "It is unusual for a tax collector to enter in to a dialogue with companies to say, 'we want to give you some money back', so first of all don't get spooked by it," says Motorsport Industry Association (MIA) chief executive Chris Aylett, who has been promoting the scheme throughout the motorsport industry. "The difficulty for HMRC has actually been engaging with engineers, as they don't believe it. But, it's taking great steps to make things easier. It wants more companies to take advantage." There is cynicism as many wonder how many hoops you'll be made to jump through. The wider story, however, is that national spend on research and development is used as a measurement of economic wellbeing and competiveness. And on the world stage the UK is lagging worryingly behind. If a country spends 2% of GDP on R&D then it is likely to grow and prosper. Less than that and it is in danger of declining. In 2000 the average spend in Europe was 1.7% and member countries were keen to raise the figure to ensure that Europe remained a key place in the world for investment in technology, innovation and development. The UK target is 3% but is currently only at 1.8% compared to Germany's 2.8% and France's 2.3%. So the scheme being managed by HMRC wants to encourage innovation and R&D activities by making it an area of tax relief. One of the key assumptions about the scheme – that seems to be well proven – is that any money claimed back is reinvested in more R&D, and hence the Governments incentive. The average size of a claim for an SME is around a third of total R&D spend. For many that is an extra design engineer, project, piece of equipment, or more cost effective quotes. Commenting on the motorsport industry Aylett says: "8 out of the 11 teams based in the UK make substantial R&D tax claims. And they spend it on more R&D as that wins them races. "The simple premise is: you will spend R&D tax credits on more R&D. It is not governed that way, but HMRC is confident you won't run away and buy a Bentley. It believes you will reinvest it in R&D and so the UK increases its community of intelligence." And with the scheme being earmarked to be in place until at least 2032, it is money that companies can put aside, against the bottom line, to help fund the following year's innovation, research and development. "You've answered that problem of how to fund next year's innovation," says Dave Pepper, director of The MPA Group, an accounting firm specialising in R&D tax credits. "It is about competitive advantage through innovation. You can get this set of funds, year on year, from the tax office provided you carry on doing the same sort of innovation and development. We have seen a trend of almost exponential growth in R&D spend for companies that have really got their heads around the scheme." For many, it's a change in mindset to how risk is assessed against innovation. Being able to claim money against development of a new technology or solution, even if it doesn't work, allows engineers to stretch the envelope of how far an activity can be pushed. "Despite this, the take-up rates have been pretty poor since it began," says Pepper. "Many organisations still do not believe they're eligible, when in fact they are. Many people think R&D is someone in a white coat and a clipboard. But this is about innovation and development, which is a much broader set of activities." Another problem can be that accountants and financial directors often do not really understand what innovation and development really is, and what qualifies under the scheme. The criteria can be vague, uncertain and changing, and it doesn't help that some engineers have been known to exhibit an element of intellectual snobbery on occasion, talking in a overly complicated way to those outside the profession. "Engineers, like many other 'knowledge professionals', need to be clearer when talking to financial people about what it is they are up to," say Pepper. "The process of making a claim requires a level of confidence and knowledge about the scheme, so if accountants don't understand the work being done, they might not get the maximum amount you're entitled to." Down to the engineer What companies absolutely need from the outset are well documented processes and project management. This is not a job purely for accountants. Engineers play a vital role in both implementing the process and recording the innovation. "This is not an accounting job for the end of the year," says Aylett. "It is a project management job that needs to be done at the beginning as it can affect the costing of the whole thing. If you leave it to an accountant or auditor to decipher at the year end, then you've made a mistake. You need to sit down at the beginning of a project with tax credits in mind. But it is SMEs that don't seem to do this quite so well." And in the early stage of putting a project together, it's a good idea to liaise with internal accountants as well as external auditors to make sure that all the necessary information is being captured. One company that has experience, and success, in claiming R&D tax credits is Torotrak. Financial director Rex Vevers says: "You need to document how you set up and manage a project to allow a claim to be made. In our experience it is not complicated, it's almost an administrative process. If you have good systems and records in place it should not be a problem." For Torotrak, which at the moment is not profitable, R&D tax credits are an invaluable source of funding and they allow it to claim back against people, consumables, sub-contractors, some overhead, as well as prototypes and testing. If you are a profitable business, however, obviously more cost is eligible to claim against as it is deducted from taxable profits. John Hamilton, commercial director at Torotrak concurs: "You need that vigorous project planning and execution. That's useful in outlining objectives but also in defining the research and development elements, which is vital at the end of the financial year." Engineers need to understand that helping the finance department in documenting relevant R&D in a project should go hand in hand with the innovation. While this may seem another box ticking exercise for the engineer that takes away time from actual problem solving, the fact of the matter is engineers need to operate more holistically than ever and integrate their activities with other departments in a business. Companies that have done this successfully are reaping the benefits, massively. And not just from an R&D tax credit point of view, but as an organisation as a whole. R&D tax credits, at a glance: • Only 10% of UK limited companies currently claim R&D tax credits • The R&D tax credit scheme is the largest single funding mechanism for UK SMEs, representing 86% of all money. • You can claim for R&D related activity performed during your company's last two accounting periods • You don't have to be profitable to claim R&D tax credits • R&D is defined in the legislation as dealing with 'scientific advances and technological uncertainty'