How to Account for R&D Tax Credits

/Published:6th March 2025/inTax

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Research and Development (R&D) tax credits are a valuable incentive for limited companies in the UK that are involved in innovation and technological advancements. If your company is investing in R&D activities, you could be eligible for financial support through the R&D tax relief scheme. However, accounting for these tax credits properly is crucial to ensure that your company maximises its claims and remains compliant with HMRC regulations.

In this post, we will explore how to account for R&D tax credits in your company, what makes a company eligible for R&D tax claims, the claiming process, and how these claims affect your financial records.

What are R&D Tax Credits?

R&D tax credits are a government initiative designed to encourage innovation within UK businesses. The scheme allows companies involved in qualifying research and development activities to receive a tax credit or a cash rebate, which can be reinvested into further research or business development.

The credit is designed to help offset the costs of R&D activities, such as wages, materials, and utilities that are directly related to the research. In the case of a limited company, R&D tax credits can reduce your Corporation Tax liability, or in some cases, result in a cash refund from HMRC.

Are You Eligible for R&D Tax Credits?

Before you can account for R&D tax credits, it’s important to determine whether your limited company qualifies for the scheme. Generally, your company will need to meet the following criteria:

  • Small or medium-sized enterprise (SME): Your business must meet the SME criteria, which includes having fewer than 500 employees and an annual turnover of less than £100 million or a balance sheet total of less than £86 million.
  • R&D activities: Your company must be engaged in scientific or technological advancements that seek to solve scientific or technological uncertainties. This can include activities such as product development, process improvements, and software development.
  • Uncertainty and innovation: The activities must aim to resolve problems that cannot be easily solved using existing knowledge or technology, making your work innovative.

What R&D Costs are Eligible for Tax Relief?

The R&D tax credits are available for a range of costs that are directly related to your R&D activities. These can include:

  • Staff costs: Salaries, wages, and NIC contributions for employees involved in R&D work.
  • Materials: The cost of materials, consumables, and utilities used during the R&D process.
  • Software: The cost of software directly used in research, such as programming tools or CAD software.
  • Subcontractors: Payments to subcontractors who are directly involved in the R&D process.

It’s important to ensure that all costs claimed are directly linked to the R&D activities your company is undertaking. HMRC is strict about what qualifies for relief, so maintaining accurate records of all R&D-related expenditures is essential.

Research and Development tax relief for SMEs
 R & D Tax Credits

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The R&D Tax Credit Claim Process

The process of claiming R&D tax credits involves several key steps. Below is an overview of the typical process for a limited company to follow:

  1. Assess Eligibility: The first step is to confirm whether your company is eligible for R&D tax relief. This involves reviewing your R&D activities to ensure they meet the criteria set out by HMRC. If you’re unsure whether your activities qualify, it can be helpful to consult with an R&D tax specialist who can guide you through the process.
  2. Calculate Your R&D Expenditure: Once you’ve confirmed eligibility, the next step is to calculate the total R&D expenditure. This includes all costs directly related to the R&D process, such as employee salaries, materials, software, and subcontractor fees. Make sure to collect detailed records and receipts to support your claim.
  3. Prepare the R&D Tax Claim: Prepare the necessary documentation, including a technical report that explains the R&D activities and why they qualify for tax relief. This report should detail the specific challenges and uncertainties faced during the R&D process and explain how your company sought to resolve them.
  4. Submit the Claim: The R&D tax claim is submitted as part of your company’s Corporation Tax Return (CT600). You will need to submit your claim alongside your annual tax return, and the claim should be made within two years of the end of the accounting period in which the R&D activities took place.
  5. HMRC Review and Approval: HMRC will review the R&D tax claim and may contact your company for further information or clarification. If the claim is approved, your company will receive the relief in the form of a reduced tax liability or a cash payment, depending on your situation.
  6. Receiving the Tax Credit: Once HMRC has approved your claim, the tax credit will be issued either as a reduction in Corporation Tax liability or as a cash refund.

Accounting for R&D Tax Claims in Your Limited Company

Once you’ve successfully claimed R&D tax credits, it’s important to account for them correctly in your company’s financial records. Here’s how to handle the accounting for R&D tax claims:

  1. Incorporating the Tax Credit into Your Financial Statements: The R&D tax credit can be treated as either an income or a reduction in costs depending on your preference and accounting policies. The most common method is to treat it as an income item, which reduces your overall taxable profit.
    • Income Treatment: You can recognise the tax credit as other income in your profit and loss account. This is typically shown under a line item such as “Other Operating Income” or “Government Grants.”
    • Reduction in Costs: Alternatively, you can treat the credit as a reduction in your R&D costs, lowering the expense reported in your financial statements. This method might be suitable if you want to keep the focus on the R&D expenditure itself.
  2. Impact on Corporation Tax: If your company is using R&D tax credits to reduce its Corporation Tax liability, you’ll need to adjust your tax provision accordingly. The reduction in tax liability will result in a lower Corporation Tax payable, and this should be reflected in the tax expense section of your financial statements.
  3. Reporting the Credit in Your Accounts: For the balance sheet, the R&D tax credit should be shown as a receivable under current assets if the credit is expected to be refunded as cash. If the credit is offset against your Corporation Tax liability, you’ll show a reduction in the Corporation Tax payable.
  4. Audit and Documentation: Ensure that all documentation supporting the R&D tax claim, such as employee time sheets, project reports, and invoices, is kept on file for potential audits. HMRC may request supporting evidence to confirm the legitimacy of your R&D activities and expenditure, so good record-keeping is essential.

What Happens if Your Claim is Rejected?

If HMRC rejects your R&D tax claim, they will explain the reasons for the rejection, and you may have the opportunity to provide additional information or make amendments. In some cases, HMRC might offer an alternative claim solution, or you can appeal their decision.

If the claim is deemed invalid, your company will not receive the expected credit, and you may face penalties or interest if HMRC determines that you’ve made a false or exaggerated claim.

Conclusion: How to Account for R&D Tax Credits in Your Limited Company

Claiming R&D tax credits can be an excellent way to reduce your company’s tax burden and reinvest in innovation. However, accounting for R&D tax credits properly is vital to ensure compliance and maximise the benefit of the scheme. By maintaining accurate records, carefully calculating eligible expenses, and following the proper procedures, your company can take full advantage of the R&D tax relief available.

If you’re unsure about any aspect of the process, Accounting Wise specialise in R&D tax claims for limited companies, we can help ensure that your claim is handled correctly and efficiently. This will not only help you optimise your financial position but also safeguard your company’s compliance with HMRC regulations.

Need help understanding R&D Tax Credits? Get started with Accounting Wise today!

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