Relief in sight

Getting money back from Gordon Brown rather than watch it flow out the other way sounds innovative indeed. Happily for technology-led businesses, innovation in the form of R&D can bring about this blissful state. Less happily, many appear to have no idea that the bounty is on offer.

When Brown's nine-year stint as chancellor finally ends in a move next door or a spell in opposition, the R&D tax credit will be one of the policies most closely identified with his time at Number 11.

The chancellor has made raising productivity a personal crusade and tax relief measures designed to encourage innovation are a key weapon in his arsenal.

Compared with some of his other initiatives, the tax relief has been uncontroversial. Rewarding companies that invest in R&D to improve their performance - and in the longer term contribute to the

's competitive position - would be hard to oppose.

By last summer, according to the government, businesses had claimed about £1.3bn under the scheme, which was launched in 2000 for SMEs and two years later for larger companies.

Despite the significant tax breaks on offer, however, professional services group Deloitte claims that a large number of companies are failing to claim their relief from

.

According to research carried out by

in the first half of this year, the firms most likely to be missing out are SMEs - the ones the scheme was set up to help and often those in most need of the financial benefits it offers (see sidebar below).

Deloitte's analysis suggests that less than half of eligible smaller firms are taking advantage of R&D tax relief. Of those that have failed to claim, a quarter are unaware that the scheme exists.

Qualifying for relief could be particularly important for a smaller business making a loss. A successful claim could lead to a repayment of up to £24 for every £100 of qualifying expenditure.

The good news is that many more companies could soon find themselves classed as SMEs for the purposes of R&D relief and so become eligible for the enhanced benefits on offer to smaller firms.

At present the scheme uses the standard EU definition of an SME to determine a company's R&D tax credit band. Broadly, this means it must have less than 250 employees and either an annual turnover lower than €50m (33.8m) or gross assets below €43m.

The government is now studying options to extend the SME regime to companies with up to 500 staff and is talking to the European Commission about how this could be done.

Bringing in a 500-employee threshold is, however, of little use if eligible businesses continue to ignore the scheme.

David Cobb, Deloitte's head of R&D tax services, said there could be a number of reasons why companies are failing to claim, ranging from a lack of effective government publicity to mistaken perceptions of the scheme on the part of businesses.

One difficulty seems to be awareness of what constitutes R&D. Even in technology-rich companies, the term is often regarded as being limited to 'men in white coats' carrying out experimental work in laboratories.

The government has gone to some lengths to define what is and is not R&D, at least as far as the Revenue is concerned. All sides agree that its original guidelines were too loosely defined, leaving much to subjective interpretations of what constitutes innovation.

According to Deloitte, under revised guidelines released in 2004 there is considerable scope for attracting R&D relief in areas that may not be obvious.

The group has set up specialist tax teams at various locations around the

, and claims that turning a spotlight on the far corners of the business can yield spectacular results. It said one recent intervention brought more than 4m in cash repayments for an SME that had previously been told it did not qualify.

One example of where engineering and technology businesses could be missing out concerns prototyping. The DTI's guidelines define a prototype as 'a basic experimental model possessing the essential characteristics of the intended process, material, device, product or service. The design, construction and testing of prototypes generally fall within the scope of R&D for tax purposes.'

Similarly with pilot plants, according to the DTI's guidance 'the construction and operation of pilot plants while assessing their operations is R&D until the scientific or technological uncertainty associated with the intended advance in science or technology has been resolved.'

The point in both cases is that until the technical advance at the root of the project is resolved, R&D is taking place.

Manufacturing process improvements and the transition from development to the production line can also qualify.

So what can companies expect if they make a claim? Negotiating with the Revenue is something few businesses would list as a favourite pastime and Deloitte's research suggests some are not claiming even if they think they might be eligible because the process is too daunting.

In fact, most who do pursue R&D tax credits find it reasonably straightforward. The main problem seems to be agreeing what qualifies for relief under the DTI guidelines.

One potential hurdle is a lack of technical understanding on the part of the tax inspector. If an engineer can find it difficult to grasp the intricacies of taxation, the reverse can be true for a Revenue official attempting to understand a technical process, and why it should qualify as R&D under the rules.

An important way Cobb's team works with its clients is to bridge this gap. 'We have to get the point across so an inspector can understand - even if he or she has a history degree,' he said.

HMRC recognises that lack of a scientific or technical background can be a problem. It has identified up to 70 inspectors with some expertise in the field and may begin channelling them towards R&D tax credit claims, which Cobb calls a 'positive step'.

Sidebar: R&D Tax credits: the basics

Large companies (those with more than 250 employees) can deduct 125 per cent of qualifying expenditure on R&D when calculating their profit for tax purposes.

SMEs can deduct 150 per cent and may be eligible for up to 24 per cent in cash credit if they make a loss.

Large companies can usually only claim for R&D spending they carry out themselves. SMEs can also claim for sub-contracted work.

SMEs must own the intellectual property arising out of the research and development. Large companies need not.