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Tax Talk – Losses v Surrender for Cash Credits

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R&D Tax Relief is often known as R&D Tax Credit, but did you know when it was first introduced the term “credit” only referred to the surrender of a tax loss cash repayment and not the entire scheme? In this Tax Talk, I look at the benefit options of the relief and how the loss surrender works in practice.

For profitable companies, the R&D tax relief reduces the company’s Corporation Tax liability. This will either result in a repayment where the tax has already been paid or reduce a future tax liability still to be paid.

Given how R&D tax relief works it can, of course, either turn a taxable profit into a tax loss or increase an existing tax loss further. This then leads to the client having to make a choice to use the loss or take a cash credit, hence R&D tax credit.

Firstly, to clarify the credit. It is not in any way a refund of tax already paid. So a start-up which has yet to pay over tax to HMRC of any kind could still receive a credit. It is a sum of cash, pure and simple.

The options:

The best option is always, where possible, to carry a loss back. A loss can only be carried back one year. This is the best option because:

  • The benefit will be a repayment of tax already paid. The rate of Corporation Tax reduced from 20% to 19% on 1 April 2017 and, therefore, any company where a loss can be carried back prior to 31 March 2017 will see a repayment at 20%.
  • Any loss carried back will also give rise to a small interest repayment from HMRC (as an aside it is interesting to see that whilst HMRC has increased its interest on overdue tax following the recent base rate increase it has not done likewise for repayment interest).

Of course, many companies may not have a profit in the prior period to carry back a loss.

The next best option, if the company is a member of a group, is to group relieve the loss to a profitable fellow group member as this will save tax at 19%.

Thereafter, the choice arises.

A company can either:

  • Carry the loss forward indefinitely (unless there is a change in the trade activities) or
  • Surrender the loss for the cash credit

Most companies opt for the cash, why?

  • Rules could change, it gives certainty
  • The company may not generate a taxable profit for some time, especially if it continues to make R&D tax relief claims
  • The benefit of the cash (14.5%) is not much less than the tax rate of 19% (to be reduced to 17% 1 April 2020)
  • Cash is King!

Where does 14.5% come from? Who knows? It is the rate HMRC has set. There is no indication, as yet, of any change either post-Brexit or when the tax rate reduces to 17%.

Let’s wrap this up with an example.

Company has a £10,000 loss which already includes R&D qualifying costs of £20,000.

After the 130% uplift (£20,000 x 130% = £26,000) the tax loss is now £36,000.

The credit of 14.5% is based on the lower of:

  • The uplifted loss £36,000 (£10,000 loss less a further £26,000) or
  • 230% of the R&D expenditure (i.e. the base amount plus the uplift) £46,000 (£20,000 plus £26,000)

The credit (cash) is £5,220 being 14.5% of £36,000 and the loss is surrendered, in other words, it cannot be used in any other way.

Same again, but the company has a £100,000 loss which already includes R&D qualifying costs of £20,000.

After the 130% uplift (£20,000 x 130% = £26,000) the tax loss is now £126,000.

The credit of 14.5% is based on the lower of:

  • The uplifted loss £126,000 (£100,000 loss less a further £26,000) or
  • 230% of the R&D expenditure (i.e. the base amount plus the uplift) £46,000 (£20,000 plus £26,000)

The credit (cash) is £6,670 being 14.5% of £46,000 and £46,000 of the loss is surrendered, but £80,000 remains to be carried forward (£126,000 less £46,000 surrendered).

Nigel Holmes, Tax Specialist at Catax
www.catax.com

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