There are many adjustments that go through a tax computation, and most company owners are likely aware of some of these, such as disallowing client entertaining or claiming capital allowances on purchases of plant and machinery.
However, there are some adjustments made in relation to Research and Development (R&D) claims which people are likely to be less familiar but that can be very beneficial. There is the R&D claim itself, of which anyone preparing and submitting claims will likely be aware, however, there are also adjustments that can be made in relation to fixed assets, e.g. machinery used for R&D purposes as well as R&D intangible assets such as knowhow or ideas development.
The first relief is research and development capital allowances (RDAs) which form part of the wider capital allowances regime. Normal capital allowances cover items such as machinery, office furniture and fixtures and fittings and provide a reduction in taxable profit for the cost of assets purchased in a year. There is the Annual Investment Allowance (AIA) which can be applied to assets purchased in a year up to a value of £1m then also the year-on-year writing down allowances which are the tax version of depreciation, whereby the capital cost is allocated against profits over time.
In addition to this, there are RDAs which can be claimed alongside the other allowances mentioned above. Where an asset is purchased for use within a company’s R&D process, a 100% deduction can be taken against taxable profits for the cost of the asset in the year the asset is purchased. This incudes purchases of items such as machinery and equipment used in the R&D activity as well as on costs in relation to the structure and fabric of the building that provides facilities for R&D which would not normally qualify for capital allowances.
For any assets where this is applicable, claiming a deduction under RDAs preserves the Annual Investment Allowance (AIA) for use on other assets not used for R&D purposes. This means you can claim the £1m AIA against general asset purchases as well as unlimited RDAs on any R&D assets purchased. A worked example is set out below.
Total additions purchased – £1,500,000
R&D qualifying additions – £500,000
| Taxable profit before capital allowances | 2,500,000 |
| Research and development allowances (RDAs) | (500,000) |
| Annual Investment Allowance (AIA) | (1,000,000) |
| Remaining taxable profit | 1,000,000 |
The second relief is in relation to R&D intangible assets. Where a company has invested resource in R&D activity and has subsequently capitalised the development costs as an intangible asset, a deduction can be taken against taxable profits for the cost of the asset in the year it is capitalised (i.e. the year in which it is an addition on the balance sheet).
Where this is the case, the value of the intangible addition can be taken as a deduction in full in the year of capitalisation. This not only reduces the taxable profits in the year of capitalisation, but also allows the costs to be included in the R&D claim for the period. Usually, any amortisation on the intangible asset would not be adjusted for in the tax computation. However, where the R&D intangible deduction is claimed, in subsequent years as the intangible asset is amortised (written off against profits), instead of no adjustment being required as would usually be the case, it is instead disallowed i.e. added back to taxable profits. This is because 100% of the intangible was treated as deductible in year 1 therefore to also allow the amortisation as a deduction would be in effect giving the same relief twice. We can use some numbers to illustrate this.
Year 1
Qualifying R&D spend – £500,000
Amount of qualifying R&D spend capitalised as an intangible – £300,000
| Taxable profit before R&D adjustments | 1,000,000 |
| R&D claim (500,000 @ 130%) | (650,000) |
| R&D intangible | (300,000) |
| Remaining taxable profit | 50,000 |
Year 2
Amortisation on qualifying capitalised R&D spend from year 1 – £100,000
| Taxable profit before amortization adjustments | 750,000 |
| Amortisation | 100,000 |
| Taxable profit | 850,000 |
There is a clear benefit to claiming the intangible deduction as it allows the costs to be deducted against taxable profits and included in the R&D claim.. There would of course be a timing issue as by claiming the full deduction on the R&D intangible in year 1, taxable profits increase in year 2 due to the additional amortisation adjustment. However, if a company has a large tax bill in year 1 or can sufficiently increase losses to carry forward to offset the additional amortisation in year 2 then it can only be beneficial as it brings forward the tax saving in respect of the expenditure.
If you need any help or advice or would like to know more, please get in contact.
