Claims for research and development (R&D) tax relief have been rising for several years, with 89,300 submitted for 2020/21 – an increase of 7% from the previous year, despite coinciding with the COVID-19 pandemic. Almost 6,000 of these claims were made by companies in the construction sector.
For construction companies looking to better understand the intricacies of this relief, it is important to note the difference between simply claiming it and maximising its commercial potential in compliance with the guidelines on the meaning of R&D for tax purposes.
The UK government offers R&D tax relief to those companies that spend money seeking industrial advances in the face of technological or scientific uncertainty. The incentive recognises both traditional R&D, which involves the development of new processes, materials, devices, products and services, as well as innovation, which entails appreciable improvement to existing processes, materials, devices, products and services.
The benefit can be received as a cash payment or as a reduction in corporation tax. Companies making a claim for the first time can typically claim R&D tax relief for the two most recently completed accounting periods, with a huge range of sectors able to claim for their innovative activity.
A number of changes to the incentive are due to come into force as part of the April 2023 Finance Bill to address various issues such as compliance and subcontracted R&D, including the time limits for making a claim.
Reinvesting in R&D can help in hard times
The past few years have proven to be extremely difficult for the construction sector. The COVID-19 pandemic and the war in Ukraine are just two factors that have led to soaring inflation and energy prices.
With procurement costs on the rise, a shortage of skilled labour and the high salary overheads associated with the sector, challenges are unlikely to disappear in the short to medium term.
Reinvesting in R&D may seem counterintuitive when running costs are already at a premium. Nevertheless, this approach is imperative to enhance a company's capability to maintain its market share and be ready for growth when the economic outlook improves.
R&D can play a critical role in helping to achieve key business goals for construction companies, and well-structured, robust tax credit claims can help reinforce the benefits of innovation.
However, before making R&D claims, companies must ensure they understand how the tax relief works and how it can be applied to a construction business.
Recognising and strategising R&D
R&D is all about pushing technological boundaries and attempting to resolve complex challenges. In many construction or engineering projects, such demands are ubiquitous. Sometimes they are aspirational or strategic ventures, but more often they arise from necessity.
Although types of R&D in the construction industry vary and are highly contextual, as far as contractors are concerned they usually relate to the innovative methodologies required for complex builds or sites, or the enhancement of materials or products beyond their existing capability.
Tax relief can also provide a strategic basis for future innovation, be used to seek an early return on projects, influence commercial decisions, and plan investments in future R&D. It can likewise help with future business growth, such as hiring new technical staff or increasing confidence in competitive bid processes.
How the relief works: an illustration
A hypothetical example can show the way R&D tax relief works in practice. An SME construction business, Smart-A-Build, specialises in off-site manufacture of building components. It has claimed R&D tax relief every year since it was first aware of the incentive.
Its qualifying costs come from categories such as materials, which are used to develop its modular products – including prototypes – and from the wages of its CAD specialist.
Its most recent claim also covered software development costs for the first time. The company had invested in developing a highly customised supply-chain management platform that allows its construction clients, typically large developers, to integrate with its enterprise resource platform.
The commercial benefit of this software to the business is in optimising when its building components arrive on site. This helps its customers run projects more efficiently, with a just-in-time approach that prevents the need for on-site storage and double handling. Altogether, Smart A-Build's costs for which it seeks R&D tax relief in its latest claim total £1.5m.
The company was able to claim £370,500 in R&D tax relief against its corporation tax bill. This is calculated by enhancing the £1.5m R&D expenditure at 130%, then reducing its taxable profits by this enhanced amount, saving tax at the corporation tax rate relevant to the year for which the claim is being made, currently 19%. More details on this calculation can be found here.
Following the changes announced in the Autumn Statement, for expenditure incurred on or after 1 April 2023 the amount of relief the company is able to claim would drop to £322,500, assuming it pays corporation tax at the main rate of 25%.
Accessing R&D relief could help companies in the construction industry to expand their business. It could also play a key part in encouraging firms to develop innovative ways of working and more cost-effective and sustainable products and materials.
Specialist advice can minimise risks
A recent rise in erroneous and fraudulent claims has triggered a heightened number of enquiries from HMRC, increasing the risk of challenge to genuine claims, and jeopardising an important financial resource for the construction sector.
To further cloud the picture, last year a landmark tribunal judgment was given against HMRC after its denial of £1m worth of R&D tax relief to construction firm Quinn (London) Limited. In Quinn (London) Limited v Revenue & Customs [2021] UKFTT 437 (TC), HMRC's challenge centred on the company's relationship with its clients, and the relationship between the price paid for its work and the R&D expenditure it incurred. This is a common scenario in many construction claims.
Tax adviser ForrestBrown successfully supported the appeal against the judgment on Quinn's behalf. However, HMRC has said it will continue to review the eligibility of customer-led projects. With similar claims remaining open to challenge, it is imperative that construction businesses proceed with caution.
Because navigating this process can be time-consuming and complex, getting quality, professional advice that is measured, robust and sensitive to the complexities of each business's tax affairs and projects is critical. It is here that a specialist tax consultancy with sector expertise can help by explaining how to use the incentive – not just as a quick influx of cash, but as a long-term mechanism to enable growth.
'Tax relief can provide a strategic basis for future innovation, be used to seek an early return on projects, influence commercial decisions, and plan investments in future R&D'