Research & Development (R&D) tax credits are one of the biggest funding mechanisms provided by Government to encourage innovation in UK businesses.  However, the definition of what constitutes R&D activity is much wider than is often thought and tax relief is available to many businesses outside the traditional research-based industries such as pharmaceuticals. Steven Blacker, director in R&D Tax Services at Deloitte in Leeds, explains how manufacturers can make the most of the opportunity R&D tax credits present.

________________________________________________________________

Over the last few years, maximising cashflow has increasingly been at the heart of many companies’ agendas. Research & Development (R&D) tax credits are one of the biggest funding mechanisms provided by Government to encourage innovation in UK businesses. Since their introduction, the schemes have supported nearly £52 billion of R&D activity by UK companies. There was further clear support for the R&D scheme from the Government in the Budget with SME tax deductions for R&D spend increasing from 175 per cent to 200 per cent in April 2011 and then to 225 per cent in April 2012, subject to State Aid approval.

What constitutes R&D activity is not always straightforward. The definition is however much wider than is often thought, and the relief is available to many businesses outside the traditional research industries such as pharmaceuticals.

Historically, one of the more difficult areas to determine is where R&D activity ends and where production, which does not qualify, begins. HMRC have recently reviewed their position on this, leading in turn to opportunities for organisations performing R&D in the manufacturing environment to potentially extend the scope of their claim. While there is no definition of production for these purposes, based on recent experiences, a number of principles are emerging.

Since 2000, companies have been able to claim valuable enhanced tax deductions for, amongst other costs, staff and consumable costs incurred on R&D projects. Broadly, for tax purposes, R&D takes place where new, or significantly improved, products or processes are being developed and it continues up to the point where the technological uncertainty is resolved. For many manufacturing companies, the transfer from the lab or bench to full scale production, or the development of full scale working prototypes can present a major technological challenge. Accordingly, a number of manufacturers have made R&D tax claims for both the materials and staff costs they have committed to these activities.

Historically HMRC had accepted these claims where the end product generated in the development trials is not sold, but have refused claims where the product is sold, even if at a loss, on the basis that this represents “production” and is therefore specifically excluded from the scope of R&D tax relief. Recognising that the position was open to interpretation, HMRC issued further guidance at the end of 2009 which prevented a claim being made if there was any intention to sell the end product.  This blocked claims even where the trials ended in failure and the product generated was scrapped.

The Government are currently in consultation over this area. However, in the meantime, HMRC have confirmed that they will continue to engage in constructive dialogue with companies to help resolve any issues. More recently, we have seen HMRC agreeing to review the fact pattern of claims where full scale trials are performed as an integral element of an eligible R&D project, even if the end product is sold. This approach is at present being tested by HMRC to confirm its applicability from a practical perspective before issuing more formal guidance, but early indications seem to be very positive, and it would seem that HMRC are starting some work on the drafting of new guidance on this matter.

Some of the common principles for agreeing future claims that we have seen emerging in the UK market include:

• The technological uncertainties that the R&D project was seeking to resolve need to be clearly identified to allow the contribution of the trial to be understood
• Technical staff working on R&D projects need to confirm how each element or phase of the trial contributes to the R&D process. In many cases, trial activities continue long after the R&D for tax purposes is complete
• The section of the plant or process involved in the trial must be carefully defined, so that the costs associated with the R&D element can be identified. For many large scale processing facilities this is not a trivial exercise

It’s your relief, so take it!  

Remember:

• R&D is not only performed by R&D departments
• R&D is not just about rocket science
• Claims are possible even if R&D costs are recharged
• Engineering and software design can be R&D
• Large maintenance and upgrade works can be R&D
• Eligibility is not contingent upon the success of the research

You do not need to retain intellectual property to make a

Much has been made of UK manufacturing’s key role in the revival of the economy with local, regional and national sourcing an important part of the mix.

In this light, a golden opportunity to fly the flag for the best of British appears to have been passed up by the Royal couple, in by-passing the craftsmanship of Stoke-on-Trent and ordering wedding tableware from a Chinese company with only 23 years history.

The grub’s coming from the Groom’s father’s estate, but will be served on china from China. We all know of the tiger economy in the Far East and have observed recent courting of that country’s leaders, but surely a little home-based pride wouldn’t have gone amiss.

In similar vein Lord Coe urged regional companies to pitch for London 2012 business but Leeds, with a proud clothes manufacturing heritage, missed out on the supply of over 5,000 uniforms for athletes and officials. OK – the deal was landed by High Street retailer Next, but will the gear be manufactured in the UK or Next-approved suppliers in Sri Lanka?

Blog from Jason Whitworth, partner and manufacturing expert based at BDO in Leeds

There’s no denying the region’s manufacturing businesses have had a tough time, but we are starting to see Yorkshire’s resilient nature pay off, as more companies report signs of improving demand and are looking to the future with greater confidence about prospects for recovery.

We have seen a larger than expected improvement in output and orders since the start of the year and Yorkshire’s manufacturing companies are starting to feel more confident and upbeat since the financial crisis began in mid-2007.

A number of risks to manufacturers’ prospects still remain and should not be overlooked. Not least uncertainty about how to repair the public finances, ongoing access to finance issues and the sustainability of recovery in export markets. As a result, I would expect to see investment intentions remain muted for a while to come.

Yorkshire manufacturers look to be making impressive gains in exports and it is hoped that the weakness of the pound enables further inroads to be made. In the short to medium term it is difficult to see significant growth in the developed nations of Europe, so as the new economic world order changes, manufacturers need to focus efforts towards high growth emerging markets.

We all need to remain vigilant of the environment in which we are operating, continuing to monitor the health of all major customers, identifying and acting if aged debts begin to mount, and reviewing the security of our supply chain. We also need to be thinking long-term in preparation for competition from a number of countries that will become economic powerhouses over the coming five years.

In terms of the recovery, manufacturers are considerably better placed to bounce back than other sectors that are more reliant on consumer spending to fuel their recovery. While I welcome George Osborne’s plan to protect manufacturers under a new corporation tax framework, there needs to be a clear strategy that rebalances the economy and encourages exporting. This means removing red tape, providing specific support to mid-market manufacturers and supporting emerging technologies, whilst not forgetting the UK’s traditional industrial base.

Manufacturing currently represents around 12 per cent of UK GDP. We need to get back to producing things and personally I would like to see manufacturing push it’s way back up towards 20 per cent of GDP with the right investment and support from the government. In the region, the manufacturing sector is 11 per cent of the total output per year, so any recovery in this sector will be a welcome positive sign that the economy is rebalancing.

Although UK manufacturers have been through some tough times, our latest survey of UK manufacturers has some encouraging news with almost two-thirds of manufacturers (62 per cent) expecting the availability of credit to remain the same or improve in the coming 12 months. It also reveals that the industry is responding positively to the economic challenges by making use of available public sector funding, with 63 per cent declaring a good understanding of available grants and incentives whilst 33 per cent of manufacturers have sought capital from alternative sources such as shareholders or parent companies.

The overriding message is that while the market is tough, manufacturers have been resilient in their response. The easing of available credit is very welcome, but there are no signs of complacency with manufacturers seeking other appropriate sources of finance where necessary. Manufacturers have also proactively sought to limit their exposure to bad debt, with 65 per cent increasing the frequency of customer credit checks over the past 12 months.

The survey highlights grant funding as one area where there is still some room for improvement. Whilst the majority of manufacturers have a good understanding of grants and other incentives, a significant minority remain in the dark. Almost one in five said they did not know where to look for information on grants, for example, with another 19 per cent not yet having considered grants as a source of funding – this suggests that some manufacturers are losing out on additional funding.

The report found that 55 per cent of manufacturers intend to invest in plant and machinery over the coming 12 months, with 54 per cent of respondents intending to invest in new product development. This shows the appetite for investment from the industry so we would encourage all manufacturers to take advantage of the funding available to them. This will be important as manufacturing emerges from the recession and looks to a future which will require investment in R&D, training and retraining and capital expenditure on new plant and machinery.

Overseas markets

The report also asked manufacturers about their intentions for the coming 12 months, focusing on investment and exports. Seventy-one per cent of respondents said they expected to increase their exports over the next 12 months, with 41 per cent planning on a double-digit increase. However, a sizeable minority of 29 per cent expected no increase at all. Seventy-five per cent of manufacturers will focus their export strategy on the Eurozone. The US and China were identified as the other key regions, with 45 per cent looking to increase trade with the US and 30 per cent with China.

These are confident figures from UK manufacturers, without being overly bullish. As the comparative value of sterling remains low and confidence in global markets picks up, there will be opportunities for manufacturers to increase their exports. However, for every willing seller you need a willing buyer and as growth in many of the major economies remains anaemic the extent to which this can happen is to some degree out of UK manufacturers’ hands.

(Survey was carried out 2-9 February 2010 by Findlay Media in association with Deloitte, and surveyed 101 manufacturers based in the UK. “Pound for Pound” is the second in a series of quarterly Point of View surveys examining key issues affecting UK manufacturers in seeking access to finance. The full report is available at www.deloitte.co.uk/pointofview