It seems that despite government encouragement to claim the most attractive Research and Development (R&D) tax incentives ever available to UK industry, many organisations still do not believe they are eligible to claim. 

For example a UK headquartered group of companies that had prepared their own claim for R&D tax relief.  The relief provides for additional tax deductions calculated as 25% of qualifying expenditure on R&D activities within the definition set out in the DTI guidelines.  As the group was a 30% taxpayer, the additional deductions represented a 7.5% absolute benefit to the Group.

In preparing the claim, the Group had focused primarily on the work undertaken by the traditional R&D department, but asked us to review their analysis for any obvious omissions.  Their claim was not large, comprising around £3m of qualifying spend for the period from commencement of the relief, 1 April 2002, until their last year end, 31 October 2004.  As the time limit for R&D claims is 6 years we were able to revisit all claims submitted to date.

Manufacturing process improvements
After reviewing their organisational structure and meeting with key members of their technical resource we discovered a Manufacturing Process Improvements Team of 50 engineers that had not been included in the existing claim at all.  After discussing their activities with the team leader we concluded that almost 60% of their activities would be eligible for the relief.

Furthermore, the activities of this team led to production scale trials at the various plants which involved significant costs that had all been written off as adverse variances.  Many of these trials were also considered to be eligible.

Approaching the activities
In the group’s main business unit, the qualifying expenditure identified was just under £2m, giving rise to an after tax benefit of around £ 150,000. After an initial discussion with the company’s technical staff we suggested that there may be scope for substantially increasing this part of the claim.

In reviewing their activities, the client had focused on individual projects and had adopted a much stricter interpretation of the meaning of R&D than is necessary under current guidance. Our team revisited this business in its entirety by considering first their main branches of activity and discussing the technical challenges they faced in each.  These conversations were facilitated by one of our own experienced engineers who had previously worked in the client’s industry for over 20 years.

Having considered the main areas of activity we then focused on the costs, capturing a number of significant prototype costs that had been considered ineligible in the client’s initial review.  In any manufacturing environment there are likely to be significant costs associated with prototypes but also with trial production runs.  Not only are these costs eligible in many cases, but the full accounting cost can be included in the claim.

Commissioning new equipment
The group had purchased a very sophisticated, state of the art, item of production line equipment in 2002.  In the two years since its arrival however, there had been numerous technical problems which meant that it was at that stage still only operating at 60% of its intended capacity.

Through a series of discussions with the factory manager, and various members of the technical team, we were able to establish that there were significant technological challenges relating to the configuration of the machine and its integration with the main production line.

An additional claim was established with qualifying expenditure of over £1m and there may be additional opportunities for similar projects elsewhere in the Group.

Information technology
The Group also had an IT team comprising around 200 technical staff members.  Whilst a substantial proportion of these people were found to be involved in routine support for the Group’s infrastructure, a third were involved in more developmental activities.

One team were involved with the software aspects of the manufacturing process improvements and so their input could be included in claims relating to that area.  Another large team had been involved in a significant IT implementation whereby a new CRM system was being integrated with the Group’s existing systems and also undergoing significant customisation for the Group’s particular purposes.

Both the internal and external costs of this activity were capitalised within fixed assets and so were not eligible for the additional tax deductions available for R&D expenditure.  They were, however, able to take advantage of the accelerated tax deductions available for capital expenditure related to R&D which provides tax deductions in the first year on all eligible costs rather than by claiming the normal 25% reducing balance allowances. 

Although this represents a cash flow timing benefit, rather than an absolute additional saving, the value of the benefit still represented around 4.5% of the eligible capital costs.

Summary
Overall, we were able to increase our client’s R&D claim by more than ten times.  This represented additional benefit of £2m for the years under review but, more importantly, it also set the precedent for future years’ claims.  Getting the full amount available in the early years, therefore, provides an ongoing annuity benefit once the full extent of the relief is understood.