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Claiming R&D Tax Relief on a Grant-Funded Project

Securing grant funding can be a great way to finance innovation, but many UK businesses think that receiving a grant will limit their ability to claim R&D tax credits. The good news? While grants can affect how much you can claim, they don’t automatically exclude you from R&D tax relief. 

Understanding the interaction between grants and R&D tax credits is key to maximising your funding. If your business relies on Innovate UK funding, EU grants, or other subsidies, it’s important to know the rules around grant funding to ensure you claim every pound you’re entitled to, without risking a compliance check.

The short answer is yes. The key is working out which scheme to claim through.

HMRC’s guidelines state:

“R&D tax reliefs under the SME scheme are not available for expenditure that is subsidised.”

However, when it comes to the R&D Expenditure Credit scheme, or the RDEC scheme, HMRC’s guidance says:

“There is no provision preventing subsidised expenditure from qualifying for R&D Expenditure Credit.”

The SME scheme is more generous than the RDEC scheme, but you cannot claim for subsidised expenditure through the SME scheme. HMRC recently updated this guidance when it comes to contracting arrangements, but grant-funded projects are still not eligible under the SME scheme.

However, you can claim any grant-funded expenditure under the RDEC Scheme, as there is no restriction on grant-funded costs (although subcontractors are still out).

Additionally, you can claim for any non-funded costs under the SME scheme. For example, a project funded by Horizon Europe’s EIC Accelerator is only ever funded up to 70%. The other 30%, which is self-funded, is eligible for the more generous SME scheme.

The conflicting rules between the SME scheme and the RDEC scheme can make it challenging to calculate your eligible costs accurately. Mistakes due to carelessness can result in penalties in the event of a compliance check.

When claiming costs partially through the SME and RDEC schemes, you need to know the differences between the schemes so you only claim eligible costs. It’s not as simple as applying different rates to the grant-funded costs and the self-funded costs.

There are four R&D tax credit schemes for UK companies; the scheme you need to claim through will depend on your accounting period, your company size and your expenditure.

Accounting periods beginning before 1 April 2024:

• SME Scheme: As you may have guessed, this is for SMEs only. It has a higher rate of relief but cannot be used for grant-funded projects.
• RDEC Scheme: This scheme is for large companies and for SMEs with subsidised expenditure. It has a lower rate of relief and slightly less generous cost categories.

Accounting periods beginning on or after 1 April 2024:

• Merged Scheme: All companies need to claim through the Merged Scheme for accounting periods beginning on or after 1 April 2024. There are no restrictions for grant-funded projects under this scheme.
• ERIS Scheme: This scheme follows the same rules as the Merged Scheme, but offers R&D-intensive, loss-making SMEs a higher rate of relief.

All the schemes differ slightly in terms of eligible companies, costs that can be claimed, and tax treatment

Merged Scheme

For accounting periods starting on or after 1 April 2024

The Merged Scheme replaces the SME and RDEC Schemes and is applicable to all companies claiming for accounting periods beginning on or after 1 April 2024.

It has a more generous approach to subcontracted expenditure, which can now be included, even for large companies, and there is no restriction on grant-funded projects.

Essentially, for companies claiming under the Merged Scheme, you can claim all expected costs, and you don’t need to worry about separating grant-funded costs from self-funded costs (win-win!).

Loss-making R&D-intensive companies can even claim a higher rate of relief through the Enhanced R&D Intensive Support (ERIS) Scheme.

SME Scheme

For accounting periods starting before 1 April 2024

The Small and Medium Enterprise (SME) Scheme for R&D tax relief has historically had the highest rate of relief and is more generous with the expenditure categories that can be claimed. It can only be claimed by SMEs.

It can be claimed as tax relief (i.e., as a reduction on a company’s corporation tax bill) or surrendered as a payable cash credit for loss-making companies. The rates of the SME Scheme changed for expenditure incurred on or after 1 April 2023, reducing the benefit that SMEs could receive.

The rate that you can claim depends on when the expenditure occurred:

• Expenditure up to 31 March 2023 gives you a real-world benefit of 24.7% for profit-making companies and 33.35% for loss-making companies.
• Expenditure from 1 April 2023 gives you a real-world benefit of 21.5% for profit-making companies and 18.6% for loss-making companies.

SMEs with subsidised projects (e.g., grant-funded projects or contracted out by another company) cannot claim these costs through the SME Scheme. In some cases, these SMEs can claim through the RDEC Scheme.

Unlike through the RDEC Scheme, SMEs can claim for subcontracted costs.

R&D Expenditure Credit (RDEC) Scheme

For accounting periods starting before 1 April 2024

The R&D Expenditure Credit (RDEC) Scheme was split out from the SME Scheme to better suit the projects of larger companies. However, it has slightly different cost categories which reduce the total R&D expenditure that can be claimed compared to the SME Scheme, as well as lower rates of relief.

As with the SME Scheme, the rates that companies could use to claim tax relief changed. However, for companies claiming through the RDEC Scheme, the rates increased, giving these companies a greater benefit for their R&D work.

• Expenditure incurred up to 31 March 2023 gives you a real-world benefit of 10.5%.
• Expenditure incurred from 1 April 2023 gives you a real-world benefit of 16.2%.

Large companies (i.e., those exceeding the SME thresholds) can claim the R&D expenditure credit, as well as SMEs who cannot claim for their subsidised projects. This includes SMEs subcontracted to do R&D for a large company (since the large company cannot claim for its subcontracted costs). Similarly, SMEs with grant-funded projects can claim through the RDEC Scheme. This only applies to grants that are state aid. Projects funded by state aid cannot be claimed through the SME Scheme, as the SME Scheme is also considered state aid. However, it can be claimed through the RDEC Scheme.

However, large companies are able to claim for contributions for independent R&D, in lieu of subcontracted costs, provided that these contributions are made by an individual, a charity or an institution of higher education.

Putting the rules into practice

Knowing the rules is half the battle; how to apply them will vary case by case.

For example:

A funding body provides Company A with a grant of £700,000 (70% of the £1 million necessary for the project). The grant is used evenly across all costs. The accounting period runs from 1 April 2023 to 31 March 2024.

£500,000 is spent on UK staff costs, £300,000 on consumable items and £200,000 on subcontractors. The grant funding covers 70% of each of these categories.

Company A initially decides to claim the grant-funded total through the RDEC scheme and the self-funded total through the SME scheme.

However, before submitting, Company A reaches out to a R&D tax specialist to confirm their workings. The specialist informs them that only the first two categories are eligible for R&D tax credits under the RDEC scheme. Therefore, Company A can only claim 70% of the staff costs and consumables under the RDEC scheme (£560,000). The self-funded portion can still be claimed under the SME scheme.

In the first instance, the company would have claimed £700k under the RDEC scheme, giving them a credit of £133,400 (i.e., 16.2%), plus £64,500 under the SME scheme (claiming at a 21.5% rate)

However, following advice from experts, Company A recognised its mistake and only claimed for the correct costs under the RDEC scheme, leading to a reduction in the amount of eligible expenditure (£560,000 instead of £700,000) and thus £90,720 from the RDEC scheme and £64,500 under the SME scheme.

Though Company A discovered their tax benefit was lower than initially expected, they also avoided the need to pay back their credit and any potential penalties.

This is a tricky part of the scheme that can get more complicated depending on the type of grant, the costs claimed and the number of projects.

Get in touch with the experts at Tax Cloud for a review of your claim. We’re always happy to talk R&D tax credits.