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Imagine you're at the helm of a small, innovative business that is working hard to develop a new product and bring it to market. Time and money are tight, and you’re not sure how much longer you can keep the lights on. Then, you hear about a government program that can help you recoup some of your research and development costs. Before you know it, you're applying for the SME R&D Tax Credit and have just received a nice check from the government that will help you continue your work and see your project through to completion. This blog will cover the ins and outs of the SME R&D Tax Credit to help you achieve objectives like yours.
At Haven, we specialize in accounting services for small businesses. Our expertise can help you achieve your goals with the SME R&D Tax Credit and beyond.
Table of Contents
How the Tax Relief Works for Profitable vs. Loss-Making SMEs
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What is the SME R&D Tax Credit?
The SME R&D Tax Credit is a UK government incentive designed to encourage small and medium-sized enterprises to invest in research and development (R&D). It provides financial relief by allowing eligible businesses to claim enhanced deductions on qualifying research and development (R&D) costs.
Under the scheme, SMEs can deduct an additional 86% of qualifying R&D expenses on top of the standard 100%, resulting in a total deduction of 186% against taxable profits. Loss-making SMEs can instead claim a payable tax credit worth up to 10% of the surrenderable loss, offering a valuable cash injection to fund further innovation and development.
How Do I Qualify for the SME R&D Tax Credit?
To qualify for the SME R&D Tax Credit, a company must meet specific size thresholds, assessed at the group level and including any linked or partner enterprises:
Fewer than 500 employees
Annual turnover of no more than €100 million (approximately £85 million)
Gross assets not exceeding €86 million (approximately £73.6 million)
These thresholds ensure the scheme is targeted at genuinely small and medium-sized businesses.
How Group Structure Affects SME R&D Tax Credit Eligibility
It’s important to note that ownership structure and group relationships can affect SME status. Companies with significant external investors or those that are part of a larger corporate group may be required to claim under the Research and Development Expenditure Credit (RDEC) scheme instead, which offers less generous benefits.
What is the Difference Between the SME R&D Tax Credit and the RDEC Scheme?
Before 2024, the UK operated two separate R&D tax relief schemes:
The SME scheme, offering more generous relief tailored to smaller businesses
The Research and Development Expenditure Credit (RDEC) scheme is designed primarily for larger companies, with lower rates and different eligibility rules
As of April 2024, these schemes have been merged into a single, unified system for all companies. However, historically, the SME scheme provided enhanced deductions and more favourable payable credits, making it especially valuable for smaller businesses engaged in R&D.
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Key Changes in 2024–2025: The Merged R&D Tax Relief Scheme
From April 2024, the UK government is merging the SME and Research and Development Expenditure Credit (RDEC) schemes into a single, streamlined R&D tax relief system. The goal is to simplify the claims process by introducing a unified set of rules for businesses of all sizes.
This change forms part of a broader set of reforms aimed at enhancing the effectiveness of R&D incentives while reducing abuse and fraudulent claims. The new scheme will adopt the RDEC model, meaning the credit will be treated as an “above-the-line” taxable benefit. This approach enhances transparency in financial reporting, allowing investors to more clearly understand the value of R&D activity in a company’s accounts.
New Credit Rates
Under the merged scheme, all companies will be eligible for a taxable credit of approximately 20% on qualifying R&D expenditure, replacing the previous SME enhanced deduction and RDEC rates.
Loss-making, R&D-intensive SMEs, those spending more than 30% of their total expenditure on R&D, will benefit from a higher rate of up to 27%, available through a separate Enhanced R&D Intensive Scheme (ERIS).
What Qualifies as an R&D-Intensive SME Under the New Rules?
This threshold was lowered from 40% to 30% as of April 2024, expanding access to the enhanced credit. As a result, while most companies will claim a 20% credit, highly innovative, loss-making SMEs will receive a more generous 27%, providing a stronger incentive for substantial R&D investment.
Impact on Payable Credits and Deduction Enhancements
Under the merged scheme, payable credits for loss-making SMEs are generally lower than those available under the previous SME regime, which offered credits of up to 33.35%. The new system provides a taxable credit of 20%, or 27% for R&D-intensive SMEs, thereby reducing the net tax burden.
How the New R&D Credit Impacts Cash Flow for SMEs
The previous 186% enhanced deduction is now replaced by a single, above-the-line taxable credit, altering how companies realize financial benefits from R&D investments. While the new system simplifies compliance, it may reduce the immediate cash benefit for some SMEs, particularly those that don’t meet the criteria for the enhanced R&D-intensive rate.
For companies with accounting periods that straddle 1 April 2024, the transition will be handled seamlessly, with no requirement to split claims between the old and new regimes.
What Haven Handles So You Don’t Have To
Let your business take flight while Haven manages your financial runway. Built by founders for founders, we handle everything from daily bookkeeping to complex tax filings and R&D credits that put cash back in your pocket, as well as fractional CFO services.
Join 400+ startups who've saved millions in tax credits, countless hours of administrative work, and never missed a filing deadline, all while accessing 24/7 Slack support from CPAs who understand the unique challenges of growing businesses. Book a call today to learn how our dedicated team can help you focus on building rather than bookkeeping.
Qualifying R&D Activities and Eligible Costs
Understanding Qualifying Research and Development Activities
To qualify for R&D tax relief under the UK scheme, a project must aim to achieve an advance in science or technology by addressing scientific or technological uncertainty. This means the work involves tackling challenges that competent professionals in the field cannot easily resolve or explain using existing knowledge or standard practice.
What Counts as Scientific or Technological Uncertainty?
Crucially, the goal must be to extend overall knowledge or capability, not simply to apply known methods routinely.
Examples of qualifying activities include:
Developing new products, processes, or services
Improving existing products or systems where uncertainty must be resolved
Engaging in experimentation, prototyping, testing, and iterative development to overcome technical obstacles
To support a claim, you must demonstrate how your project sought to resolve uncertainty, including documentation of your methodology, findings, and both successful and unsuccessful outcomes.
Eligible Costs for R&D Tax Relief
The following types of costs directly related to qualifying R&D activities can be claimed:
Staff costs: Salaries, wages, employer National Insurance contributions (NIC), and pension contributions for employees directly involved in R&D projects.
Consumables: Materials and utilities used up or transformed in the R&D process (e.g., raw materials, energy).
Software licenses: Software used directly in the R&D activities.
Subcontracted R&D: Payments made to third-party contractors for R&D work, subject to restrictions (see below).
Externally Provided Workers (EPWs): Costs of workers provided by agencies who work under your direction on R&D projects.
Data licenses and cloud computing: Costs of data and cloud services directly used for R&D purposes.
Important Restrictions and Exclusions
From 1 April 2024, subcontracted R&D work and Externally Provided Workers (EPWs) must generally be carried out within the UK to qualify for R&D tax relief, unless they meet narrowly defined overseas expenditure exceptions.
Specific categories of expenditure are specifically excluded from R&D claims, including:
Capital costs related to plant, machinery, buildings, or land (although these may qualify under separate capital allowances)
Routine testing, quality control, and post-development production activities
General overheads, such as administrative or marketing expenses
Purely commercial or market research, which does not aim to resolve scientific or technological uncertainty
Only costs that contribute directly to eligible R&D activity, aimed at advancing science or technology, can be claimed.
Practical Steps to Claim SME R&D Tax Credits
Keep Detailed Records of Your R&D Projects and Costs
Thorough documentation is essential when claiming SME R&D tax credits. Keeping detailed records of your R&D projects and associated costs significantly strengthens your claim. Clearly outline the scientific or technological uncertainties your projects address, and explain how your work seeks to resolve them.
What Records Do You Need to Substantiate an R&D Tax Credit Claim
You should also maintain accurate records of all qualifying expenses, including:
Staff time and payroll allocations
Consumables and materials
Software licences used in development
Subcontractor and externally provided worker (EPW) costs
To support your claim and prepare for any HMRC enquiry, retain timesheets, project plans, technical documentation, financial reports, and other contemporaneous records that demonstrate both the R&D activity and the basis for cost attribution.
Notify HMRC of Your Claim Within Six Months of the Accounting Period End
Timely notification of your claim to HMRC is critical. For accounting periods starting on or after April 1, 2023, you must notify HMRC of your intention to claim R&D tax relief within six months of the end of the accounting period. This notification is crucial to avoid delays or rejection of your claim and ensure compliance with updated rules. The accounting period end date may differ from your tax return filing date, so track deadlines carefully.
If You’re a First-Time Claimant, Consider Advance Assurance
To ease the process of claiming R&D tax credits, first-time claimants should apply for advance assurance from HMRC. This voluntary process allows HMRC to review your claim in advance and confirm eligibility. Advance assurance provides greater certainty and smoother processing, reducing the risk of disputes or delays. Applying for advance assurance can be especially helpful for startups and SMEs new to R&D tax credits.
Work with Tax Professionals to Ensure You Maximize Your Claim
Claiming SME R&D tax credits can be complex. Working with experienced tax advisors or R&D specialists can ensure your claim is:
Accurate
Comprehensive
Optimized for maximum benefit
Professionals can assist in preparing the:
Technical narrative
Calculating eligible costs
Managing HMRC correspondence
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How the Tax Relief Works for Profitable vs. Loss-Making SMEs
Profitable SMEs benefit from enhanced deductions that reduce their taxable profits. When a profitable SME claims R&D tax relief, it can deduct an additional 86% of its qualifying R&D costs on top of the standard 100% deduction. This means that for every £100,000 spent on R&D, a profitable SME can claim £186,000 in tax relief. For example, at a 25% corporation tax rate, this enhanced deduction effectively saves the company about £21,500 in tax. This additional cash flow enables SMEs to reinvest in innovation and advance their R&D projects.
Tax Relief For Loss-Making SMEs
Loss-making SMEs can choose to surrender their enhanced R&D-related losses in exchange for a payable tax credit from HMRC. The surrenderable loss is based on 186% of qualifying R&D expenditure, and the credit is calculated as a percentage of that amount. For accounting periods beginning after April 2023, the standard credit rate is 10% of the surrenderable loss. For example, an SME with £100,000 of qualifying R&D costs could claim a cash credit of £18,600 (10% of £186,000).
Understanding the PAYE/NIC Cap on R&D Payable Credits
A cap applies to the amount that can be received as a payable credit:
£20,000 + 300% of the company’s PAYE and NIC liabilities for the period.
For instance, if a company incurs £200,000 in PAYE and NIC liabilities, the cap would be:
£20,000 + (3 × £200,000) = £620,000.
Any amount exceeding the cap can be carried forward to offset future Corporation Tax liabilities, ensuring that relief remains targeted at genuine R&D without creating opportunities for abuse.
The “Intensity Condition” for Higher Credits
R&D-intensive SMEs, those spending a substantial portion of their total business expenditure on R&D, may qualify for an enhanced payable credit rate of 14.5% of their surrenderable loss. The intensity threshold was initially set at 40% for expenditures incurred on or after April 1, 2023. Still, it will be reduced to 30% for accounting periods commencing on or after 1 April 2024, making the enhanced credit more accessible to a broader range of businesses.
Enhanced R&D Tax Credit: How It Supports Innovation-Led Growth
For example, an SME with £100,000 in qualifying R&D spend would have a surrenderable loss of £186,000. At the enhanced rate, this would generate a cash credit of approximately £27,000 (14.5% of £186,000), a significantly more generous return than the standard rate. This higher credit is designed to support highly innovative, loss-making SMEs, helping them manage early-stage funding gaps and reinvest in further R&D activity.
Book a Call to Learn More About our Accounting Services (Trusted by 400+ Startups)
Because the R&D Tax Credit is so complex, it’s a good idea to work with a tax professional who understands the ins and outs of the credit and can help your business claim the full benefit. A professional can help to identify all of the qualifying activities your business has undertaken, even those that may not be obvious.
They can also help to gather and organize the documentation needed to support your claim. If your business is audited after claiming the credit, having a tax professional involved can help to ensure the process goes smoothly and any issues are resolved quickly.
Why Startups Choose Haven: Real Results from 400+ Founders
Let your business take flight while Haven manages your financial runway. Built by founders for founders, we handle everything from daily bookkeeping to complex tax filings and R&D credits that put cash back in your pocket, as well as fractional CFO services.
Join 400+ startups who've saved millions in tax credits, countless hours of administrative work, and never missed a filing deadline - all while accessing 24/7 Slack support from CPAs who understand the unique challenges of growing businesses. Book a call today to learn how our dedicated team can help you focus on building rather than bookkeeping.