The Complete Guide to R&D Tax Credit Loans
The R&D tax credit loan is still a largely uncharted form of finance in the UK.
This guide will give you all the details you need to understand this new form of alternative finance. It will help you figure out if it can be useful to you and get the most out of your future R&D tax credit payments.
What is an R&D tax credit loan?
An R&D tax credit loan is a new type of financial instrument that uses a company’s future R&D tax credit payments as collateral for a debt facility.
The R&D tax credit is a predictable source of cash for many UK companies, but one of the major issues is that it’s very slow. For a company to be able to access the payments that it’s eligible for it has to:
1. Spend money on R&D in the current financial year
2. Wait until the company’s financial year end comes around
3. Prepare the accounts
4. File the R&D tax credit claim as part of the CT600 form
5. Wait from 6–12 additional weeks for the R&D tax credit to be processed and paid out by HMRC
With an R&D tax credit loan, the company can have access to the funds in the year in which the R&D spending occurs. This is often many months before their earliest HMRC payment date.
So, the timeline looks more like this:
1. Spend money on R&D in the current financial year
2. Draw down funds from mid-year onwards
3. Increase your spending until the end of the year
4. Use the funds earlier and net a larger R&D credit at the end of the year
R&D tax credit factoring is a close cousin to invoice factoring. An R&D loan is simply factoring for expected “invoices” from the government, in this case, from HMRC.
For you to be able to access an R&D tax credit loan, the first and most important step is to qualify for UK’s R&D tax credit.
This type of tax credit payment is not limited to companies registered in the UK. Many governments have adopted a proactive approach to encouraging technological discovery. So, there are equivalent financing options all around the world. For example, you could access R&D incentive loans in Australia, or SR&ED loans in Canada as well, which our local Fundsquire teams can help you with.
Which companies qualify for the R&D tax credit scheme in the UK?
For Small and Medium Enterprises (SMEs) the R&D tax relief allows companies to deduct an additional 130% of their qualifying R&D costs from their yearly profit, on top of the usual 100% deduction, making it a total 230% deduction.
If the company is loss-making, the SME scheme allows it to claim a tax credit worth up to 14.5% of the surrenderable loss. Overall that means that companies can claim back between 20% and 33% of their eligible expenditure.
A company is defined as an SME if it has “less than 500 staff” and “a turnover of under €100m or a balance sheet total under €86m”. If a company is larger than the SME scheme parameters, it can still claim R&D tax relief, just under the more restrictive and less lucrative Research and Development Expenditure Credit (RDEC) scheme. For the purposes of R&D tax credit factoring, the SME scheme is most relevant. RDEC claims have complexities that often make them unsuitable for financing.
What is eligible expenditure for the R&D tax credit?
The costs that are claimable under the R&D tax credit incentive are direct staff costs, subcontracted expenses, software, R&D related travel expenses and consumables that were integral to the process of R&D.
Costs that are not eligible are infrastructure related costs. It also includes expenses that a company that did not conduct research and development would incur as well. This includes rent, utilities, capital expenditure, hosting, or costs associated with the use of or creation of a trademark.
What is eligible technology for a claim?
In the words of HMRC:
“For tax purposes, R&D takes place when a project seeks to achieve an advance in overall knowledge or capability in a field of science or technology.”
Simply put, for a technology to be eligible it has to be innovative in itself. If it is just a reconfiguration of existing technologies, it doesn’t qualify. An important distinction here is between a technological innovation and a market innovation. Developing a new AI algorithm is a technological innovation, and would qualify. Applying pre-existing AI modules in a new market is a market innovation and would not qualify.
But no worries, things aren’t that black and white. If, for example, you introduced pre-existing AI models into the insurance business and that resulted in additional software solutions created by your developers, that could qualify for R&D.
A good rule of thumb: if you have a technological problem and can’t find the right solution off the shelf or on the first 3 pages of search results or on StackOverflow, you’ve hit on eligible R&D.
Knowing these criteria, you now know with a good probability if you’re eligible for the R&D tax credit scheme. This also allows you to see approximately how much you are eligible to claim back. If your potential claim is sizeable but still many months away, you could access it now through an R&D tax credit advance.
How does the R&D tax credit loan process work?
There are a few simple steps to the application. On average, it can take between 2–4 weeks from the initial conversation to the loan agreement.
The first stage of the application is the due diligence that happens before a Term Sheet. At this stage, the lender looks at both the company’s history with the R&D tax credit (if the company has a history with it) and at a few key company documents, This includes things like the previous year’s accounts and a cash flow forecast. This allows the lender to understand the company’s status quo and its business trajectory and goals.
Then, the future borrower is issued a term sheet which contains the headline terms of the loan: the size of the facility, the interest & any other fees, the term and a list of any other needed documents. Once the term sheet is signed, the application fee is paid and the credit review process starts. At this point, a few additional documents and clarifications are requested and the credit team is dotting the Is.
If the credit review goes smoothly, the loan agreement is signed, the debenture is created and the payment schedule is agreed.
What are the benefits of an R&D Tax Loan?
An R&D tax credit loan can be a great source of liquidity for a growing company. This works especially well for companies that are pre-revenue or between funding rounds.
Other types of funding are either unavailable at this stage, like most bank loans, or very expensive, like venture debt.
It’s a virtuous cycle
As a high growth company with considerable technology, chances are you will continue to invest in tech. So, at least some of the advance funding you receive will go back into R&D. If, for example, you use the R&D tax credit advance to hire an additional developer, around 33% of their salary will flow into a larger R&D tax credit at the end of the year.
Take this example:
With the Leveraged (R&D Tax Credit Loan) funding, the company receives its R&D tax credit in increments throughout the year. This allows it to get a positive net cashflow at the HMRC repayment date compared to the traditional timeline.
It allows you to act fast
In technology, speed is everything. With barriers to entry at an all-time-low, new companies can catch up and surpass even giants in a matter of months. But all too often, funding is the bottleneck on a company’s growth path. With an R&D loan, the company can access funds early, when they can use them best.
It allows you to maintain control
For a company that is pre-revenue, it can seem that selling equity is the only viable funding option. R&D tax credit finance is a good alternative, as it uses a future asset to fund current liquidity. All this without diluting the position of current shareholders or inviting investors to the table.
Investors can, of course, offer value beyond the sheer amount of funding. Even then, it doesn’t hurt to seek investment from a strong operating position.
It’s cheaper than selling equity
With debt financing, you know exactly how much you will end up paying the lender: the principal plus fixed interest fees.
A major difference between debt and equity financing is that selling shares is permanent, while debt is temporary.
What do you need to apply for an R&D loan?
For a company to apply for an R&D tax credit debt facility the requirements are simple:
- A UK (or Canada/Australia) based company
- Significant levels of R&D expenditure
- Qualified expenditure for HMRC’s R&D tax credit
- Are pre-profit
If you want to chat with us at Fundsquire about the option of R&D Advance Funding, you can chat to us.
Alternatively, if you feel pretty certain about your eligibility you can skip the line and apply directly (takes about 15–20 minutes). This helps us get you to a term sheet much faster. It also speeds up the overall process to your potential R&D tax credit advance.
Originally published at https://fundsquire.co.uk on May 14, 2019.
