R&D tax credits for engineering: what may qualify

Which engineering companies can claim R&D tax credits?

For accounting periods beginning on or after 1 April 2024, an engineering company can claim the merged R&D expenditure credit if it is trading, is chargeable to Corporation Tax and has a project that meets the definition of R&D. ^[1] For a mechanical, electrical, civil or process engineering firm, the starting point is usually the design, prototyping and test work that tried to resolve something a competent professional in the field could not readily work out, and whether that work may qualify for R&D tax credits.

There are restrictions on claiming for some expenditure incurred overseas, which may matter where an engineering group runs test programmes or design offices outside the UK. The credit rates, how the credit is taxed and the separate support for loss-making R&D intensive companies are set out in how R&D tax credits are calculated, and notification and filing in claiming R&D tax credits for earlier years.

What an engineering project has to show

To qualify, an engineering project must seek an advance in a field of science or technology by resolving scientific or technological uncertainty. ^[2] A scientific or technological uncertainty exists when an expert on the subject cannot say if something is technologically possible, or how it can be done, even after referring to all the available evidence. The advance must be in the overall field, not just for the business, although a process, product or service can still be an advance if it has been developed by another company but is not publicly known or available.

A competent professional working in that field would recognise the advance as an appreciable improvement. Appreciably improving an existing process, material, device, product or service can count, for example to save costs or reduce waste, where it is a genuine non-trivial improvement that results in more than a minor or routine upgrade. In engineering, that could describe a gearbox redesigned to cut vibration where no published method gave the answer, a bracket made from a new alloy to save weight without losing strength, or a welding or machining process changed to reduce scrap.

Creating a process, material, device, product or service that increases overall knowledge or capability in the field may also count, as may using science or technology to copy the effect of a current one in a new or improved way. An engineering example could be a sensor arrangement that achieves what an existing mechanical linkage does, but by a different route.

An engineering company needs to be able to explain the work it did to overcome the uncertainty, and a simple description of the successes and failures during the project can do this. For an engineering team, that record may be test reports, failed prototypes, design iterations, rig data and simulation results. The company can also show that the engineers on the project are professionals in that field and get them to explain the uncertainties involved.

A practical way for an engineering team to test this is to write down what the available knowledge and standard methods were at the start, what the engineers tried first, and why those approaches did not give the answer. Rejected design routes, failed concepts and test results that contradicted the model are often the clearest sign that the uncertainty was real.

Engineering work done to a client's specification

Many engineering firms design or build to a client's brief, so it matters which side of the contract the R&D sits on. Subject to transitional provisions, claimants generally can claim for expenditure on R&D contracted out by them, and can't claim for expenditure on R&D contracted out to them. ^[3]

For accounting periods beginning on or after 1 April 2024, only the company that makes the decision that R&D needs to be carried out can claim the tax relief. ^[4] A firm developing a bespoke machine, jig or control system under a client contract can claim for the allowable costs of work done to fulfil that contract if it can provide evidence that shows it made the decision to carry out the R&D and planned the R&D. The client must also not have initiated the R&D or known it needed to be done to fulfil the contract.

In practice, the records should show who decided that R&D needed to be carried out, who planned it and that the client had not initiated it or known it needed to be done to fulfil the contract, rather than only who chose the engineering solution. A firm that engages a test house, foundry or specialist machine shop to carry out R&D that the firm itself decided to do may be on the commissioning side of that line.

Engineering costs and where the project starts and ends

Costs should be included only from the start to the end of the project, and a cost must already have been paid to be claimed, since costs not paid before the claim is made are not eligible. ^[4] R&D starts when work begins to resolve the scientific or technological uncertainty and ends when that uncertainty is resolved, or the work to resolve it stops; a feasibility study to inform the strategic direction of a specific R&D activity is separately listed as a qualifying indirect activity.

Staff costs can be claimed for the time spent working on the R&D project, including secondary Class 1 National Insurance contributions paid by the company. For example, if a member of staff spends 90% of their time working on R&D activities and 10% on other activities, 90% of their salary can be claimed. For a design engineer who splits time between a new product and routine drawing work, the time to track is the time spent on qualifying R&D activities within the new product project, kept separate from routine drawing and other non-qualifying work.

A proportion of consumable items used up in the R&D can be included, although the costs cannot be claimed if the company sells or transfers ownership of those items. In engineering, that may cover material machined into test pieces or destroyed in fatigue and load testing. Software licence fees for R&D can be included, with a reasonable share of the costs for software partly used in the R&D, which may apply to CAD, finite element or fluid dynamics packages. For accounting periods beginning on or after 1 April 2023, most data licence and cloud computing costs spent on R&D can be claimed, but not those that are for qualifying indirect activities. Cloud capacity bought for simulation runs may fall under that heading.

Maintaining R&D equipment, including computers used for R&D purposes, is a qualifying indirect activity where it is essential to carry out the R&D, which may include upkeep of a test rig. Only the costs listed in the official guidance can be claimed, and capital expenditure is given as an example of a cost that cannot be claimed, which may matter where a rig or machine tool is bought outright.

The PAYE cap on the credit, and how agency and subcontracted engineers are treated in the calculation, are covered in the guide to how R&D tax credits are calculated.