Understanding the accounting treatment for R&D tax credits

What is accounting treatment?

“Accounting Treatment” refers to the systematic process of recording, classifying, and presenting a business’s financial transactions in compliance with accounting principles.

For R&D tax credits, this involves accurately reflecting tax benefits in financial statements, depending on the scheme SME, RDEC, merged or ERIS. Proper handling ensures compliance, transparency, and maximises the value of innovation investments.

So you’ve successfully claimed R&D tax credits, but how do you account for the relief while preparing financial statements? We delve into the accounting treatment for R&D tax credits, including how they differ for the SME scheme, RDEC, the merged scheme and ERIS scheme. What’s more, we navigate the benefits of proper accounting treatments, with professional tips on successfully accounting for R&D tax relief. 

A clear financial statement can help stakeholders make proactive decisions that enhance business growth. For UK businesses investing in research and development, understanding the accounting treatment for R&D tax relief becomes a necessary part of a financial statement.

Since the introduction of HMRC’s merged R&D tax credit scheme, the scope of accounting treatments has broadened. So in our mission to simplify the relief, we’re revisiting the process of accounting treatments, ensuring you have the right information to maintain your impeccable accounting standards. 

Accounting treatments for R&D tax relief

When accounting for R&D tax relief, the goal is to accurately reflect the tax credit benefit in your financial statements. This involves deciding whether the relief should:

• Appear as income
• Reduce research and development expenses
• Be treated as a government grant

Accounting for R&D tax credits is also about timing, as understanding when to recognise the credit and clear disclosure is essential to achieving financial accuracy. 

By properly handling the tax relief from an accounting perspective, businesses can ensure that they are compliant and transparent while presenting the value of their investments in innovation.

The PAYE/NIC cap limits the cash amount of R&D tax credit you can claim to 300% of your total PAYE and NIC liabilities for staff involved in R&D. Some companies use a prior year adjustment to reflect R&D tax relief benefits in their financial statements. This is generally treated as an adjustment to their current year’s tax charge.

What are disclosures and estimates in R&D tax credit accounting?

When accounting for R&D tax credits, it’s important to have a clear, consistent disclosure policy. Estimates may be required for qualifying expenditure, apportioning staff time, and assessing the likelihood of claims being accepted by HMRC. These estimates should be based on verifiable data and disclosed transparently in the financial statements to ensure compliance and reliability.

At year-end, you should distinguish between prior year R&D claims (based on your final HMRC-submitted figures) and current year estimates, ensuring that any estimated credit is updated once the final qualifying expenditure is confirmed.

Accounting treatments under different R&D relief schemes

Claims made on accounting periods beginning before 1 April 2024 can be filed under:

1. The SME scheme – small and medium enterprises
2. RDEC Scheme – large companies

Claims on accounting periods beginning on or after 1 April 2024 can be filed under:

1. The merged scheme – SMEs and large companies
2. ERIS Scheme – R&D-intensive businesses

While each of these schemes are united in their goal to help businesses offset qualifying research and development costs, they all have different accounting treatments for the relief. They are as follows:

Accounting treatment for the SME scheme

Created to provide additional support for small and medium sized enterprises (SMEs) investing in innovative research and development, this scheme provides enhanced deduction rates and even cash credit relief opportunities. 

If you’re claiming under the SME scheme, you’ll find the accounting treatment of R&D tax relief pretty straightforward, because the tax credits are non taxable. This means that when you include R&D tax credit benefits under the SME scheme in financial statements, you should recognise the relief as an additional deduction. 

Accounting treatment for RDEC

Providing financial relief primarily to large companies investing in cutting edge advancement, this scheme offers a reasonable return on eligible investment in qualifying research and development projects.

If you’re claiming under RDEC, the accounting treatment is quite simple, as the tax relief is considered to be profit before tax. This means when you claim R&D tax credits under RDEC, the financial relief that you receive is subject to taxation. When including the relief in financial statements, it should be recognised as above the line income. 

Accounting treatments for the merged scheme

For accounting periods beginning on or after 1 April 2024, your gross credit payout will be considered taxable income. Combining the SME scheme and RDEC, this scheme was introduced by HMRC to simplify the claims process, and improve compliance with existing policy. This is treated as above the line (typically ‘other income’) like the RDEC scheme. The tax on that credit is recorded in the tax line. Some choose to net it off against their R&D costs for presentation, but it still remains taxable income, not simply a reduction in your current tax liability. 

If you’re new to claiming under the merged scheme, the accounting treatment may seem a little more complex at first, because there are two ways of accounting for R&D tax relief. You can treat the relief as either: 

• A reduction in payable tax (which offsets the tax liability)
• A government grant (credits are treated as profitable income, reducing the expense of long term projects)

With an option to treat R&D tax credits in a way that suits business interests, it’s important to include accounting treatments in project planning processes. 

Accounting treatment for ERIS (Enhanced R&D Intensive Support) scheme

The Enhanced R&D Intensive Support (ERIS) scheme is part of the new merged R&D scheme and is designed to protect companies that invest heavily in innovation but do not yet generate substantial profits. It allows qualifying businesses to claim a higher rate of relief on eligible research and development expenditure.

For accounting treatment, ERIS follows a similar structure to the SME scheme, as the financial support received is not considered taxable income, and is treated as ‘below the line’.

Instead, when preparing your financial statements, you record it as an extra deduction. If your company claims a cash repayment, this can also be shown as money owed to you by HMRC until the payment is received.

Because ERIS applies to businesses with high R&D spend, it’s important to keep clear records. Showing the relief separately in your accounts will make it easier to demonstrate compliance and highlight how the scheme supports your company’s cashflow and future liabilities.

What are the benefits of proper accounting treatments for R&D tax relief?

There’s more to proper accounting treatments than ticking boxes. In fact the proper treatment for R&D tax relief has an array of benefits that set your business up for another year of financial success. Some of the benefits include: 

• Clear presentation of finances – when presenting your business finances to investors, lenders and regulators, accurately reflecting how R&D tax credits benefit your business can build trust and confidence
• Improves cash flow – properly handling tax relief can lower taxable profits, leading to increased revenue which can be reinvested in future or ongoing innovation
• Reduces risk – by aligning accounting treatment with HMRC guidelines, you reduce the risk of potential penalties 

When it comes down to it, proper accounting treatment of R&D tax relief is about making the most of what you’ve earned and keeping your business on solid ground.

What are the challenges in proper accounting treatments for R&D tax relief?

While the benefits of proper accounting treatment are lucrative, it’s not always that simple. In fact, navigating the accounting treatment for R&D tax relief can sometimes feel like walking a tight rope. Some of the biggest challenges that businesses face in proper accounting treatments include:

• Trouble interpreting complex rules – due to extensive criteria, varying accounting standards and technical jargon, it can be difficult to understand what the financial reporting requirements actually are – which is why we simplified it right here in this article
• Timing relief recognition – finding the right time to recognise claims that remain subject to approval or R&D tax relief for projects that span across different accounting periods can be complex

Tips for successful accounting treatment for R&D tax relief

One of the greatest ways to avoid mistakes with the accounting treatments for R&D tax relief, is to have a few smart strategies in place. We recommend you take into consideration these helpful steps in order to smooth the accounting treatment process:

1. Build collaboration between finance team and R&D tax specialists – R&D tax specialists have a professional knowledge of the relief, and will be able to provide information on each step of the claims process – including accounting treatments
2. Actively maintain detailed documentation – Documentation provides ample support for your claim, and can be referenced back to throughout the development of financial statements, making detailed documentation the key to successfully claiming, accounting for, and allocating R&D tax credits
3. Stay up to date with policy and accounting treatment processes – By closely monitoring the scheme your business qualifies under, you can stay in the loop should any changes be made to the accounting treatment or even to the claims process itself
4. Keep to a timing strategy – Check timelines for R&D tax relief submission and benefit income to ensure you meet deadlines like the additional information form (AIF)

With these tips, you’ll confidently be able to navigate the accounting treatment, and successfully breeze past common challenges that usually stump other businesses.

Alexander Clifford’s role in R&D tax relief

As one of the UK’s leading R&D tax credit advisories, the specialist team at Alexander Clifford provides a thorough understanding of HMRC policy. We pride ourselves on supporting innovative businesses like yours, by helping to maximise their R&D tax credit claims.

From start to finish, we provide comprehensive support, applying our meticulous approach to ensure that no qualifying activity or cost is overlooked. So far, this has helped our clients secure over £83 million in tax credit benefits.

Don’t leave money on the table, start your R&D tax credit claim with us today. Fill out the contact form below or click here to schedule an appointment at your convenience. Let us help you unlock the full value of your innovation.