10 September 2018

R&D tax relief - time to rethink remuneration strategy for directors?

Specialist consultants RDP explain how R&D tax relief could affect your remuneration strategy

R&D tax relief is expanding rapidly with the number of claims made by companies increasing 20% year on year. The relief is calculated on the basis of three primary cost categories:

  • Staffing
  • Outsourced R&D (e.g. subcontracted R&D /externally provided workers)
  • Consumables

Whilst the latter two are most easily understood, in terms of being invoiced costs to claim against, it is the first category that creates the most confusion amongst potential claimants of the scheme.

Common misconceptions in this category include:

  • Director shareholders that just started a business but don’t have enough resources to pay themselves a salary. They ask whether they can claim on the market value of the R&D services they have provided to the company
  • Director shareholders drawing out a loan in the early years want to know if they can claim against the loan
  • Director shareholders that don’t draw a large salary, and largely draw dividends from the company which they think should surely qualify

The cold hard facts are that, unfortunately, none of the above scenarios apply. Only salaries physically paid through the payroll to individuals qualify. This also means that any accrued salaries charged in the accounts, only qualify once they are actually paid.

Whilst there is little that can be done on the first two cases until a company starts to grow/find investment to fund salaries, the third area is where a business has a level of discretion available to influence the amount of research and development tax relief claimable.

In recent years, it has been very common for director shareholders to remunerate themselves with a low salary to maintain their National Insurance record while drawing the balance of their pay package by dividends which have lower rates of Income Tax than salary/no National Insurance contributions.

While this results in significant tax savings for the individual, however, when it comes to R&D tax relief the picture for the company becomes less rosy. As we mentioned above, an often-misunderstood rule is that dividends paid to directors qualify for relief. So all that hard work spent on R&D by a large number of directors in the UK today accounts for very little reward in R&D tax relief terms – a disappointing message to communicate to clients.

However, while the dividend tax savings were always historically attractive (especially when there was a zero % tax rate in the basic rate band up to two years ago), there was little to counter this strategy as in the round a director would need to be more or less 100% devoted to R&D to make a switch to salary effective and when coupled with the other duties of running a business was a pretty unachievable feat!

With the reforms of dividend taxation in April 2016, the equation changed with the imposition of a new rate of 7.5% in the basic rate band, and higher rates for higher earners as the government sought to level the playing field.

Income tax rates

Pre 1/4/16

Post 1/4/16

Basic rate 0% 7.5%
Higher rate 25% 32.5%
Additional rate 30.56% 38.1%

Note £5,000 annual allowance available (reducing to £2,000 in 18/19)

Suddenly, the balance shifted and when you bring R&D tax relief into the equation, it can now work out in favour of adopting a salary basis for hands-on directors.

RDP has done some analysis to look at the trigger points where the salaried route becomes more effective and the approximate percentage of R&D time needed to make it so.We found that there is a sliding scale: the higher the level of the dividend being replaced, the lower the percentage of R&D time spent by the director needs to be. For example, at the bonus equivalent of a £90,000 dividend, only 31% of a director’s time needs to be spent on R&D to save money.

To calculate the point at which it becomes more tax efficient to use a salary compared to dividend based on the % of your time spent on R&D, please ask for a copy of RDP Associate's Dividend vs. Salary for R&D Performers table here.

Other factors to consider include calculation of director salary you want to include, employer’s National Insurance contributions, employer pension contributions, and some reimbursed business expenses. Adding these costs will also increase the R&D tax credit claim.

Finally, you also want to include all the eligible R&D activities carried out by the Director such as:

  • Meetings and conceptualisation
  • Project management
  • Technical direction
  • Technical planning
  • Design and development
  • Testing

You should also consult your financial advisor before you make a switch from dividends to salary. You should take into consideration the following questions:

  • Would there be any impact on shareholders’ agreement?
  • Would there be any impact on banking arrangements? or
  • Would it affect any other tax plan you have in effect?

So, is it time you started rethinking your remuneration strategy?

This article was written by Richard Thorpe-Manley and has been re-published with kind permission of RDP Associates .

For more information on R&D tax relief contact Kirsty Murray

Bookmark and Share