Securing investment from Angels, Venture Capital (VC) firms, and even friends and family, is an exciting milestone for any business. But some entrepreneurs don’t realise that receiving external funding may affect the R&D Tax Credit claim process, moving forwards.
By no means does this make fundraising an unattractive prospect!
But it’s important to have a clear picture of the relationship between investment and R&D tax relief, before approaching a raise.
While gaining equity-based funding won’t make you ineligible for Research and Development (R&D) Tax Credits, it could mean that your claim benefit is somewhat reduced.
What determines the amount you lose out on? Well, it all depends on how HMRC classifies your business’ financial relationship with your investor/investors.
Your business / investor relationship matters
HMRC has established three categories as a basis for identifying a business’ financial relationship with their investor. These are:
👉🏼 Autonomous enterprises;
👉🏼 Linked enterprises;
👉🏼 Partner enterprises.
If you fall under the category of an ‘autonomous enterprise’, your r and d tax credits won’t be affected by your connection to your investor!
Congratulations – this means you’ll be eligible to claim the maximum for your chosen R&D tax relief scheme (SME or RDEC).
But if your financial connection with your investors is classified as a ‘linked’ or ‘partner enterprise’, your R & D claim size might be capped.
So, what defines these three types of enterprise?
What is an autonomous enterprise?
HMRC defines an autonomous enterprise as a business that does not have an external investor with 25% (or more) equity share or voting rights.
It's worth knowing that even if you have multiple investors, each with a stake of under 25%, your investor relationship will still be classed as an autonomous enterprise – only if the investors are not linked in any way (linked investors will push you into the ‘linked’ or ‘partnered enterprise’ bracket).
There are some exceptions to the rule.
Below, we’ve listed the investors that can exceed the 25% threshold and still belong to an autonomous enterprise:
Public investment corporations and VCs
Angels - Individuals (or groups) that demonstrate regular VC investment activity, who invest equity capital in unquoted businesses, provided the total investment of Angels in the same enterprise is less than €1.25 million.
Universities or non-profit research centres.
Institutional investors.
Autonomous local authorities, with an annual budget of less than €10 million and under 5,000 inhabitants.
What is a linked enterprise?
According to HMRC, a business and their investor constitute a linked enterprise if the investor has control over the business’ operation. There are three ways in which this is determined:
Your investor has a majority share (over 50% of your company’s equity and voting rights).
Your investor has the ability to appoint or remove your business’ management, administrative, or supervisory body.
Your investor is able to exercise a ‘dominant influence’ over your business.
So, what does this mean for R&D Tax Credits?
If this definition of a ‘linked enterprise’ sounds like your relationship with an investor, there are a few things you need to incorporate into your R & D claim submission.
You’ll need to include your investor’s:
💸 Employee headcount;
💸 Revenue;
💸 Balance sheet;
💸 Any other company your investor is ‘linked’ to.
This information is vital in determining which R&D Tax Credit scheme is right for you. This is because HMRC look to company size when differentiating between SME Scheme candidates and RDEC Scheme candidates.
For example, the SME Scheme provides R&D tax relief for companies with less than 500 employees, less than €100 million in annual turnover, and less than €86m in gross assets.
This more conventional scheme allows companies to claim back up to 27% of eligible R&D expenditure.*
Surpassing these metrics will mean that you must claim through the RDEC Scheme – which offers a fixed rate of 20% of eligible R&D costs (subject to corporation tax).
An investing body will likely display high figures across three size metrics, which will bump yours up a great deal.
So, being classed as a ‘linked enterprise’ with your investor could land you in RDEC territory.
What is a partner enterprise?
A business/investor relationship is classed as a ‘partner enterprise’ when the investor is a larger business, owning between 25%-50% of your SME.
A significant share – but not a controlling stake.
As the investor doesn’t have a majority share, this is different from a ‘linked enterprise'.
What does this mean for research and development tax credits?
If you receive funding from a partner enterprise, you must add a fraction of its staff, turnover and balance sheet to your own when taking the company size test.
As a result, the amount you contribute is dependent on how much of your equity belongs to your partner.
If your partner owns 25% of your company, you’ll add a quarter of its staff and assets. If it owns 50%, you’ll add half, and so on.
Let’s run through an example.
If your partner company owns 30% of your business, and their balance sheet is worth €10 million, you would add €3m to your balance sheet. If you had a balance sheet worth €1 million, adding the two together would result in €4m.
When it comes to research & development tax credits, that’s still well within the boundaries of the SME Scheme.
Even if you were to be classified as a large company (one that exceeds the above metrics of the SME scheme), certain investment corporations are excluded from the ‘partner enterprise’ rule.
These are the same as the exceptions outlined under the autonomous enterprise relationship.
That’s all you need to know about how external investment can affect your Research and Development Tax Relief.
Fortunately, you’ll never have to piece together your R & D claim alone. Our specialist team at Claim Capital is experienced in assessing and maximising R&D Tax Credit claims, year after year.
Our end-to-end R&D Tax Credit service has successfully delivered over £25.8 million in tax benefit to our clients, whilst adhering to changing HMRC regulation.
We help innovative companies get the most out of their R&D tax credit claim.
If you want to do the same, arrange a free consultation with our experts.
*These are the updated figures in line with the new legislation announced in the April 2023 Spring Budget.