KPMG's David O'Keeffe, Dharmini Dharmabalan, and Naro Roxane Markarian describe how companies can access some of the R&D tax incentives they may be missing out on.
It is no secret that growth in the food and beverage industry is fuelled by consumers looking for new product and packaging choices.
In addition to consumer pressure, manufacturers must comply with regulatory bodies such as the UK's Food Standards Agency (FSA), and the US' Food and Drug Administration (FDA).
As a result, food and beverage manufacturers must continually reassess product formulations, processes, packaging materials and equipment in order to improve product performance, enhance overall efficiencies and remain competitive.
The UK government is offering an incentive by way of additional tax relief, and it is likely that some of these activities will be eligible for that incentive.
Research and Development (R&D) tax relief is available to any company in the UK that is carrying out qualifying activities.
Many people overlook this valuable incentive because they do not realise just how broad the definition of R&D is for these purposes; it's not all about white coats and Bunsen burners!
Large companies can go back to 1 April 2002 to make claims, whilst smaller companies can go back six years.
However time is also running out. The government has now reduced the time limit for making historic R&D tax relief claims. From 31 March 2006, companies will only be able to claim historic R&D tax relief going back two years instead of six.
For accounting periods ended on or before 31 March 2006 all claims have to have been made by the earlier of 6 years after the accounting period or by 31 March 2008.
For those that have yet to make a claim, this could see them potentially miss out on millions in possible tax relief.
Basic systems of tax relief There are two basic systems under which companies can claim; small and medium-sized enterprise (SME) relief and large company relief.
There are considerable benefits to companies in claiming R&D tax relief, yet many food and beverage manufacturers let their R&D tax relief entitlements pass.
In 2004, the food, beverage and tobacco product manufacturing businesses disclosed R&D expenditure representing only 0.025 per cent of the total R&D expenditure across the manufacturing sectors, according to the Office of National Statistics (ONS).
It is clear, that most businesses are under claiming because of a lack of understanding about the incentive.
One key misconception is that eligible R&D activities occur only in a laboratory setting, a mistake that leads many manufacturers to only claim activities that take place in their R&D departments.
This is a major oversight, as there are many other projects which may involve qualifying R&D activities.
Qualifying activities can include scale-up to commercial production volume, process improvements, equipment upgrades or improving existing products or processes.
Manufacturers who rely on their overseas parent companies to perform R&D also often assume that there are no eligible R&D activities in the UK plant.
This is not always true, as products and process developed in overseas associated companies for manufacturing in a UK plant frequently need to be adapted to be successful in local markets.
This is often due to ingredient or process variability. Therefore, the activities in the local market, undertaken in the UK plant to adapt the process or formulation may be eligible to receive R&D tax relief.
Qualifying Activities There are a number of activities that may qualify for R&D tax relief in the food and beverage industry. The following list shows just some of these:
- New product and package development, product improvement, formulation alterations and product line extension;
- Development or improvement of the manufacturing processes for product fabrication;
- Experimentation performed to establish formulation and manufacturing parameters;
- Experimentation performed to establish product consistency, product quality, process control procedures and manufacturing parameters;
- Experimentation performed to improve productivity; and
- Modification and improvement of equipment for product manufacturing which is non-capital in nature.
A summary of the different phases of new or modified product/package development in the food and beverage industry is presented in Figure 1, along with possible activities under each section.
The boxes shaded in orange represent where eligible R&D activities may be found.
Figure 1: Different phases in product development and modification.
In all cases, the key consideration in determining whether a project qualifies is whether or not the eligibility criteria have been fulfilled.
That is, for work to qualify for the tax relief the company must demonstrate that the work was technically challenging and an advance was being sought. Advances in science or technology can include new or improved products, processes, materials, devices, services or software.
Qualifying R&D expenditure
Whilst there are differences in eligible qualifying expenditures for a large company compared to that of SMEs, qualifying expenditure generally includes:
R&D staffing expenditure; Qualifying expenditure on externally provided workers;
Subcontracting and/or third-party payments to research institutions or universities (in some cases); and Materials consumed or transformed, including water, fuel and power used in the R&D activity.
Enhancing your tax credits If your company is already claiming R&D tax relief, you may want to consider whether all eligible activities are being identified and claimed, and whether your operations are structured to enhance R&D tax relief.
One area that is often overlooked involves situations in which U.K affiliates are receiving funding from the non-resident parent corporation to carry out R&D in the UK.
Often the UK affiliate does not claim the R&D costs on the grounds that they were fully funded.
However, under the R&D tax relief incentive, non-resident funded R&D costs may still be eligible. In general, most businesses can benefit from structuring their accounting system to capture all the qualifying costs.
Special attention should be given to third-party contracts, to ensure that companies claim any related tax benefits under the relevant relief. Once the claim is filed, HMRC will review it and carry out a technology and financial audit if necessary.
Companies often outsource this compliance work to consulting firms that offer services in preparing R&D claims.
While many of these consulting firms offer such services, it's important to ensure that knowledgeable professionals who have experience in identifying eligible activities in the food and beverage industries are consulted.
The consulting firm should have an integrated approach, with the ability to prepare both the scientific and tax filing by having engineers, scientists, technologists, accountants and tax professionals on staff.
They should also possess significant proven experience in defending claims before HMRC.
All three authors are with KPMG's Research and Development Tax group in the UK. David O'Keeffe is a partner. Dharmini Dharmabalan is assistant manager. Naro Roxane Markarian is manager.