UK R&D Tax Credits for Small Businesses 2026/27: Merged RDEC Scheme Explained
The UK research and development (R&D) tax credit system was overhauled in April 2024 with the introduction of a merged RDEC scheme replacing the old two-tier SME and large company frameworks. For most small businesses, this means a 20% above-the-line credit on qualifying expenditure. Loss-making companies that are R&D-intensive can access a higher 27% credit under the SME intensive scheme. This guide explains the new rules, qualifying costs, the PAYE cap, and how to claim correctly.
The old UK R&D tax credit system had two parallel schemes: the SME scheme (which provided an enhanced deduction of 130% on qualifying costs, with a 14.5% payable credit for loss-making companies) and the Research and Development Expenditure Credit (RDEC) for larger companies (a 20% above-the-line credit). The co-existence of two schemes created complexity, opportunities for abuse, and inconsistent treatment of similar activities.
HMRC had also identified significant levels of fraudulent and inflated claims, particularly via third-party advisers taking contingent fees on claims. From August 2023, all R&D claims require an online additional information form. From April 2024, the merged scheme simplifies the framework: one credit rate (20%) for most companies, one set of qualifying costs rules, and one compliance framework.
The exception is the SME intensive scheme, preserved for the most R&D-intensive loss-making small businesses that would otherwise be disadvantaged by the merger.
The Merged RDEC -- How It Works
Under the merged scheme, a company claims a credit equal to 20% of its qualifying R&D expenditure. This credit is recognised "above the line" -- as other income in the profit and loss account. It increases the accounting profit (or reduces the loss) in the year of claim.
Example: Profitable company with £500,000 qualifying R&D spend
RDEC credit: £500,000 x 20% = £100,000
Credit recognised as income above the line: +£100,000
Corporation tax on credit at 25%: £25,000
Net benefit after tax: £100,000 - £25,000 = £75,000
Effective net rate: 15% of qualifying expenditure
For a loss-making company, the 20% credit is applied against the corporation tax liability. Any remaining credit (after exhausting the tax liability) is reduced by the relevant tax rate and paid as cash, subject to the PAYE cap. The effective cash benefit for a loss-making company using the merged scheme is approximately 15% of qualifying expenditure.
SME Intensive Scheme -- The Higher Rate
The SME intensive scheme provides a 27% credit (compared to 20% under the merged scheme) for qualifying loss-making SMEs where R&D expenditure represents at least 30% of total expenditure. This recognises that deeply R&D-intensive small businesses -- early-stage biotech, deep-tech startups, advanced engineering companies -- have a different risk and cost profile from larger profitable businesses claiming RDEC.
Scheme
Credit rate
Who qualifies
Net effective rate
Merged RDEC
20%
All companies (most claims)
~15% after corporation tax
SME Intensive
27%
Loss-making SMEs, R&D 30%+ of costs
~20.25% after corporation tax
Qualifying Activities -- The Advance in Science or Technology Test
The qualifying activity test has not changed despite the scheme restructuring. HMRC uses the Department for Science, Innovation and Technology (DSIT) guidelines. The core question is: does the project seek an advance in overall knowledge or capability in a field of science or technology, and does it involve resolving a scientific or technological uncertainty that is not readily deducible by a competent professional in the field?
This test is deliberately technology-neutral. Software development, manufacturing process innovation, chemical formulation, medical device design, and many other activities can qualify provided they meet the scientific or technological uncertainty test. The uncertainty must be about whether something is technically achievable, not just whether a commercial approach will be profitable.
Common disqualifiers: adapting an existing library or framework for a new use (no uncertainty); improving aesthetics or user experience without underlying technical innovation; routine testing and quality assurance; and social science or mathematical research (specifically excluded unless applied to a physical science).
Qualifying Costs Under the Merged Scheme
Staff costs:Salaries, employer NI, employer pension contributions, and reimbursed travel and subsistence for employees who directly work on qualifying R&D. Includes a reasonable apportionment for supporting activities.
Subcontracted R&D:65% of payments to unconnected subcontractors performing qualifying R&D on the company's behalf. 65% also applies to contributions to independent research.
Software:Software costs directly used in R&D activities (including cloud computing and data costs from April 2023).
Consumable items:Materials and consumables used or transformed during R&D (not resold as part of a product without transformation).
Clinical trial volunteers: Payments to participants in qualifying clinical trials.
Capital expenditure on equipment used in R&D is generally excluded from the R&D credit calculation (though it may qualify for capital allowances under the Annual Investment Allowance or full expensing). Licence fees for intellectual property and rent are not qualifying costs.
Key R&D Tax Credit Facts at a Glance (2026/27)
Merged RDEC credit rate
20% of qualifying expenditure
SME intensive scheme rate
27% (loss-making, 30%+ R&D intensity)
Effective net rate (merged)
~15% after 25% corporation tax
Subcontractor inclusion rate
65% of payments to unconnected parties
PAYE cap minimum
£20,000 or 300% of PAYE/NI liability
Additional information form
Required for all claims (from Aug 2023)
Advance Assurance
Available for first-time claimants (under £2m, 50 staff)
Merged scheme start date
Accounting periods starting on/after 1 April 2024
Frequently Asked Questions
Frequently Asked Questions
What changed with R and D tax credits from April 2024?
From 1 April 2024, the old two-scheme system (SME R&D relief and the large company RDEC) was merged into a single merged RDEC scheme for most companies. Under the merged scheme, companies of all sizes receive a 20% above-the-line credit on qualifying R and D expenditure. Loss-making companies without sufficient tax liability can receive the credit as a payable cash amount subject to the PAYE cap. The separate SME scheme was abolished, except for the new SME intensive scheme for loss-making R and D-intensive small and medium-sized enterprises.
What is the merged RDEC rate and how does it work?
The merged RDEC credit rate is 20% of qualifying R and D expenditure. This credit is "above the line" -- it is recognised as a credit in the profit and loss account before tax is calculated, increasing accounting profit. It is then offset against the corporation tax liability. If the credit exceeds the tax liability (for example, in a loss-making year), the net credit after tax (at 25% corporation tax rate) is approximately 15% of qualifying expenditure and can be received as a payable cash amount, subject to the PAYE cap.
What is the SME intensive scheme and who qualifies?
The SME intensive scheme is a higher-rate R and D credit of 27% (after the 25% corporation tax rate, an effective net benefit of approximately 20.25%) available to loss-making SMEs that are R and D intensive. To qualify, the company must be a qualifying SME (fewer than 500 employees, turnover below EUR 100 million or balance sheet below EUR 86 million), must be loss-making in the claim period, and must have qualifying R and D expenditure equal to at least 30% of total expenditure in that period. Companies that just fall below the 30% threshold in one year may be able to use a grace period provision.
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What activities qualify as R and D for tax credit purposes?
HMRC uses the Department for Science, Innovation and Technology (DSIT) guidelines to define qualifying R and D. The key test is whether the project seeks an advance in science or technology by resolving a scientific or technological uncertainty -- something that is not readily deducible from existing knowledge. Routine software development, market research, adapting existing technology for a new use (where no technological uncertainty exists), and social sciences do not qualify. Genuine innovation -- new algorithms, novel materials, new manufacturing processes, or software solving problems at the cutting edge of what is technically feasible -- typically qualifies.
What costs can be included in an R and D tax credit claim?
Qualifying costs under the merged scheme include: staffing costs (salaries, employer NI, employer pension contributions, and reimbursed business expenses of employees working on R and D); sub-contracted R and D costs (at 65% of payments to unconnected parties); contributions to independent research (at 65%); software and consumable items used in R and D; payments to clinical trial volunteers; and cloud computing and data costs where directly used for R and D. Capital expenditure on equipment is generally excluded (though capital allowances may apply separately).
What is the PAYE cap on R and D payable credits?
To prevent abuse by companies with no UK employees, a PAYE cap limits the payable credit (cash repayment) to the greater of £20,000 or 300% of the company's total PAYE and NI liability for the period. This means a company with no UK employees generating an R and D credit above £20,000 cannot receive more than £20,000 as a cash refund. The PAYE cap does not affect the ability to offset credits against the corporation tax liability -- it only restricts the cash-repayable portion for companies with low UK payrolls.
Can I include subcontractor costs in my R and D claim?
Yes, but subject to restrictions. Under the merged RDEC scheme, payments to unconnected subcontractors for R and D activity can be included at 65% of the amount paid. Payments to connected parties (for example, a parent company or subsidiary) can also be included but are subject to stricter rules and must represent staff costs or other qualifying expenditure at the connected party. The 35% haircut on subcontractor costs was introduced to ensure only genuine R and D expenditure (not management fees or profit margins) is credited.
What records should I keep for an R and D tax credit claim?
HMRC expects companies to maintain contemporaneous records of their R and D projects. This includes: project descriptions explaining the scientific or technological uncertainty being resolved; records of staff time allocation to qualifying projects; purchase orders and invoices for qualifying consumables, software, and subcontracted work; and technical reports demonstrating the advance being sought. Retrospective record construction is a common issue in HMRC enquiries. Starting to document projects as they happen -- with project logs, timesheets, and technical write-ups -- greatly reduces enquiry risk and speeds up the claims process.
How long does HMRC take to process an R and D claim and pay the credit?
For companies using the mandatory online additional information form (required since August 2023 for all claims), HMRC aims to process claims within 40 working days. Companies submitting additional information before or alongside the corporation tax return typically see credits paid within 6 to 8 weeks of submission. Claims without the additional information form will be rejected. If HMRC opens an enquiry into the claim, processing is suspended until the enquiry is resolved -- which can take 12 months or more for complex cases.
Is advance clearance available before I invest in R and D?
HMRC operates an Advance Assurance scheme for new claimants (companies making their first R and D claim) with annual turnover under £2 million and fewer than 50 employees. Advance Assurance provides comfort that HMRC agrees the activity qualifies before the claim is made. It is not available to larger companies or repeat claimants. For businesses uncertain whether their projects qualify, commissioning a professional R and D claim review before committing significant expenditure is advisable -- specialist R and D tax advisers can assess qualifying activities and costs.