SME R&D relief and private equity firms

The issue

As mentioned in numerous previous tax bites, research and development (R&D) relief continues to be massively generous, particularly for SME’s. For an SME, R&D costs enjoy tax relief at a whopping 230%. Therefore for a profitable company this relief is effectively worth £24,700 (£130,000 @19%) for every £100,000 of costs that can be identified.

By way of recap for a company to be an ‘SME’ it needs to meet the following EU conditions:

1. It needs to have less than 500 staff
2. It also needs to either have a turnover of under €100m or a balance sheet total under €86m

When a company stops being an SME then it can no longer benefit from this generous relief (although a less generous version is available). One consequence of a takeover by a private equity firm is that a company may lose its SME status. This can happen because often the firm will have controlling stakes in other ventures which will mean that the staff, turnover and balance sheet total (above) of those other ventures have to be amalgamated when considering if the SME definition holds. For example if two companies are owned by a third company, the measures of each company would have to be amalgamated for SME purposes.

For this reason many advisors are discounting the possibility of R&D relief when a private equity firm has a controlling stake, but… don’t give up too soon…

 

The beauty of partnerships

When a ‘private equity firm’ is examined in detail it is often made up of a variety of investment partnerships and this can be important as far as maintaining SME status for the company in question. This is because partnerships are transparent for the purposes of applying SME definitions and therefore one has to look through to the investors underneath. Indeed, HMRC point out in their guidance that:

However, where two corporate groups are owned by a transparent entity, such as an English limited partnership, and no single limited partner has more than a 50% interest in the partnership, the two groups will not be taken to be linked enterprises.

This can give us an out in various private equity firm cases because although a ‘firm’ may control various companies it will often be the case that the ‘firm’ is actually a partnership made up of minority investors who do not jeopardise the SME status.

 

Final thought

As R&D claims can be worth many hundreds of thousands of pounds it is worth private equity firms keeping an eye on this when structuring a controlling stake in a company. With careful structuring they may be able to preserve this valuable relief for years to come!

 

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