This article was first published in the March 2016 UK edition of Accounting and Business magazine.

Many small and medium-sized enterprises (SMEs) fail to take advantage of valuable tax breaks that could make a difference to their bottom line and offer valuable funding. Here are some of the most underused tax breaks you could flag up to your clients, and some changes that may affect the shareholders’ own tax positions.

Research and development

Tax reliefs for research and development (R&D) expenditure have never been more generous, but the take-up by SMEs remains low. This is despite the fact that the credits available for SMEs are substantially greater than those available to larger companies. In 2015 HMRC published a consultation paper Improving access to R&D tax credits for small business, and one of the key outcomes has been to make the claims process easier, especially for businesses making a claim for the first time. Not only are the reliefs now higher than ever, but making a claim should be simpler.

There is a common perception among SMEs and their advisers that unless the business has people in white coats on the premises, then R&D cannot possibly be relevant to them. In fact, the terms ‘science’ and ‘technology’ are interpreted by HMRC extremely widely, and there are very few business sectors where R&D relief is a non-starter.

The property development and construction sectors can be fertile areas for R&D claims. Development projects often face significant technological challenges. As long as the solution is not available to (or readily deducible by) a ‘competent professional in the field’, then any related R&D work to solve these challenges could qualify for the enhanced tax relief.

For R&D purposes, a company or group qualifies as an SME if it employs fewer than 500 people and has either an annual turnover of no more than £76m or a balance sheet total not exceeding £65m. SMEs can claim a tax deduction of 230% of the qualifying expenditure, which effectively reduces the R&D cost by 46%. Loss-making SMEs have the alternative option of claiming a payable cash credit, which can be a useful improvement to cashflow.

Some other points to note:

  • There is no minimum amount of expenditure required to claim relief.
  • An SME acting as an R&D subcontractor for a large company is able to claim R&D relief under the large company scheme.
  • Companies have up to two years after the end of the accounting period in which the money was spent to make a claim.
  • Software is specifically recognised by HMRC as technology, and HMRC also accepts that its development is often difficult and uncertain. As a result, businesses that have some element of digital output, such as some marketing services agencies, may find that they can make an R&D claim.

It is worth noting that R&D tax relief is only available for companies. For businesses that are conducted through limited liability partnerships, sole traders or partnerships, the possibility of claiming tax relief for R&D expenditure would be a significant factor in deciding whether to incorporate the business as a limited company.

Dividend tax

Many clients in the SME arena are concerned about the impact of the change to dividend taxation, which comes into effect on 6 April 2016. The one-ninth notional tax credit will disappear and be replaced by an effective nil-rate band for the first £5,000 of dividends, with dividends above £5,000 being taxed at 7.5%, 32.5% and 38.1% for basic, higher and additional rate taxpayers respectively. Dividends will be treated as the top slice of the individual’s income for the purpose of determining which rates apply.

The overall impact of the change is that the effective rate of tax on dividends increases by 7.5% for each rate band for 2016/17 onwards, subject to the availability of the dividend exemption.

The most obvious point is to consider whether dividends should be accelerated so that they are paid before 6 April 2016 to take advantage of the lower rates. This may simply be a question of bringing forward next year’s dividend or paying a dividend that was not contemplated so that some cash can be taken out of the business while tax rates are low.

The second point is to review the cash extraction policy for a company in view of the change. Many entrepreneurs choose to pay themselves a minimal salary and supplement this with dividends, as the effective rate of tax on the dividends is about 9% less than the equivalent taxes on salary. This difference will reduce from around 9% to around 3% from 6 April 2016, so the benefits of paying dividends will be limited.

Notwithstanding the above, making use of the £5,000 dividend exemption is a must, and for family-owned companies, using it as much as possible for the family can be attractive. The new dividend regime will also make the decision of whether or not to incorporate even more finely balanced.

Wind-ups and entrepreneurs

A key element of advising SME owners in relation to taking value out of their company is the possibility of winding the company up under a members’ voluntary resolution, perhaps when the trade ceases or has been sold. A tightening of the law in this area is proposed, which may cause the denial of entrepreneurs’ relief in such circumstances and make it worthwhile accelerating any winding-up process so that distributions are made before 6 April 2016.

Changes in the qualifying conditions for entrepreneurs’ relief were widely expected, given the government’s concern that the relief was being claimed too widely and costing too much. It has tackled the problem in an ingenious way – not by changing the entrepreneurs’ relief rules, but by widening the circumstances in which capital receipts can be recategorised for tax purposes as income under the transactions in securities anti-avoidance rules.

A key change is that where an entrepreneur receives capital distributions on the winding-up of a company, these can be recategorised as income for tax purposes if the entrepreneur is involved (whether as a sole trader, partner or shareholder) in a similar activity within the next two years and if one of the main purposes of the transactions is to obtain a tax advantage.

The changes are not likely to affect entrepreneurs’ relief in cases where an entrepreneur is retiring and does not intend to participate in a similar business in the future. But where, for example, an entrepreneur retires from their company and winds it up, but wants to keep their hand in by carrying on a similar business on a small scale, the capital treatment of their liquidation distributions could be in jeopardy. The changes are likely to have a particular impact on sectors such as property development, where it is common practice for a company to be set up to carry on a particular development and then be liquidated after its completion.

It is proposed that the changes will apply to winding-up distributions from 6 April 2016. Clients and advisers alike should be looking at accelerating the winding-up of companies concerned and, if possible, making distributions before the 6 April cut-off. It is not necessary for the winding-up to be completed by 6 April – only for the distributions to be made before then so that they can benefit from current tax treatment.

It is worth spending the time and effort to make sure that your client is maximising their business tax breaks. However, it is important to ensure that you discuss the pros and cons of each relief or tax credit scheme with them thoroughly to avoid any complications or misunderstandings further down the road.

Mike Hayes is a tax partner at Kingston Smith