Clarifying Trading Status for R&D Tax Relief Claims

Early-stage research and development (R&D) investments could help lay the groundwork for a company’s long-term innovation goals.  However, the tax treatment of pre-trading expenditure becomes complex when R&D-related costs are incurred before a company officially begins trading. Typically, pre-trading expenditure is treated as being incurred on the first day of trading. However, for small and medium-sized enterprises (SMEs), there are some exceptions that could  allow for the deduction of pre-trading R&D-related expenditure in the period it is incurred, enhancing the potential for R&D intensive support.

Before exploring how pre-trading expenditure can be treated in these scenarios, it’s important to understand what qualifies as trading. Megan Young, Senior Consultant, R&D Technical at Ryan, investigates below.

What Is Pre-Trading Expenditure?

UK tax legislation recognises that certain expenses incurred in preparation for trade, including those related to R&D, may arise before a company officially begins trading. Generally, revenue expenses incurred in a trade, profession, or vocation before it commences can be considered where that expenditure:

• Is incurred within a period of seven years prior to the commencement of the trade, profession or vocation, and;
• Is not allowable as a deduction in computing the profits of the trade, profession or vocation but would have been allowable if incurred after the trade had commenced.¹

Examples of this expenditure, relevant to R&D projects, could include the salaries for technical or supporting staff, payments to third parties conducting qualifying R&D on behalf of the company, or consumables like chemicals, components, or other materials used up in the R&D process. 

When Does a Company Start Trading?

To determine the eligibility of pre-trading expenditure, we must first define what “trading” means for tax purposes. HMRC’s Corporate Intangibles Research and Development (CIRD) Manual provides guidance on how tax relief rules apply in the UK. CIRD81400 deals with the concept of “trade” in relation to R&D activities and states:

“The carrying out of R&D is not necessarily a trade of itself. Generally, a person must enter into contracts to provide goods or services to another person in return for a reward to be trading.”

That is the only guidance given in CIRD81400, and the taxes acts give very little additional direction on the meaning of the word “trade”. Definitions found in both S989 ITA 2007 and S1119 CTA 2010—specific sections of UK tax legislation—simply say that “trade” includes any “venture in the nature of trade.”

To support companies and provide clarity in the event of a dispute, the courts have determined their own criteria for defining what constitutes a “trade” or “trading”, outlined as follows:

“Broadly, “trade” can be taken to refer to operations of a commercial kind by which the trader provides to customers for reward some kind of goods or services. The extension of the definition to “ventures in the nature of trade” allows for the inclusion of isolated or speculative transactions, although not all such transactions will be within the definition.”²

The correct understanding of when a company is considered to be “trading”, based on these limited explanations, is crucial for determining the eligibility of pre-trading expenditure. Sales are not required, but there must be real commercial engagement. This comes down to three important questions relative to the period being considered:

1. Was there a defined concept of the intended activity? There must be a clear idea of the intended profit-making activity.
2. Has a trade been set up? It is an important distinction that the acts of “setting up”—such as preparing premises or buying equipment—are not the same as beginning to trade or carrying on trading activities.
3. Was there operational activity? For example, an agreement or entering into a customer contract to provide goods/services. Alternatively, it could be considered that the acquisition of the goods to sell or to turn into items to be sold are operational activities, as long as it is hoped it will give rise to expected profit.³ 

How Pre-Trading R&D Expenditure Is Treated

The tax treatment of pre-trading R&D costs depends on the company type, scheme under which the claim is made, and accounting period.

For Accounting Periods Starting Before April 2024

For Accounting Periods Starting on or After 1 April 2024

With the introduction of reformed R&D tax relief, a single set of rules now applies to most claimants, regardless of company size. Importantly, under the merged RDEC scheme, companies must be trading to submit a claim, a change which could catch out SMEs that are still in the pre-trading phase. These pre-trading expenditure relief provisions have been a strong catalyst for SMEs to enable the scaling of their businesses and investment in further innovation, which makes it more surprising that no relaxation was maintained to drive further growth.

Can You Claim R&D Relief on a Loss-Making Company?

Loss-making, R&D-intensive SMEs remain an exception, as they can still benefit from enhanced relief rates under the new Enhanced R&D Intensive Support (ERIS) regime. To claim for pre-trading expenditure in the year it is incurred, claimants will need to be a loss-making SME, which either has:

• An R&D intensity of 30% or more, or;
• Claimed under ERIS or the old SME scheme for its last 12-month accounting period and met the R&D intensity condition for that period.⁴

To calculate this intensity figure, a company must use the following formula:

Importantly, this calculation for determining R&D intensity involves expenditure of both the claimant and of all companies connected to the claimant, whether based in the UK or elsewhere. The definitions for relevant R&D expenditure and total relevant expenditure can be found within CIRD123000.

Maximise Available R&D Tax Relief with Our Experts

Understanding when a company is considered to be “trading” is critical for determining the eligibility of pre-trading R&D expenditure. While early-stage investment in innovation is vital for growth, the tax rules governing these costs can be complex—especially with recent reforms and the introduction of the merged RDEC scheme. SMEs, in particular, should pay close attention to trading status and relief options to avoid missed opportunities or compliance risks. For loss-making, R&D-intensive businesses, the ERIS regime offers an enhanced benefit, but eligibility criteria must be carefully assessed.

If you are unsure about how these rules apply to your business or need support in calculating R&D intensity, our team of R&D tax specialists can help you navigate these challenges and maximise available relief.

¹ HM Revenue & Customs, “BIM46351 - Specific deductions: pre-trading expenditure: scope”, HMRC Business Income Manual (2013), https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim46351

² HM Revenue & Customs, “BIM20060 - Meaning of trade: general: definition”, HMRC Business Income Manual (2013), https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim20060

³ HM Revenue & Customs, “BIM80505 - Computing the amount to assess: business changes: commencement: general principles”, HMRC Business Income Manual (2013), https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim80505

⁴ HM Revenue & Customs, “CIRD123000 - R&D Tax Reliefs: reformed reliefs: ERIS: R&D intensity condition”, HMRC Corporate Intangibles Research and Development Manual (2016), https://www.gov.uk/hmrc-internal-manuals/corporate-intangibles-research-and-development-manual/cird123000