If your company carries out research and development in the UK, the tax relief you can claim depends on which scheme you fall under. The two main routes are the Research and Development Expenditure Credit (RDEC) and the SME R&D scheme. But the rules changed significantly from April 2024, and the distinction between the two is not always obvious.

This article explains the RDEC vs SME R&D scheme comparison for a company that is notified or has been told they fall under the large company rules. We will cover who qualifies, what the rates are, how the merged scheme affects contractors and smaller businesses, and what to do if HMRC has challenged your status.

What is the SME R&D Scheme?

The SME R&D scheme is designed for companies with fewer than 500 employees and either an annual turnover under €100 million or a balance sheet under €86 million. These are the EU definition thresholds, and HMRC applies them strictly.

Under the SME scheme, qualifying R&D expenditure attracts an enhanced deduction of 186% (for accounting periods starting on or after 1 April 2023, but before 1 April 2024). For periods starting on or after 1 April 2024, the SME enhanced deduction was removed entirely for most companies. Instead, the merged scheme applies.

If your company is loss-making and R&D intensive (meaning at least 30% of your total spend is on R&D), you may qualify for the enhanced R&D Intensive Scheme (ERIS). This gives a payable credit worth 14.5% of the surrendered loss, calculated on the enhanced expenditure.

What is the RDEC Scheme?

The RDEC scheme is the main route for large companies. It also applies to SMEs that are notified by HMRC, or that have been subcontracted to do R&D work for a large company. Under RDEC, you get a taxable credit of 20% of your qualifying R&D expenditure (for expenditure incurred on or after 1 April 2023). For periods starting on or after 1 April 2024, the rate is 20%.

The credit is taxable as income. So the net benefit after corporation tax is roughly 15% for a company paying the main 25% rate, or 16.2% for a company at the small profits rate of 19%.

RDEC can be used to reduce your corporation tax liability. If you are loss-making, you can receive a cash payment, though it is capped at the total of your PAYE and NIC liabilities for the period.

The Merged Scheme from April 2024

From 1 April 2024, the old distinction between SME and RDEC schemes was largely removed for most companies. HMRC introduced a single merged R&D scheme that applies to all companies, regardless of size. Under the merged scheme, the calculation is based on a 20% taxable credit, similar to RDEC.

However, the SME scheme still exists for loss-making R&D intensive companies. And the RDEC rules still apply to companies that are notified or that fall outside the SME thresholds.

For a company that is notified by HMRC that it must use the RDEC scheme, the merged scheme rules are effectively the same as RDEC. The key difference is that the notification process determines which set of rules you follow, not just your company size.

Who Gets Notified and Why?

HMRC can notify a company that it must use the RDEC scheme if the company is part of a larger group, or if it has received a grant or subsidy that restricts its ability to claim under the SME scheme. Notification can also happen if HMRC determines that your company is not genuinely independent, for example if a corporate investor holds more than 25% of your shares.

If you receive a notification from HMRC, you must use the RDEC rules for that accounting period. You cannot choose to use the SME scheme instead.

In practice, notification is relatively rare for genuine small businesses. It is more common for companies that have received state aid, or that are part of a larger corporate structure. But if you are a contractor working through your own limited company and have received a grant from Innovate UK, for example, you may be notified.

RDEC vs SME R&D Scheme Comparison: Key Differences

Let us look at the main differences side by side.

  • Credit rate: RDEC gives a 20% taxable credit on qualifying expenditure. The SME scheme (pre-April 2024) gave a 186% enhanced deduction, reducing taxable profits. Under the merged scheme from April 2024, the RDEC-style 20% credit applies to most companies.
  • Payable credit for loss-makers: Under RDEC, loss-making companies can receive a cash payment capped at PAYE and NIC. Under the SME scheme (pre-April 2024), loss-makers could surrender the enhanced loss for a 14.5% payable credit. Under ERIS (post-April 2024), the payable credit is 14.5% for intensive companies.
  • Subcontracted R&D: If you subcontract R&D to a third party, the rules differ. Under RDEC, you can claim the cost of the subcontractor. Under the SME scheme, the subcontractor cannot claim if they are connected to you.
  • Notification impact: If you are notified, you must use RDEC. You cannot switch to the SME scheme for that period.
  • PAYE cap: Both schemes have a PAYE and NIC cap on payable credits. The cap is calculated differently. Under RDEC, the cap is the total of your PAYE and NIC liabilities. Under the SME scheme (pre-April 2024), the cap was £20,000 plus 300% of your PAYE and NIC.

Real Example: A Software Consultancy in Manchester

Take a software consultancy in Manchester's Northern Quarter. They have 12 employees, turnover of £1.8 million, and spend £150,000 on qualifying R&D (developing a new AI platform). They are not part of a group and have no state aid.

Under the merged scheme (post-April 2024), they would claim a 20% RDEC-style credit. That gives them a credit of £30,000. This is taxable, so after corporation tax at 25%, the net benefit is £22,500. They can use this to reduce their corporation tax bill, or if loss-making, claim a cash payment capped at their PAYE and NIC.

If they were still under the old SME scheme (pre-April 2024), they would get an enhanced deduction of 186%, reducing taxable profits by £279,000. At 19% corporation tax, that saves them £53,010. A significant difference.

The merged scheme is less generous for profitable SMEs. But for loss-making intensive companies, ERIS can still deliver a valuable cash credit.

What About Contractors and Small Ltds?

Most contractors working through their own limited company will not qualify for R&D tax credits at all, because they do not carry out qualifying R&D. But if you are a contractor developing new software, processes, or materials, you might.

If you are a one-person limited company, you are likely an SME. You would use the merged scheme rules. But if you are notified by HMRC that you must use RDEC, perhaps because you received a grant, then RDEC applies.

For a contractor in Shoreditch running a six-figure consultancy, the difference matters. Under the merged scheme, a £50,000 R&D spend gives a £10,000 credit, worth about £7,500 after tax. Under the old SME scheme, the same spend would save around £9,500 in corporation tax. The gap is real.

How to Handle a Notification from HMRC

If HMRC notifies you that you must use the RDEC scheme, do not ignore it. You must file your corporation tax return (CT600) using the RDEC rules. You cannot claim under the SME scheme for that period.

You can appeal the notification if you believe it is incorrect. The process involves writing to HMRC within 30 days, explaining why you qualify as an SME. You may need to provide evidence of your company structure, shareholding, and independence.

If you are unsure whether the notification is correct, speak to an ICAEW qualified accountant. We deal with these notifications regularly and can help you challenge them if appropriate.

Which Scheme Should You Use?

If you have not been notified, you should use the merged scheme rules for accounting periods starting on or after 1 April 2024. The old SME scheme no longer applies to most companies, except for loss-making R&D intensive companies using ERIS.

If you have been notified, you must use RDEC. There is no choice.

If you are a profitable SME with significant R&D spend, the merged scheme is less generous than the old SME scheme. But it is still worth claiming. A 20% credit on your R&D costs is better than nothing.

If you are loss-making and R&D intensive, ERIS may give you a better outcome. You need to check whether your R&D spend exceeds 30% of your total expenditure. If it does, you can claim a 14.5% payable credit on the enhanced loss.

Common Mistakes to Avoid

Do not assume you qualify for the SME scheme just because you are a small company. The merged scheme applies from April 2024, and many businesses are still catching up.

Do not ignore a notification from HMRC. If you file under the wrong scheme, HMRC will reject your claim and may open an enquiry.

Do not overclaim. Only include qualifying R&D costs. HMRC is increasingly strict on what counts as R&D, especially for software development.

Do not forget the PAYE cap. If you are loss-making and claiming a payable credit, the amount you can receive is capped. Plan accordingly.

Final Thoughts

The RDEC vs SME R&D scheme comparison matters most when you have been notified by HMRC. If you have not been notified, the merged scheme applies from April 2024, and the old SME scheme is largely gone except for intensive loss-makers.

If you are unsure which scheme applies to your company, check your company size against the EU thresholds, review any grants or state aid you have received, and look for any notification letters from HMRC. Then speak to an accountant who specialises in R&D claims.

At Holloway Davies, our ICAEW qualified team handles R&D claims for businesses across every sector, from software consultancies in Manchester to engineering firms in Bristol. If your turnover has grown or you have received a grant, we can help you determine the correct scheme and prepare a robust claim.

If you would like to discuss your R&D claim or a notification from HMRC, contact us. We can review your situation and advise on the best approach.