R&D Tax Credits and Grant Funding: The Correct Treatment
R&D tax credits can be complex at the best of times, but when grant funding is involved the rules become significantly more nuanced. Incorrect treatment of grants is one of the most common reasons HMRC enquiries escalate, often leading to reduced claims or retrospective adjustments.
Grants and R&D tax credits can coexist — but only if handled correctly. Understanding how different types of grant funding interact with the R&D tax relief schemes is essential if you want to maximise innovation funding and remain compliant.
Innovation Grants and State Aid
Government and international grants are typically awarded to encourage innovation. In this context, we are focusing on grants related to research and development activity — not grants awarded for marketing, recruitment, or regional development.
At a high level, grants fall into two categories:
Notified state aid
Non‑state aid
This distinction is critical, as it determines how much (and which type) of R&D tax relief you can claim.
Common Sources of Innovation Funding
UK Innovation Grants
UK Government innovation grants are commonly awarded through Innovate UK, usually via competitive funding rounds. UK‑based businesses submit proposals and successful applicants receive funding that can range from tens of thousands of pounds to several million.
These grants are often technology‑focused and, in many cases, are classified as notified state aid (including GBER funding).
De minimis Grants
Some grants fall below the threshold for state aid classification. These are known as de minimis grants and are not treated as notified state aid for R&D tax purposes.
EU and International Grants
EU innovation funding (such as Horizon programmes and their successor schemes) is not sourced from member states and is therefore not classified as state aid. While these grants still affect the treatment of R&D spend, they do not restrict access to the SME R&D tax credit scheme in the same way as notified state aid.
How Grants Affect R&D Tax Credits
There are two main R&D tax relief schemes:
The SME R&D tax credit scheme, which offers a higher rate of relief
The Research and Development Expenditure Credit (RDEC) scheme, which offers a lower but still valuable net benefit
Because the SME scheme is considered notifiable state aid, its use can be restricted where certain grants are present. RDEC, by contrast, is not classified as state aid and is not restricted by grant funding.
This does not mean grants and R&D tax credits cannot be used together — only that the correct scheme must be applied to the correct expenditure.
The Three Key Grant Scenarios HMRC Considers
The impact of a grant depends primarily on its wording and structure, not on how the company intended to use the funds.
1. Non‑Project‑Specific Notified State Aid
A non‑project‑specific grant is awarded to the company without being ring‑fenced to a particular project. This commonly occurs where a business is focused on a single product or development, such as a start‑up.
From an R&D tax perspective, this is generally the least favourable scenario. All R&D expenditure is treated as part of the same “pot” and must usually be claimed under the RDEC scheme.
This still provides a benefit, but at a lower rate than the SME scheme.
2. Project‑Specific Notified State Aid
Where a notified state aid grant is clearly linked to a specific project — for example, an Innovate UK grant allocated to one development stream — different treatment applies.
In this case:
Only the grant‑funded project is typically restricted to RDEC
Other R&D projects may still qualify under the SME scheme
The impact can be significant, often substantially increasing the total benefit without any increase in R&D spend.
3. De minimis and Other Non‑State Aid Grants
De minimis grants and international (non‑state aid) grants are treated more favourably.
The grant‑funded expenditure itself is generally claimed under RDEC
The remaining R&D spend may still qualify for the SME scheme
This is typically the best‑case outcome and highlights the importance of understanding grant classification before funding is accepted.
What HMRC Will Review During a Grant‑Funded R&D Enquiry
HMRC does not rely on assumptions or intentions. During an enquiry, they will review the original documentation to determine how a grant should be treated.
HMRC commonly requests:
Grant offer letters and funding agreements
Terms and conditions attached to the grant
Evidence showing whether the grant is project‑specific or company‑wide
Drawdown requests and payment schedules
Correspondence with the funding body (e.g. Innovate UK)
Cost breakdowns submitted with grant claims
Evidence demonstrating how grant‑funded and non‑grant‑funded R&D costs were separated
Crucially, HMRC will place greater weight on the wording of the grant agreement than on internal allocations or management intent.
Once a grant has been accepted, its classification for R&D tax purposes cannot usually be changed retrospectively.
Common Errors We See
Companies frequently encounter problems where:
They have been told that grants and R&D tax credits cannot be claimed together
Grant‑funded expenditure has been incorrectly treated as SME spend
All R&D expenditure has been pushed unnecessarily into RDEC
Grant funding has been ignored entirely in the R&D calculation
In some cases, these errors can result in HMRC disallowing part — or all — of an SME claim.
Why Early Advice Matters
The greatest opportunity to maximise innovation funding usually arises before a grant is accepted, not after the R&D tax claim is submitted.
Correctly structuring grant applications, understanding restrictions, and preparing R&D claims with grant interaction in mind can make a substantial difference to the total funding a company ultimately receives.
Incorrect grant treatment is also a frequent trigger for extended HMRC enquiries.
Summary
For companies seeking to maximise innovation funding while remaining compliant:
Grants and R&D tax credits can be used together
The type and wording of the grant are critical
Incorrect treatment can materially reduce claims and increase HMRC risk
Expert advice pays for itself many times over in this area
This is a technically complex intersection of tax law and funding policy. Companies that fail to obtain specialist advice often discover the cost too late.
If you require support with grant interaction, claim preparation, or HMRC enquiries, expert guidance is strongly recommended.
