Short answer
“Above the line” means the credit is taxable income that appears in your profit and loss account before the tax charge is calculated — this is how the merged scheme’s R&D expenditure credit works, and it’s why it needs its own multi-step mechanism to turn a gross, taxable credit into the net cash benefit a company actually receives. “Below the line” means the credit only affects the tax line and never touches pre-tax profit — this is how the SME scheme and ERIS payable credit work, and it’s mechanically simpler because it was never a taxable receipt to begin with. Why one scheme’s credit is taxable and the other isn’t is covered in How do I account for an R&D tax relief claim in my company’s accounts? This entry covers what actually happens to the numbers.
Applies to
- Schemes
- Merged scheme · ERIS · Legacy SME · Legacy RDEC
- Periods
- 1 April 2013 onwards
Why “above the line” at all
The above-the-line structure wasn’t the original design of UK R&D relief — large companies originally received relief the same way SMEs still do: as an extra deduction reducing taxable profit, with no benefit for a loss-making claimant until it had profits to relieve. The 2012 consultation that introduced RDEC was explicit about why that changed: the aim was “to increase the attractiveness of the UK as a location for large company R&D investment by introducing a more visible, more certain, and more effective form of R&D relief,” replacing “the current deduction system with a payable credit… to all large companies including those who have no liability to corporation tax,” specifically “to make the benefits more visible and certain.” A credit buried in the tax computation doesn’t show up anywhere a finance director, a board, or an external investor looking at the income statement would see it. A credit treated as income does.
How the gross credit becomes a net benefit
The mechanism has two distinct legal steps, and conflating them is where most confusion about the “real” value of the credit comes from.
Step one: the whole gross credit is a taxable receipt. If you’re entitled to and claim the R&D expenditure credit, you must bring the full amount into account as a receipt in calculating your trading profits — there’s no partial or net figure at this stage; it’s the gross percentage of qualifying expenditure, brought in in full.
Step two: the credit is then run through a set order of uses to arrive at what you actually get. The legislation sets this out as seven steps:
- Discharge the company’s own corporation tax liability for the accounting period.
- Apply the notional tax deduction (see below) to whatever remains.
- Deduct any excess over the PAYE and NIC cap — see What is the PAYE and NIC cap on the R&D tax credit? for how that cap is worked out.
- Discharge the company’s corporation tax liability for any other accounting period.
- Surrender to another group company, if the claimant is a group member.
- Discharge any other liability the company owes HMRC.
- Pay whatever’s left to the company in cash.
The notional tax deduction at step 2 determines the credit’s real economic value, and it’s easy to misunderstand. It isn’t a second, separate tax charge on top of the credit — it’s a mechanism to net the gross credit down to a comparable after-tax value regardless of what rate of corporation tax the claimant actually pays. The deduction is calculated as the corporation tax that would be due on the gross credit amount if it were itself a slice of taxable profit, at whichever rate — the main rate or the small profits rate — would apply to the company’s own profits for the period. A company already paying tax at the main rate and one paying at the small profits rate end up with the same net-of-notional-tax benefit relative to their qualifying spend, which is the entire point of running the deduction through the company’s own effective rate rather than a flat assumption.
The notional amount doesn’t disappear or get paid to HMRC as real tax. It’s set aside, and the company can either surrender it to another group company or carry it forward to discharge its own corporation tax liability in a later period. This is a genuinely separate use from the step 4 and step 5 amounts (the ordinary excess credit left over after the PAYE/NIC cap), and where both kinds of amount are competing to discharge the same period’s tax liability — for instance, a group with several years of accumulated notional-tax carry-forwards alongside a current year’s ordinary excess credit — the notional-tax-deduction amounts (and anything surrendered from them) are applied first, ahead of the ordinary step 4/5 amounts, under a dedicated priority rule.
What this means for the numbers in your accounts
The gross credit is what’s recognised as other operating income above the line — the full percentage of qualifying expenditure, before any of the seven steps are applied. The notional tax deduction then reduces the amount actually available in cash or group surrender, but because it’s routed back into reducing the company’s own (or a group member’s) real corporation tax liability rather than simply vanishing, it isn’t presented as an additional standalone tax expense in its own right — its effect shows up in the ordinary tax line, through whichever accounting period’s liability it ends up discharging. Getting this right in a forecast or a set of management accounts means distinguishing three different numbers that are easy to blur together: the gross credit brought into taxable profit, the amount left after the notional tax deduction (which is closer to what a finance team should budget as the claim’s real cash-plus-tax-saved value), and the amount that actually arrives as cash once the PAYE/NIC cap and any group surrender or other HMRC debts have been applied.
Below the line: how the SME scheme and ERIS differ mechanically
There’s no equivalent two-step gross-then-net mechanism for the SME scheme or ERIS credit, because there’s no equivalent to the gross taxable receipt to net down in the first place. The Chapter 2 credit is simply the lower of a set percentage of the company’s surrenderable loss and the PAYE/NIC cap — a single calculation, not a seven-step redemption process — and because it was never brought into account as a receipt, there’s no notional tax deduction step either. The whole “netting down to a comparable benefit regardless of tax rate” problem that step 2 solves for the merged scheme doesn’t arise, because a loss-making SME or R&D-intensive company claiming under Chapter 2 typically has no corporation tax liability for the credit to interact with in the first place.
Position for accounting periods beginning before 1 April 2024
The legacy RDEC scheme used the identical above-the-line legal mechanism, just under different section numbers and different rates. The credit had to “be brought into account as a receipt in calculating the profits of the trade for an accounting period” under the old Chapter 6A — the same requirement now carried by the merged scheme’s own provision — and was run through the same kind of seven-step redemption process, with its own notional-tax-style adjustment step. If you’re dealing with a legacy RDEC claim, an amendment to one, or a claim spanning the 1 April 2024 boundary, the mechanism described above is the right one to reason from; only the rates and section references differ, and those sit in reference/rate-timeline, not here.
Group and multi-period complexity
Groups with several R&D-claiming members, or with notional-tax-deduction amounts carried forward from earlier periods alongside a current year’s claim, can end up with several different pools of credit — ordinary excess, notional-tax carry-forward, surrendered-in amounts from other group members — all competing for the same period’s tax liabilities under the priority rule described above. The full mechanics of group surrender, and how this interacts with ordinary group relief for losses, are covered in How does group relief interact with an R&D claim?.
Worked example
Illustrative net-down of a merged scheme claim for a company paying corporation tax at the main rate. Figures are illustrative only — check reference/rate-timeline for the actual current gross credit rate and CT rates before using these in any client-facing material.
| Step | Illustrative amount | What happens |
|---|---|---|
| Gross R&D expenditure credit | £100,000 | Brought into account as a taxable receipt (s1042H) |
| Step 1: discharge current-period CT liability | £30,000 applied | Company had £30,000 of CT due for the period |
| Remaining after step 1 | £70,000 | — |
| Step 2: notional tax deduction | £17,500 deducted | Tax that would be due on the gross £100,000 credit at the company’s applicable rate; set aside, not paid to HMRC as such — carried forward or surrendered |
| Remaining after step 2 | £52,500 | — |
| Step 3: PAYE/NIC cap check | No further deduction (within cap) | See the PAYE/NIC cap entry |
| Steps 4–6: other periods, group, other HMRC debts | None applicable this example | — |
| Step 7: cash paid to the company | £52,500 | — |
Where claims go wrong
- Assuming the quoted “credit rate” is what lands in the bank. The gross percentage of qualifying expenditure is what enters taxable profit; the cash or usable amount is what’s left after the notional tax deduction, the PAYE/NIC cap, and any group or other debt set-off. Forecasting cash flow from the gross figure alone overstates it.
- Treating the notional tax deduction as a mystery missing amount. It isn’t lost — it’s set aside to discharge the company’s own (or a group member’s) real corporation tax liability, now or later. Not knowing where it’s gone usually signals the seven steps haven’t been walked through explicitly for that claim.
- Assuming the whole gross credit is available to surrender within a group. Only what’s left after steps 1 to 3 can be surrendered at step 5 — a group cannot surrender the full headline credit figure before its own use and the PAYE/NIC cap have been applied.
- Applying the merged scheme’s notional-tax mechanism to an SME/ERIS claim, or vice versa. The two credits are computed under entirely different provisions with no shared mechanism — there’s no “notional tax deduction” concept in a Chapter 2 claim at all, because the credit was never a taxable receipt in the first place.
John Mapother
Founder & Director
Last reviewed 7 September 2026