Research and development tax relief has been more in focus in the last four years than the prior twenty years, with the UK government focused on achieving wider R&D tax reform. There is now no avoiding the fact that the biggest change since its introduction in 2000 has now arrived with the single merged R&D tax incentive scheme. This will be relevant for companies with accounting periods commencing on or after 1 April 2024.
As this comes close on the heels of other significant changes to the R&D regimes (as reported in our last issue of Talking Tax), we are all in danger of becoming entangled in the detail, whilst also needing to navigate HMRC’s more aggressive approach to claims and enquiries. In this article, we want to set out some of the key headlines to note and to provide an overview on what the changes will mean. It is worth bearing in mind that the single merged scheme was billed as necessary to achieve significant tax simplification – time will tell whether this can truly be achieved!
The single merged scheme will operate on similar lines to the existing R&D Expenditure Credit (‘RDEC’) scheme for large companies but incorporating aspects of the existing SME scheme as well as introducing new rules for all. This is a big shift in the R&D landscape and is a very different mechanism and approach for many businesses to identify R&D eligibility and to determine the quantum of relief available.
The mechanics of the single merged scheme
Rather than additional tax relief, an ‘above the line’ credit will be given, reported in pre-tax income as is currently the case with RDEC, and set at 20% of qualifying expenditure. This credit is then subject to corporation tax providing overall tax relief of between 14.7% and 16.2% depending on the tax rate applicable to the company. Companies with tax losses will be able to claim the credit in cash, after a deduction of notional tax at 19%.
Understanding the position as early as possible for the relevant accounting period will become vital to accounts preparation, cashflow forecasting and proactive tax planning as the RDEC increases taxable profit before the credit either discharges the tax liability or gives rise to a repayable R&D expenditure credit.
A further reason for early consideration, is the new advance notification rules which apply to accounting periods beginning on or after 1 April 2023. These rules require notification to HMRC of the intention to make a claim within six months of the relevant period end in cases where the company has not made an R&D claim in the past three years.
A focus on the UK
There are now restrictions on R&D carried out overseas which will see payments to contractors and other externally provided workers being excluded from the claim, where the R&D has not been undertaken in the UK, unless it has been undertaken in particular circumstances (due to legal or regulatory requirements, or to geographical or environmental and social conditions).
There are no exceptions for connected parties so group arrangements will need careful consideration. Furthermore, availability of resource and costs to undertake the R&D activity are not included as exceptions.
New guidance issued by HMRC states that companies must take reasonable care to determine where the R&D takes place but the guidance on evidence requirements does remain in part rather complex, vague and ambiguous.
Contracted out R&D and shift in eligibility
Due to the merging of the two schemes (SME and RDEC), the legislative differences between the two, and the ongoing complexity of interpretation, HMRC has now drafted fairly extensive guidance on which party is entitled to claim the R&D relief. This can be either the customer (Co A) or supplier (Co B) depending on who is the ‘decision maker’ in respect of the contracted out R&D. All three of the below conditions must be present:
- there must be a contract (either written, verbal or implied); and
- R&D must actually be undertaken to meet the obligations under the contract; and
- it must be reasonable to assume that A intended or contemplated that R&D would be undertaken to meet the contractual obligations.
In summary, under the new guidance, if the R&D is explicit or implicit then Co A (the customer) will claim relief; if hidden R&D then it will be for Co B (as supplier) to claim. Obtaining the right level of detail will be key to making the right decision early in the claim process but will not necessarily be straightforward.
Funding and subsidies
As there is now one merged scheme, rules have changed such that grant funding and other subsidies no longer impact the R&D benefit. This means there are new opportunities to explore additional external funding to support a company’s innovation and development plans that can then lead to both R&D and Patent Box benefits.
Enhanced R&D intensive support
Just to ensure it is not as simple as one merged scheme, more favourable provisions will also apply to ‘R&D intensive’ companies that are loss making. A company will now be deemed to be ‘R&D intensive’ if 30% of its total expenditure relates to qualifying R&D (originally introduced as 40% on 1 April 2023). There will also be a year of grace provision, allowing R&D intensive SMEs to continue to claim enhanced relief in the year after it ceases to meet the expenditure threshold.
HMRC R&D enquiries and further consultation
Much has been reported in the media and on various forums on the topic of increased HMRC enquiries into R&D tax relief claims, which were in response to the level of ‘error and fraud’ being identified in the R&D market – from the ‘volume’ compliance approach, to the nameless case workers involved at HMRC, and to the ultimate rejection of many claims. This culminated in the Chartered Institute of Taxation (‘CIOT’) presenting a letter to HMRC highlighting concerns which led to some welcome discussions and new initiatives to start to drive a more positive relationship and experience for companies, tax agents and HMRC. It has some way to go but there is acknowledgement that improvements and standards can be implemented on all sides.
What may surprise some companies even now is that tax advisory services are not officially regulated, so anyone can provide tax advice (including advice in relation to R&D tax relief). There have been regular and ongoing updates to ensure members of professional bodies (e.g. ICAEW or CIOT) adhere to a strict code of conduct (‘professional conduct in relation to taxation’).
In a very recent update provided by HMRC’s Research and Development Communication Forum (RDCF) this month, HMRC has introduced a Professional Bodies Mailbox – this has been implemented for members of recognised tax or accountancy professional bodies to report a breach in standards relating to R&D only. It is a way to draw attention to agent malpractice but not to details of specific claims and will be used by HMRC to inform its compliance strategy for R&D agents.
As with any new initiative, and particularly one which is asking the tax agent community to police itself and call out unacceptable and unprofessional behaviour, time will tell whether this proves an effective way to raise standards in the tax advice market. However, this marks the beginning of a potential mood swing as further government consultation remains open until the end of May into raising standards and strengthening the regulatory framework, and we anticipate more widespread changes to impact the tax profession and not just in relation to R&D tax advice.
This landscape can be complex to navigate so seeking expert advice is always best. Click the button below to access the Summer edition of our Talking Tax publication and read more about the topics discussed in this article.
