Changes to R&D tax relief

R&D tax credits are a valuable tax relief available for companies that are seeking an advance in science or technology. For a small or medium company (SME) qualifying R&D expenditure receives a 230% tax deduction and a 14.5% repayable tax credit is available on the surrender of R&D tax losses. For large companies (and SMEs conducting subsidised or subcontracted R&D) relief is available under the RDEC scheme, creating a taxable credit of 13% of qualifying R&D expenditure. It is also possible to surrender part of the R&D expenditure credit for a cash payment.

The reliefs have been identified as open to abuse with some companies making fraudulent or questionable claims. In particular, this is a problem within the SME scheme due to the taxpayer being able to claim often large cash payments from HMRC. Whilst there have been measures put in place to combat this issue, including a cap linked to the company’s PAYE & NIC liabilities on the SME scheme cash repayment that can be claimed as well as extra HMRC resource employed in checking claims, the Government are planning further steps.

As part of the review into R&D tax reliefs, the Chancellor of the Exchequer announced in the Autumn Budget 2021, that the reliefs would be reformed to continue work on tackling abuse but also to bring the relief in line with modern research methods (specifically in the IT/software sector) and to encourage innovation in the UK, with proposed changes taking effect from April 2023.

Following the announcement, details of the proposed changes have been set out which we consider below.

Claims process

There are changes proposed to the way in which R&D claims are made so that they can only be made digitally and with sufficient detail, aiding HMRC in checking eligibility. It is also proposed that claims will need to be notified to HMRC in advance of making a claim, require endorsement by a named senior officer of the claimant company and provision of R&D agent details. It is hoped that this will incentivise individuals and agents to improve the quality of claims as well as identify underqualified agents involved in making claims.

We at Kreston Reeves, do not foresee any issues with these requirements but it is likely R&D claims will need to be notified before the company’s period end, therefore some pre year end planning will be required.

Innovation in the UK

The current rules allow companies to claim R&D tax relief where they are utilising overseas subcontractors or Externally Provided Workers (EPWs) as part of their R&D project. This can be a common arrangement where the expertise or facilities do not exist or are limited in the UK or prices are more competitive elsewhere.

To encourage the work to be performed in the UK, improving innovation here, the rules are set to be updated such that relief is only available on the costs where the subcontracted work is performed in the UK or where EPWs are paid through a UK payroll. This could have a significant impact on R&D in some sectors, where it is not possible or cost-effective to move such work to the UK, we expect to see a reduction in R&D tax relief available in these cases resulting in less funding for R&D projects.

Data and cloud computing costs

The announcement in the Autumn Budget that data and cloud computing costs would be included as qualifying R&D expenditure was welcome news in modernising the relief given the fast-paced advancements being made in software development. However, the proposed changes mean there are still limits to the relief for such costs.

To claim R&D tax relief on the cost from April 2023 it must either be a licence for datasets (that cannot be sold nor have a lasting value to the company beyond the project) or cloud computer costs to the extent that they can be attributed to computation, data processing and software. In particular, general overheads for servers and data storage within a cloud computing package must be excluded from the claim. Whilst this limitation is introduced to recognise that storage costs are generally not R&D qualifying expenditure, in practice is may be difficult to apportion the expenditure from the overall subscription charges if the supplier cannot provide this information.

In summary, the biggest change we are likely to see introduced from April 2023 is the restriction in qualifying costs where work is being performed overseas. The currently generous relief is under continued review by the Government, and it is clear they are trying to close in on misuse of the schemes whilst encouraging innovation in the UK. We are expecting draft legislation in the Summer and we will be able to advise further on these changes then.

If you believe these potential changes will impact your future R&D tax credit claim, please do not hesitate to contact me or your normal Kreston Reeves contact.