Video Games Tax Relief (VGTR) – or its new equivalent, the Video Games Expenditure Credit (VGEC) – and R&D tax incentives are usually key to the cashflow of video game businesses. Often, there will be an element of R&D in the development of games and an element that doesn't meet the criteria for R&D.
Both regimes have changed recently, so you'll need to be aware of what's changed and work out the best way of navigating through both to ensure you obtain the relief you're entitled to.
Game over for VGTR as VGEC comes into play
VGTR is in the process of being replaced, with VGEC being brought into legislation to replace it and can be claimed on expenditure incurred from 1 January 2024. Broadly, the main focus is to maintain the benefits of VGTR but to switch from an additional deduction which is surrendered for a tax credit to an above-the-line taxable credit based on the qualifying expenditure incurred.
Many aspects of VGTR will remain. The criteria for being a qualifying development company, having a qualifying game and the type of expenditure that can form a claim is broadly consistent. And there's still the need to pass the British Film Institute cultural tests and obtain a certificate as part of compiling a claim. But, as mentioned, the mechanism for receiving the tax credit will change and instead of resulting in an additional deduction which is surrendered for a below-the-line tax credit, VGEC will result in a taxable above-the-line credit. The headline tax credit rate will be increased to 34% to reflect the fact that the credit is taxable, which results in a marginally more generous rate of relief of 20.4% compared with the previous 20%.
Other key changes are also coming in with VGEC. After much lobbying from the industry, the subcontractor caps, which limit subcontractor spend over the life of a game, will be removed. Qualifying expenditure will be restricted to those costs that are used and consumed in the UK rather than spend incurred in the European Economic Area (EEA). And costs incurred on goods and services with connected parties must be on arm’s length terms in order to qualify.
Similar to a recent change around R&D tax incentives (see next section), an additional information form will be required as part of any submission. There's also speculation that HMRC will put more scrutiny on future claims.
As VGEC can be claimed from 1 January 2024, there's a period in which you may be able to choose under which scheme you claim. You'll need to weigh up the pros and cons of switching to VGEC before it comes mandatory. Some may find that VGEC results in a more optimum position for them, but others will find the contrary, and care needs to be taken in order to make the right choice. All game development starting after the 1 April 2025 must prepare claims under VGEC but where development is started beforehand, companies will have a choice. From 1 April 2027 all games must transition to VGEC. Until then, careful consideration is required.
Changes to R&D tax incentives start to bite
There've been many changes to the R&D tax regimes in recent years. All companies will start to feel the impact of these as new rules will apply to all companies for accounting periods commencing on or after 1 April 2024. You can read the key details of the new rules here.
To encourage innovation in the UK, the Government is also applying restrictions on certain expenditure incurred on activities undertaken outside of the UK. For accounting periods commencing on or after 1 April 2024, qualifying expenditure on sub-contracted R&D activities will be restricted to activities undertaken in the UK. Qualifying expenditure on externally provided workers (EPWs) will also be limited to those whose earnings are subject to Pay As You Earn (PAYE) and Class 1 National Insurance contributions (NICs).
Despite all of the recent and upcoming legislative changes, it's clear that compliance remains at the top of HMRC’s agenda, given its most recent announcement that 17% of R&D claims in 2023-24 were subject to compliance checks. This follows HMRC’s estimate that the level of error and fraud in 2021-22 stands at £1.3 billion, from the £7.6 billion of support claimed.
The additional information form is now a requirement for all companies submitting an R&D tax claim. And there's a new advance claim notification form to consider within six months of your relevant claim period end. It’s important, therefore, that you're across both the administrative process and have robust documentation in place to support a claim.
How will VGEC and R&D tax relief interact?
Previously, there was a difference in the interaction between VGTR and R&D, depending on whether a claim was being made under the SME R&D tax relief scheme or under the R&D expenditure credit (RDEC) scheme for large companies. This was partly driven by the EU State Aid rules, which remained in place post-Brexit but have now been superseded by different UK legislation.
The VGEC legislation, however, states that where expenditure meets the conditions for R&D tax incentives under the new rules then this expenditure will not qualify for VGEC, regardless of whether any actual R&D claim is made or not.
Given this significant change, and the numerous independent changes to both VGTR and R&D tax incentives, this is a key area for video game developers to get right in order to optimise claims and prevent any action denying tax relief that would otherwise be available. You'll need to proactively assess your spend for each game being produced and work through the impact of the various changes summarised here. Then you can work out the optimum claims that can be made.
For insight and guidance, get in touch with Ian Rowland and Douglas Tailby.
