The government’s R&D tax regime reform agenda continues at pace, with a number of key updates provided recently and others expected at the Autumn Statement, now confirmed for 22 November. Claimant companies should already be thinking about how the latest round of proposed changes will impact them and be ready to begin planning in earnest once the government's R&D tax policy is confirmed at the Autumn Statement.
1 Amended rates of support for the SME and research and development expenditure credit (RDEC) schemes apply to expenditure incurred on or after 1 April 2023
2 R&D cost category updates concerning the eligibility of data and cloud computing services are now in effect for accounting periods beginning on or after 1 April 2023. These updates help better align support with the nature of modern R&D
3 Extension of the definition of R&D activity for tax purposes from April 2023 so that mathematical advances in themselves are to be treated as science. This is of interest to those companies undertaking complex mathematics-based activities in sectors such as robotics and artificial intelligence
4 Several compliance and administrative measures, including those relating to the Claim Notification requirement, time limits, SME status, and HMRC powers to remove claims made in error and to collect overpaid R&D amounts now apply to accounting periods beginning on or after 1 April 2023
5 Commencement of the Additional Information requirement for claims made on or after 8 August 2023
6 Introduction of draft legislation on ‘L Day,’ which proposes increased support for R&D intensive SMEs, an RDEC-style single scheme for other claimant companies, restrictions on the eligibility of overseas R&D expenditure and other compliance and administration focused reforms. The release of this draft legislation follows the most recent consultation on R&D tax regime reform, the government’s response provides insight into the reasoning behind the policies reflected in the draft legislation
7 Closure of the technical consultation on 12 September which invited comment on the technical aspects of the draft legislation introduced on ‘L Day’ and on the policy approach to the difficult issues of subsidisation and subcontracting in R&D tax
8 Continuing engagement between HMRC and stakeholders regarding HMRC’s compliance activities and the conduct of enquiries into claims
9 Publication of HMRC’s Annual Report and Accounts including a significant upward revision to the 2020/2021 R&D tax error and fraud estimates
There is certainly much complexity for claimant companies to get to grips with before any Autumn Statement confirmation of R&D tax policy into 2024, amendments or surprises. Getting it right has never been so crucial.
Increased support for R&D intensive SMEs
On ‘L Day’, draft legislation was published for additional support for R&D intensive SMEs – this follows a previous government commitment to consider ways to better support innovative SMEs. This will provide a payable tax credit of up to 26.97% (186% x 14.5%) of qualifying R&D expenditure from 1 April 2023 (though eligible companies won’t be able to claim until the legislation receives Royal Ascent). This compares to the current maximum payable tax credit for expenditure incurred on or after 1 April 2023 of 18.6% and is subject to confirmation at the Autumn Statement.
The 14.5% payable tax credit rate, which is currently reduced to 10% from 1 April 2023, will effectively be reinstated for loss-making R&D intensive SMEs and apply within an amended version of the current SME scheme legislation. The draft legislation applies the reform retrospectively to 1 April 2023 through transitional provisions ahead of a formal April 2024 implementation date. However, eligible SMEs may be disappointed that this increased support may not be accessed until the next Finance Bill receives Royal Assent which will be some time away. Eligible companies are also likely to need to file amended Corporation Tax Returns to access the additional support – adding to their administrative and cost burdens.
There will be no change to the reduced additional deduction rate of 86% which applies to expenditure incurred on/after 1 April 2023 (the rate was previously 130%). We await confirmation at the Autumn Statement as to whether profit-making R&D intensive SMEs may claim the additional deduction of 86% rather than claiming under the proposed single scheme, should it be implemented from April 2024. The previously deferred overseas expenditure restriction is also expected to apply to R&D intensive SMEs from April 2024.
The draft legislation issued broadly defines an R&D intensive company as having relevant R&D expenditure of 40% or more of its total relevant expenditure. Determining eligibility will require a detailed calculation and claimant companies will need to be aware of the aggregation requirement in calculating R&D intensity where there are connected companies. We would anticipate that many SMEs that are extremely R&D intensive at an entity level will miss out due to the impact of their corporate structure.
While this measure will be broadly welcome, many genuine SMEs will be ineligible, and the level of support to be provided to R&D intensive SMEs will still be lower than it was pre-April 2023 – the maximum payable tax credit was 33.35% but will now be 26.97%.
No decision has yet been made on whether the government will proceed with merging the SME and RDEC schemes into a single scheme for all claimant companies except R&D intensive SMEs. The Chancellor is expected to confirm his decision at the Autumn Statement. If the proposed single scheme is to proceed, an April 2024 implementation date is likely, meaning time to adapt will be short.
The draft legislation proposes a single RDEC-style scheme which will merge features of the existing schemes and provide a cash benefit (after tax) of 15%. It will run alongside the scheme for R&D intensive SMEs.
- The single scheme is similar in design to the current RDEC regime but incorporated in a much-modified version of the present SME scheme legislation – the gross credit available is 20% (the same as under the existing RDEC scheme from 1 April 2023) and the notional step 2 deduction is at the main corporation tax rate of 25% to give a net tax benefit of 15%
- Companies may claim for expenditure on subcontractors in a similar way to the current SME scheme – support is therefore targeted at the customer in an R&D subcontractor arrangement
- It is a condition for qualifying R&D expenditure that the claimant company is not undertaking R&D as a subcontractor for a person undertaking a chargeable trade in the UK
- UK companies are able to claim where they undertake R&D as a subcontractor for a person that is not undertaking a chargeable trade in the UK
- There are no provisions for the claiming of contributions to independent research
- There is a requirement that R&D expenditure is not subsidised
- The overseas expenditure restrictions are reintroduced – these were initially planned for 1 April 2023 but deferred
- A seven-step calculation process to determine if a payable tax credit is available, similar to that in the current RDEC scheme, but the step 3 restriction for expenditure on workers (PAYE/NIC based) reflects the more generous SME cap – there is a potential IP-related exception in the proposal
- Institutions of higher education, charities and companies prescribed by Treasury regulations are excluded (there is a similar provision in the current RDEC scheme)
- A new condition that the R&D expenditure is not attributable to an exempt foreign permanent establishment
- The introduction of new anti-avoidance and compliance provisions
The visibility and certainty of tax benefit, irrespective of loss or profit making status, that an above the line credit approach provides and the ability of SMEs to benefit from carried forward losses instead of surrendering them for payable tax credits were key factors in the RDEC-style design of the proposed single scheme. These features will be welcomed by many claimant companies.
The proposal is based on the current SME scheme’s approach to subcontractors – the customer of the R&D (the party subcontracting out the work) would be able to claim and not the party doing the work. Currently, the RDEC scheme is very restrictive in that only expenditure on subcontractors that are individuals, partnerships of individuals or qualifying bodies may be claimed. Therefore, some RDEC scheme claimant companies could benefit under the proposed single scheme.
However, the requirement in the proposed single scheme that the claimant company is not undertaking R&D as a subcontractor for a person carrying on a chargeable trade in the UK means that SMEs and large companies undertaking R&D as a subcontractor for a UK large company would no longer be able to claim – they may currently claim under the RDEC scheme.
An exception to this requirement is proposed to enable subcontractors engaged by persons not carrying on a UK chargeable trade to claim. This will support R&D activity in the UK where it is subcontracted into the UK from overseas as there is little risk of double dipping, ie, both parties to the contract seeking to claim.
Exceptions to this overseas expenditure restriction are limited – cost and availability of workers will not give rise to exceptions. Some companies’ claims will be impacted by this restriction from April 2024 where they are quite dependent on overseas resource.
Stakeholders were given until 12 September to comment on the draft legislation, this technical consultation was to ensure that the draft legislation captures the policy as intended rather than to continue a debate on the merits, or otherwise, of policy decisions with the exception of the approach to subcontracting and subsidisation. We expect that the government will have received several submissions from stakeholders to consider, including ourselves.
The government was keen to discuss how ‘normal’ contracts and ‘contracted out’ R&D might be distinguished so that R&D activity may be supported while avoiding the risk of double dipping. Hopefully a level of fairness and certainty can be achieved in the final policy decision and legislation to eliminate the complexities put under the spotlight in the Hadee Engineering case.
The final policy decision on the subsidisation issue will be particularly important for companies undertaking R&D related to their contractual obligations to clients, for example – the Quinn and Hadee Engineering cases. As the draft legislation stands, SMEs and large companies with subsidised R&D expenditure that could claim for this expenditure under the current RDEC scheme cannot do so under the proposed single scheme. We have advocated for a relaxation of the subsidisation-related restrictions.
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Impact on rates of support under the proposed single scheme
There will be no change to the rate of support for those companies claiming under the existing RDEC scheme following the rate changes of 1 April 2023 - the net tax benefit will remain at 15%. However, those SMEs that do not qualify as R&D intensive will see a further reduction in support to 15% from April 2024. Following the recent rate changes, profitable SMEs can currently obtain a tax saving of up to 21.5% whereas loss making SMEs can obtain a payable tax credit of up to 18.6% of their qualifying R&D expenditure.
While the headline rates of support are important, claimant companies will need to consider how their individual circumstances will be impacted by the final policy decisions taken in respect of the treatment of subsidised expenditure and subcontracted R&D in addition to recent cost category and qualifying activity reforms. There may well be winners and losers.
What’s next for the policy debate ?
It is perhaps unlikely that the approach that will ultimately be adopted to subcontracting and subsidisation will be welcomed by all so need for further reform is likely to be topical among some stakeholders. Whether there will be government appetite to engage on this will remain to be seen.
For the moment, the government has not provided further thoughts on the introduction of varying levels of support for different types of R&D or certain sectors. Though with over 60% of respondents to the previous consultation supportive of some kind of targeted R&D support, it is likely the policy debate over the merits of targeting certain sectors/activities will be revived in the future.
HMRC are known to be concerned about high levels of inaccuracy in small claims and therefore a minimum threshold level of R&D expenditure may yet be introduced. If so, we would hope that alternatives such as grant funding will be considered to support those companies with low levels of expenditure but valid R&D projects. Linked to concerns about boundary pushing, the eligibility of qualifying indirect R&D activities may well be considered further by the government.
Should the recent measures to tackle abuse prove successful, we would expect stakeholders to debate whether there may be scope to remove the PAYE/NIC cap which is expected to apply to the proposed single scheme. More generally, it may be debated how error and fraud savings may be deployed to further support innovative companies.
Publication of regulations regarding the Additional Information and Claim Notification requirements
Regulations to give effect to the previously announced Additional Information and Claim Notification requirements came into force on 8 August 2023, and it is essential that all companies claiming R&D tax support ensure they are compliant, or they risk having their claim rejected. This is an important point, HMRC have already flagged a high incidence of claims being rejected for non-compliance with the Additional Information requirement.
It is also noteworthy that a digital filing requirement for all amendments to Corporation Tax Returns containing an R&D tax claim, whether before or after the amendment, is contained in the regulations. This requirement also came into effect on 8 August and applies to accounting periods beginning on or after 1 April 2023.
HMRC is investing in compliance activities
HMRC’s Annual Report and Accounts were also published recently and include a significant upward revision to the 2020/2021 R&D tax error and fraud estimates, providing further context to the increased scrutiny that claimant companies are currently facing. HMRC’s recent volume compliance campaign which focused on SMEs has come under the spotlight and we and other stakeholders are in discussion with HMRC on the challenges being encountered by claimant companies undergoing the enquiry process. It is intended that the recent introduction of new compliance measures to the R&D tax regime, and the significantly increased resource now available to HMRC to tackle abuse, will reduce error and fraud in subsequent periods.
The Comptroller and Auditor General has previously noted concerns about HMRC’s estimates of the level of error and fraud in R&D tax claims and measures to tackle it. As part of the wider R&D tax regime reform agenda, steps have been taken to address the concerns raised including HMRC investing into their compliance activities – HMRC has a dedicated R&D anti-abuse unit and there are now over 500 officials involved in R&D compliance, including 191 specialists. HMRC are also combining expertise across their teams and other government departments to combat abuse, this includes collaboration with the Fraud Investigation Services teams.
The increased HMRC compliance activity has included a Mandatory Random Enquiry Process (MREP) covering approximately 500 claims made by SMEs, which has driven the significantly increased error and fraud estimates for 2020/2021. While the accounts again include a qualified opinion, the Comptroller and Auditor General has expressed general satisfaction that these estimates are now more accurate, despite some reservations that no review of large company RDEC claims took place to inform the revised estimates. While there may be more faith in the reporting, the results themselves are concerning:
|Rate of error and fraud||Monetary value (£bn)|
|Error and fraud – SME scheme||24.4%||1.04|
|Error and fraud – RDEC scheme||3.6%||0.09|
|Error and fraud - Total||16.7%||1.13|
They broadly show that smaller claims are more likely to be inaccurate, the SME regime is higher risk than the RDEC regime, analysis of MREP shows that almost half of all claims (by volume) contained some element of non-compliance, with nearly 10% of MREP cases involving suspected fraud.
These errors are largely attributed to the qualification of R&D activity – does the R&D project satisfy the definition of R&D for tax purposes per the Department for Science, Innovation and Technology (DSIT) guidelines? The MREP found that 25% of claims were not at all qualifying and 19% were partly qualifying (44% of the total). It would be interesting to have more details on the apparent disconnect between claimant companies’ interpretation of the DSIT guidelines and HMRC’s interpretation and the extent to which deficiencies in record keeping were behind claim rejections.
HMRC has produced a compliance and MREP summary which is worth a read as it provides a useful insight into their approach.
What’s next for HMRC’s compliance approach ?
The Chartered Institute of Taxation's (CIOT) recent letter to HMRC outlines challenges encountered in the MREP and Grant Thornton and other stakeholders are engaging with HMRC with a view to further improving the enquiry experience.
HMRC have since published a letter in response to CIOT addressing the concerns raised. On a positive note, HMRC have confirmed their commitment to their Charter, amended quality assurance processes, begun rolling-out training for caseworkers and introduced escalation routes for caseworkers to obtain support. A process to update the R&D manual and to produce more compliance-focused guidance is underway, with the intention of helping claimant companies get their claims right first time.
However, volume compliance will remain part of HMRC’s approach and we can expect HMRC to remain robust on the issue of penalties. Compliance activity is likely to have a sector focus, for example, HMRC has recently launched a one to many letter campaign aimed at claimant companies in the care home sector. We can also expect that HMRC will leverage the additional information which claimant companies now have to provide in order to develop their risk analysis processes and to inform compliance activity.
There is no doubt that error and fraud remain high on the agendas of HMRC and the government. We can expect further MREP rounds aimed at later periods. It is hoped that HMRC will continue engaging on the enquiry process and to better support those striving to be compliant and that the reforms already introduced will lead to reduced abuse. We anticipate further compliance activity updates from HMRC in due course. Getting R&D tax claims right first time is paramount and has never been more challenging than in this environment of legislative change and high HMRC scrutiny.
Outlook for the R&D tax regime
The pace of change in R&D tax already seems unrelenting as stakeholders get to grips with the reforms implemented on 1 April 2023 and the introduction of the Additional Information requirement. The ‘L-Day’ announcements and any amendments that may be made at the upcoming Autumn Statement mean that there will likely be no respite through 2024. Many stakeholders will be hoping that certainty as to the future shape of the R&D tax regime is now not too far away given the importance of being able to plan ahead with confidence.
However, there remains uncertainty as to the future shape of the R&D tax regime and time to prepare may be extremely limited ahead of a potential April 2024 implementation of the draft legislation. Given the significant reforms and additional requirements that claimant companies are already dealing with, we would anticipate that the government has received calls for deferral, not least to afford an opportunity for evidence to be gathered as to the effectiveness of the recent reforms which could inform policy direction.
Claimant companies will need to keep their finger on the pulse of developments and make the necessary preparations in good time. The right advice has never been more important. This is true whether you are planning ahead or working through an enquiry process.
We have fostered a strong working relationship with HMRC and will continue to engage with them and to participate in the R&D Communication Forum – this is part of how we support our clients.
For more insight and guidance, get in touch with Lindsey Copland.