To encourage UK innovation, tax reliefs exist to either reduce tax liabilities or generate a repayment for companies carrying on Research & Development (R&D). Where firms seek an advance in science and/or technology via the resolution of technical uncertainties, HMRC offers two types of tax relief schemes available to incentivise their development: the SME scheme and the R&D Expenditure Credit scheme for larger companies or where the R&D is subsidised or subcontracted.
UK R&D reliefs are amongst the most generous in the world, based on amounts spent by the government, with promises to increase public investment to £20bn per year by 2024-25. However, partly due to HMRC having to deal with fraudulent R&D claims, lengthy delays are being experienced by companies awaiting a tax cash credit.
To help address issues such as fraudulent claims, new R&D tax relief legislation will come into effect from 1st April 2023. This article highlights some of the key issues regarding changes to R&D tax reliefs, identifying the key changes that could impact your business.
Delays to Tax Reliefs
As part of their plan to reduce the number of fraudulent claims, HMRC announced a pause on the payment of some R&D credits as it steps up the scrutiny and carries out enhanced checks.
HMRC aimed to process all R&D claims submitted within 28 days of receipt, but now this has been temporarily being increased to 40 days. In a time when businesses may be struggling with cashflow, this will not be welcome news.
To ensure claims are dealt with as efficiently as possible, it is advised that as much information as possible be submitted alongside the R&D claim and that a comprehensive narrative is included. We advise that clients provide their information to the person preparing their claim promptly to mitigate the effects of these delays.
At the moment, agents and claimants have been asked not to contact the helpline to chase their claims.
Tackling abuse of R&D reliefs
HMRC have also announced additional efforts to tackle the increasing numbers of fraudulent R&D tax relief claims, primarily being made through unregulated boutique advisers submitting claims which fail to meet the requirements for R&D relief. Firms across the country are noting the emergence of R&D advisers, often not belonging to any professional body, cold-calling SMEs suggesting how they can make an R&D relief claim.
HMRC have recruited over 100 new compliance officers but the increase in claims far outweighs the benefit of these additional resources.
Additional measures being put in place will include the need for each R&D claim to be endorsed by a named senior officer of the company, as well as a requirement to inform HMRC beforehand that the company plans to make a claim. These requirements are intended to come into effect from April 2023 alongside the changes below.
How Do I Submit a Legitimate R&D Tax relief Claim?
We recommend submitting detailed narratives for several of the projects within the claim, including as much detail as possible on the expenditure the claim is covering, the technological/scientific advances being sought and the uncertainties which needed to be overcome, to demonstrate the genuine nature of the claim.
Legislation changes from 1 April 2023
As first announced back in Spring 2021, the government are proposing changes to the R&D tax relief scheme to be effective from 1 April 2023. As this date approaches, with draft legislation now having been released, we consider these upcoming changes and how best to prepare for them.
Data & cloud computing costs
The scope of allowable costs is being widened such that cloud and data costs relating to R&D projects will be allowable for the enhanced deduction, this includes cloud storage costs – an increasingly prevalent and often significant cost. Where costs relate only partially to R&D work, an appropriate proportion can be applied to the relevant costs incurred, for example, based on staff numbers or floor space.
License payments for datasets will only be eligible if the datasets cannot be resold or don’t provide a lasting benefit to the business.
As part of the changes being made, it has been recognised that advances in R&D including in Artificial Intelligence (AI), quantum computing and robotics, are increasingly being underpinned by pure mathematics; costs relating to pure mathematics are now eligible to be included as qualifying R&D.
Businesses with costs in either of the above categories should ensure they have appropriate records and procedures in place to easily identify the relevant costs to include in their R&D relief claims.
Refocussing R&D relief on UK innovation
To encourage R&D activities to be carried out within the UK, there will be no relief for R&D activity subcontracted to a third party unless the work is undertaken in the UK. This change will primarily impact SMEs as subcontracted expenditure is already heavily restricted under the Research and Development Expenditure Credit (RDEC) scheme.
For externally provided workers (EPWs), relief will only be available where the workers are paid via a UK payroll.
There are specific exceptions to this rule, where it is necessary for R&D to take place overseas due to environmental requirements (such as deep ocean research which is physically impossible in UK waters) or due to legal requirements (such as regulatory restrictions on certain clinical trials).
Whilst the objective of this change is clear, it fails to account for challenges UK businesses are currently facing in terms of resourcing from within the UK. Skills shortages, specifically in R&D intensive sectors such as engineering and software, mean that UK businesses will struggle to recruit domestically. This situation has also been exacerbated by Brexit and Covid, both by reducing the number of skilled workers migrating into the UK, but also with many former UK workers leaving the UK to return to their home countries.
Businesses currently outsourcing R&D activities or engaging overseas EPWs should consider the impact the new rules will have and whether the overall cash benefit merits onshoring any activities. Any new arrangements should bear the above in mind when considering UK or overseas workers for future projects. Some businesses may even consider relocating overseas, defeating the aim of incentivising UK innovation.
If you would like professional guidance or support on this issue, get in contact with one of our experts to discuss your situation in further detail.
An increase to the RDEC rate?
The Chancellor’s 2022 Spring Statement announced that the government would consider making the R&D incentive scheme more generous, with rumblings of a rate increase for the RDEC scheme.
This would be welcome news for larger businesses and those where R&D is subsidised or subcontracted, meaning the more generous SME scheme is unavailable.
The RDEC rate, currently set at 13% of qualifying expenditure, is taxable income meaning the business pays corporation tax on the credit received. However, this raises a significant problem. Corporation tax is due to increase from 19% to 25% in April next year, meaning businesses will receive less net credit than before, potentially leading to a subsequent reduction in future investment.
Will the government increase the RDEC rate to mitigate the change? An increase to 14% would almost exactly cancel out the effect of the corporation tax increase, whilst simultaneously being an opportunity to sell the rise as an increase in investment. However, no such rise has been announced meaning we may instead see a reduction in innovation investment by these companies.