On 18 July 2023, the Government published draft legislation for the Finance Bill 2024. Included within the draft legislation was a proposal for a single merged Research & Development (R&D) regime. The draft legislation is for technical consultation and may not be enacted, however, the new rules could be effective from as early as 1 April 2024.
While the legislation is only draft at this stage, it is worth considering the potential impacts on business decisions and future cashflows of the business. HMRC is reviewing the implementation of a single scheme to simplify this area of tax relief and tackle the level of fraud and error with R&D claims.
HMRC estimate that during 2020/21 the overall level of error and fraud within claims was £1.13 billion, representing 16.7% of total claims. The majority of the non-compliance is estimated to have been generated from the SME scheme, where HMRC predicts up to 24.4% of claims contained fraud or error.
If introduced, the single regime will apply to all companies regardless of their size, with the exception of R&D Intensive SMEs (see below). The scheme is broadly modelled on the Research & Development expenditure credit (RDEC) scheme and the SME scheme would cease to exist.
The merged scheme will offer a taxable credit, based on a percentage of R&D qualifying expenditure, that can be offset against company's tax liability or, paid in cash to the business after tax. The headline rate of relief under the proposals is 20% of R&D qualifying expenditure. This translates into a net benefit of 15 pence for every £1 spent on R&D qualifying activities after the deduction of corporation tax currently set at 25%.
The main difference between the Merged Scheme and the current RDEC scheme is that all qualifying subcontractor costs, regardless of their entity type, will be eligible under the scheme. Under the current rules for the RDEC scheme, subcontractor costs can only beclaimed if they are individuals, partnerships of individuals or qualifying bodies (e.g. Universities).
This should allow the costs of most outsourced R&D to be reclaimed, subject to the existing restriction of 65% under the SME scheme and overseas costs (see below).
It is important to note that based on the draft legislation, relief may only be claimed by the principal company and not organisation undertaking the R&D as a subcontractor. This differs from the existing RDEC rules where a company undertaking R&D activities on a subcontract basis can make a claim as long as the principle is a large company or not subject to UK corporation tax.
Under the merged scheme, it is proposed that subsidised R&D would not be eligible for the claim. On the face of it this would preclude companies from claiming relief where they have received a subsidy or grant in respect of an R&D project although the exact definition of subsidised expenditure needs to be defined.
These rules may need to be considered when entering into grants like Innovate UK where the company expects to undertake R&D qualifying activities as part of the project.
The draft legislation makes an allowance for R&D intensive SMEs, a term which first introduced in the Spring Budget 2023 and came into effect on 1 April 2023. From this date, companies which met the conditions of an R&D intensive SME were entitled to a higher rate of payable credit ("the Intensives Scheme"). The rules for loss making companies which meet the conditions from 1 April 2024 will not change and these companies will still claim under "the Intensives Scheme".
These companies would be able to continue to claim an additional deduction for R&D qualifying expenditure, and where that deduction produces or contributes to a loss, claim a payable credit for that loss. The rate of the additional deduction will remain at 86%, with the rate of payable credit for surrenderable losses being 14.5%. This translates to an effective benefit of 27 pence for every £1 spent on R&D qualifying costs, making the scheme considerably more beneficial than the merged R&D scheme.
The criteria to meet the definition of an R&D intensive SME is challenging to achieve, with the company required to be loss making and at least 40 percent of the company's (and that of connected companies) total relevant expenditure for the purposes of calculating profits chargeable to corporation tax must be qualifying R&D costs.
The reforms surrounding overseas R&D expenditure originally expected to come into effect from 1 April 2023 and now expected to be introduced from 1 April 2024. As detailed in earlier articles, the ability to claim the cost of overseas R&D expenditure will be significantly reduced.
Only 'qualifying overseas expenditure' will now qualify for the claim. The requirement states that it must be necessary to perform the work overseas due to geographical, environmental or social conditions that are not present or replicable in the UK. Cost of the work, and availability of workers, are specifically excluded as factors.
The technical consultation period on the proposed changes is due to end on 12 September 2023. If the legislation is going to be published, it will likely be announced as part of the Chancellor's Autumn Statement. We will communicate any changes with our client base following the announcement.
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