Updated 17 March 2023
From the introduction of R&D (research and development) tax credits over 20 years ago, to the major changes due to take effect in April 2023, we explore what this shifting landscape means for businesses looking to take advantage of the schemes.
How it started
R&D tax relief was first introduced for SMEs back in April 2000. It was a relatively simple scheme, designed to reward innovative companies who could benefit either from a reduction in their taxable profits or from a tax credit when loss-making. The latter was particularly valuable to cash-hungry startups.
The definition of an SME was particularly generous: businesses with up to 500 employees were eligible. However, a second relief for large companies was also introduced. This morphed into the R&D Expenditure Credit (RDEC) scheme in April 2013.
Although the schemes have all relied on the same, somewhat subjective definition of what is qualifying R&D for these purposes, the two schemes still have fundamentally different rules as to what costs qualify, the rate of relief and even how to account for them. But more on that later.
For a while the schemes worked well. And with the introduction of the albeit more complex Patent Box, the UK provided valuable incentives for cutting-edge businesses.
However, it became apparent that improvements were needed:
- Although simple, this meant that regimes were poorly targeted, in particular with software claims at a far higher level than anticipated.
- Claims were poorly policed by HMRC which muddied what was truly qualifying R&D work.
- This encouraged abuse. Many fly-by-night intermediaries made spurious claims with a far greater interest in the size of their commission than the accuracy of submission.
- With SMEs able to claim for subcontracted work even when done overseas, taxpayers’ money was being spent with no tangible benefit to the UK economy.
Recent and forthcoming changes
2021 saw the start of a number of changes. Firstly, the repayable tax credit for SMEs was capped at broadly three times their total PAYE costs (subject to certain limited exceptions).
Then we had a number of changes announced with effect from 1 April 2023, in particular the restriction on subcontracting qualifying work outside the UK so as to target innovation in the UK.
In addition, to further deter the fraud that is estimated to have cost nearly £0.5bn to date, a number of procedural changes were announced. These include:
- Claims must be submitted in a digital format, no doubt to try to standardise the supporting information provided in respect of each claim.
- All claims must be signed off by a named officer of the company;
- Companies must notify HMRC within six months of their year-end of the intention to claim.
The expansion of qualifying costs to include data and cloud computer costs was a more welcome announcement.
But that wasn’t the end of the changes. In the 2022 Autumn Statement, it was announced that also from 1 April 2023, the rate of super-deduction on qualifying R&D expenditure was to be cut from 130% to 86%. By contrast, the RDEC credit rate will be increased from 13% to 20% at the same time.
This was far from coincidence: the clear financial benefits of the SME scheme have now been largely eroded and HMRC are now consulting on merging the two schemes.
HMRC’s changing approach
In many respects, replacing the two current R&D tax relief schemes with one would be welcome simplification. However, difficulties remain: in particular, how to deal with subcontracted work which generally does not qualify under the large company scheme.
More fundamentally though, the definition of R&D has remained unchanged for nearly 20 years. And whilst requiring an advance in science and technology through the resolution of uncertainties seems relatively clear, the apparent change in HMRC policy has been the most controversial element of recent developments.
Emboldened by the recruitment of 100 new R&D inspectors, HMRC are now taking a much tougher line on whether claims fall within this definition. Indeed, they have been revisiting credits previously repaid and spent in good faith by businesses.
HMRC have recently been targeting the claimants in the software sector, inviting them to revisit and amend claims before they get a proverbial knock on the door. With the implicit threat of tax-geared penalties, HMRC will be worrying many legitimate claimants.
It is not just the level of enquiries which is causing concern. In the past, HMRC have seen themselves as empowered to deliver R&D benefits to worthy taxpayers; now, their approach seems to be finding reasons to say no. With the benchmark of demonstrating beyond doubt that the company has made an advance in technology being set so high, many companies will no longer feel comfortable claiming.
We can only hope that the pendulum will swing back to a more equitable position where HMRC encourage the right businesses to claim the right amount of relief. But for now, we recommend that businesses take extreme care with any R&D claim so as to ensure that it can be fully justified. Don’t rely on cowboy intermediaries who may lead you down the wrong R&D road!
How BKL can help
Our tax specialists have generated significant tax refunds and savings for clients investing in R&D. The projects have ranged from fingerprint recognition systems to robotic machinery for the flat-glass industry.
To learn more about how R&D tax reliefs may apply to your business or for assistance with making a claim, please get in touch using our enquiry form.
Update, March 2023: Spring Budget 2023 announced that from 1 April 2023, there will be an increased rate of relief for loss-making R&D intensive SMEs. Eligible companies will receive £27 from HMRC for every £100 of R&D investment.
A company is considered R&D intensive where its qualifying R&D expenditure is 40% or more of its total expenditure.
Previously announced restrictions on some overseas expenditure will now come into effect from 1 April 2024 instead of 1 April 2023.