Changes to R&D tax relief in April: what you need to know

R&D tax relief has been a key driver of innovation for UK businesses, with HMRC reporting a record claim of £7.6bn for the 2021-2022 tax year.

But in early 2021, the government launched a consultation to overhaul the scheme, due to growing worries about misuse.

Following several rounds of technical feedback, the government announced in late 2022 that its final aim was to combine the two existing schemes, with the purpose of simplifying the incentive and preventing it from abuse in the future.

The merged R&D scheme will apply for accounting periods starting on or after 1 April 2024.

The new merged scheme will cover both, - the existing incentive for small and medium-sized enterprises (SMEs) and the research and development expenditure credit (RDEC) for larger businesses.Businesses have welcomed some aspects of the combined scheme, but there are clear winners and losers as the government’s goal to ‘rebalance’ the different rates available will lead to lower benefit for most SMEs.

Accountants will keep playing a crucial role in making sure their clients are informed of the changes and helping them to prepare. It will be essential to grasp the complexities – as the long-lasting consultation means there are several significant changes, which will affect all companies using R&D reliefs.

A new deal for R&D-intensive SMEs

While the combined scheme was the main topic of discussion in last year’s Autumn Statement, there will still be two separate incentive schemes in place, with the continuation of the enhanced rate for R&D-intensive SMEs (introduced in 2023) operating under the current SME model.

The R&D intensive SME scheme only applies to loss making SMEs that spend a certain percentage of their total business expenditure on R&D.

One of the key decisions made in the Autumn Statement 2023 was to lower the qualifying threshold for this scheme from 40%to 30% of a company’s total expenditure – as a result, this means thelegislation will allow more loss making SMEs to qualify as R&D intensive, giving them access to enhanced financial relief to support their growth and development.

Additionally, there will be a one-year grace period for companies that drop below the 30% R&D intensity threshold,allowing longer term financial planning and investment decisions by limiting cases where businesses move in and out of the R&D-intensive regime every year.

Even though the initial cut in rates for SME relief and the latest changes to the R&D intensive SME scheme are positive, there is still a clear gap between the government’s overall innovation policy and its implementation.

While 10% cut is a welcome reduction to the threshold, the level is still high. A business with a quarter of its overall expenditure invested in R&D will still not be seen as R&D intensive when it comes to accessing the scheme.

The policy will definitely help some smaller businesses that are committed to significant R&D investment by protecting them from the most severe cuts to relief rates, but there is notable room for improvement given the diversity of SME R&D.

Contracted out R&D

The merged scheme uses the RDEC mechanism, but there are important changes that could affect existing RDEC claimants if they are not well prepared.

A technical note shared after the announcement of the merged scheme showed the specific complexity of how the incentive will handle contracted out R&D.

The government has repeated the policy goal of increasing the overall level of R&D investment by lowering the cost of investing in R&D. As a result, the merged scheme aims to give R&D relief to the R&D decision maker in a supply chain.

In addition, the reformed policy will let most companies that outsource their R&D activities to claim tax relief for the costs related to these contracted out R&D activities (similar to the current SME scheme).

To achieve this, the merged scheme introduces a detailed legislative definition of contracted out R&D, using a principles-based approach. While the decision to explain this definition will solve some of the previous doubt in this complex area, a policy change of this size is always likely to create winners and losers.

The current rules allow businesses that do R&D activities for a larger company to usually claim under RDEC (as the large companies cannot include those costs into their R&D claims).

However, under the newly announced merged scheme, they will not be recognised as the R&D decision-maker and will not be able to make a claim if their contractor can. On the other hand, the large company contractor should see a rise in the value of their claim.

For example, a small company that concentrates on developing healthcare technology may have been employed by a large firm to aid in finding a solution to a specific challenge they are facing.

Under the current scheme, the small company is likely to be recognised as an R&D subcontractor and able to claim relief under the RDEC scheme. However, under the new merged scheme, the subcontractor will no longer be able to claim, but the large firm can access relief on the amounts paid.

Whether this change motivates or discourages R&D investment, and how much it leads to specific commercial discussions between the parties who are losing and gaining the relief, is still unclear.

The lack of modelling and consultation on the impact of this significant change is one of the main criticisms of the speed at which the merger is being carried out.

No more restrictions on subsidised expenditure

2024 also marks the removal of all restrictions on subsidised expenditure, from both the merged RDEC scheme and the R&D intensive SME scheme.

Under the previous SME framework, if a company’s R&D project got any form of subsidy, it would face restrictions in claiming tax credits for either the subsidised part of its R&D expenditure, or in some cases the wider project costs.

These restrictions were removed from RDEC, but were part of an earlier proposal for the merged scheme, causing some debate.

The removal of these restrictions in the future means that companies can now claim R&D tax credits on expenditures that have been either partly or fully subsidised, which is a positive move in terms of generosity and simplicity.

For now, only well-informed accountants,updated on the planned changes coming into force in April 2024, could correctly assess the eligibility, value and the claim process for businesses involved in R&D activities.

Please talk to us if you need any further advice regarding R&D tax relief available to your business.

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