Insight: R&D tax relief changes and the impact on your business

For several years, the R&D tax relief scheme showed little sign of changing or evolving. However, we have seen more proposed changes in the last two years than in the previous five years. Why? Government sources suggest that increasing abuse of the scheme is leading Government to modify the legislation and guidelines to reduce the incidence of inaccurate claims and misuse of this invaluable form of support. Sandy Findlay from Visiativ looks at the changes and impacts on the sector.

These changes could significantly impact SMEs and manufacturers. If you aren’t already aware of these, it will be worth taking time to familiarise yourself with the changes and their potential impact on your business.

The key changes are:
1 –  Exclusion of overseas R&D spend
2 – Inclusion of cloud computing and data costs
3 – Pre-submission notification to HMR
4 – Changes to the enhancement rate and tax credit relief rate for the SME scheme

1 – Exclusion of overseas R&D spend  – how will it affect your business?

As of April 2024, expenditure on subcontracted R&D and the cost of EPWs employed on R&D projects outside the UK would no longer be eligible for UK R&D tax relief.

On the bright side, materials sourced overseas and costs related to data and cloud computing sourced overseas can still be claimed if these are an intrinsic part of R&D carried out in the UK.

There will be some circumstances when companies can’t conduct research within the UK, and as such, claimants will still be allowed to claim relief on R&D expenditure outside the UK. For example, in some instances, material factors such as geography, environment, population or other conditions that are not present in the UK but are indispensable to the research may dictate that a research project is carried out overseas.

While Treasury only recently postponed the implementation of this exclusion, it will affect many companies with overseas R&D teams.

2 – R&D tax credits to include data and cloud computing costs – more bang for your buck?

From this April, companies can claim relief against the costs associated with using third-party resources and services in the acquisition, analysis and storage of big data.

Including such costs in R&D tax relief claims will significantly benefit the “modernising manufacturing” agenda, which relies heavily on the use

of data throughout R&D, design and innovation processes. While those involved in digital simulation and prototyping projects or using big data to analyse and resolve issues (aerodynamics, the performance of materials under stress, etc.) will benefit significantly from this change.

Furthermore, the ability to claim relief against costs for using outsourced data services makes these resources more accessible for smaller companies that may have previously been excluded due to high entry costs, levelling the playing field in the digitalisation of R&D.

Businesses will also be able to claim relief for pushing the boundaries of pure maths – such as mathematical modelling projects, which help to better understand vibration patterns in electrical equipment to effect better dampening strategies or to improve the performance of optical identification systems on inspection lines.

Management teams need to be more aware of how more effective use of data could speed up[ or enhance the results of R&D projects alongside the cost-benefit analysis of owning these virtual services for themselves or buying in expertise.

3 – Pre-Submission Notification & Additional information – an unexpected complication?

For periods starting April 2023, companies considering applying for R&D tax relief will need to give advanced notification of their intention to claim within six months of the period-end for which they plan to submit a claim, creating an unexpected obstacle for companies that have yet to previously claim. Companies that have already submitted a claim on any of the three previous periods will not need to give prior notification.

This will require companies new to the R&D tax relief scheme and with no previous track record of claims to be much more agile in identifying and assessing the size of the opportunity before them, e.g.:

• Is the work they have undertaken eligible for relief?
• Is there sufficient spend to make a claim worthwhile?
• More importantly, can they undertake this assessment within the six-month

This challenge is compounded by the introduction of a mandatory requirement for the digital submission of additional information relating to R&D tax relief claims. This requirement comes into effect in August of this year and requires all companies to submit.

• A detailed breakdown of costs across qualifying categories
• A detailed description of the R&D work carried out to establish eligibility for relief

For many SMEs, these additional requirements could be sufficient enough obstacles to deter companies not already claiming from accessing this valuable incentive. While fostering a relationship with an R&D specialist could ensure that first-time claimants can meet the new reporting requirements.

4 – Changes to the enhancement rate and tax credit relief rate for the SME scheme – a hydraulic hammer to crack a nut?

In an apparent attempt to reduce the financial impact of a burgeoning number of claims under the SME scheme, in November last year, the government announced a significant cut to the enhancement rate applied to eligible expenditure, from 130% to 86% of expenditure, from April this year. The effect of this will be to reduce the net tax benefit for a tax-paying company from 24.7% currently to 21.5% on eligible expenditure incurred from 1 April 2023.

However, it will be loss-making companies who suffer the most. For many years now, SMEs in a loss-making position have been able to surrender their losses for a cash credit of 14.5%. However, this rate is being reduced to 10% from April 2023. The effect of this will be to reduce the potential tax benefit from 33% of eligible spend to 18.5% from April 2023.

In recognition of the significant impact such cuts in tax credit rates could have on the  funding of young innovative SMEs, the Chancellor, in his 2023 spring budget, announced an enhanced relief rate for “R&D intensive SMEs.” This will allow SMEs spending more than 40% of their total expenditure on R&D to claim a tax benefit of 27% of expenditure from April 2023.

While this is a welcome move and will provide an invaluable injection of funds back into young innovative companies, it also creates yet another administrative burden for those companies in having to prove and provide evidence that their R&D expenditure meets the 40% threshold. While simultaneously providing another opportunity for less scrupulous companies to take advantage of the higher tax credit rate!

The net effect of these changes will be a cut in the funds flowing back into SMEs, ultimately reducing the funds available for reinvestment by between 13% and 40%, depending on whether a company is paying tax or claiming tax credits and, in turn, affecting SMEs’ willingness and ability to maintain or grow future investment.

Whilst it fitting that measures should be introduced to address concerns that the SME regime has been subject to abuse and error, the cuts to the abovementioned SME regime have gone too far. These changes will significantly impact the resources available to SMEs for reinvestment in their businesses, creating a hostile environment, endangering management teams’ commitment to ongoing investment, and ultimately compromising businesses’ competitiveness.

5  – Increasing HMRC Enquiry Rates – what to do to keep inspectors at bay?

In the last three years, HMRC has increased the rotation of inspectors around its units and has employed up to 1300 additional inspectors, specifically within their R&D tax relief claims unit. The rationale behind the increased number of staff and rotation of existing staff is a focus on improving compliance of claims and ultimately reducing tax avoidance through misuse of the R&D tax relief scheme. This has led to a significant increase in R&D tax relief compliance checks, also known as “enquiries”.

While enquiries take up valuable time, the ultimate consequence is a delay in HMRC settling the claim, which in turn hinders the injection of funds back into the claiming company. Worse still, there could be a reduction to the benefit offered by HMRC or a total rejection of the claim!

So, what are the three steps companies must follow to ensure they minimise the likelihood and impact of an enquiry? It’s vitally important that businesses provide crystal-clear supporting documentation for their claims.

1 – When it comes to justifying the claim, there should be an explicit statement of the baseline of knowledge at the start of the project, a clear explanation of the advance in the baseline the company was seeking to achieve, identification of the technical uncertainties which were addressed in the process of making the advance, as well as the work done to resolve these uncertainties.
2 – The claiming company then needs to accurately report costs and expenditures, including a breakdown of costs across qualifying categories.
3 – Finally, the company needs to clearly identify the credentials of individuals cited as “competent professionals” in relation to the eligible R&D carried out and those of their chosen agent preparing the R&D tax relief claim.

Following these three steps whilst compiling your claim should satisfy HMRC inspectors that the claim is justified, accurate and robust.

6 – Is your subcontracted R&D putting you at risk of an HMRC enquiry?

This increase in the number of enquiries outlined above is partly due to HMRC’s ongoing efforts to crack down on non-compliance and drive accuracy in the interpretation of guiding legislation as well as the accuracy of the information in tax relief claims.

One area of contention causing many enquiries is the interpretation of the rules related to claiming R&D tax relief in subcontract scenarios. Over the last two years, many high-profile cases have highlighted HMRC’s growing confidence in asserting its own interpretation of these rules. In the case of Quinn v HMRC 2021, HMRC considered the R&D to be subsidised by the commissioning company, as the claimant did the work while completing a commissioned contract. HMRC concluded that the company making the claim would need to claim through the RDEC scheme for subsidised work and the SME scheme for non-subsidised elements.

To ensure that they stay on the right side of HMRC’s interpretation of the rules and reduce the likelihood of an enquiry, it is critical that claiming companies are clear on several points:

1 – Are the technical challenges intrinsic and critical to the completion of a contract, or could the contract be completed without addressing the technical challenges? Meaning the eligible R&D activity is beyond the remit of the contract.
2 – Similarly, did the financial compensation for the contract include a payment specifically for any R&D work packages carried out or were R&D expenditure at the discretion of the subcontractor and paid for from its own resources?

The answers to these questions strongly indicate where both the technical and financial risk might lie within a contract and, consequently, which party has the strongest claim over a potential R&D tax relief claim.

Conclusion

Mindful that innovation is critical to economic recovery, the Government will continue to provide innovation incentives but will double down on ensuring that tax reliefs only go to those who are genuinely eligible.

It’s easy to see that whilst many companies will have applied for R&D Tax Relief for many years or have a good understanding of the scheme but continued reform of the R&D tax relief scheme by HMRC will introduce new uncertainty for claiming companies and means that extra caution will be needed.

That’s why it’s always a good idea to have an R&D tax expert such as Visiativ help you through the process to ensure your claims are compliant, maximised and risk-free.

If you have any questions relating to R&D tax relief or wish to discuss the implications of recent changes to the R&D tax relief scheme on your own claims, please get in touch with Visiativ, and a representative will get back to you to discuss your unique needs and explain how we can assist.