R&D tax relief: strategic implications for capital markets firms

The UK's Research and Development (R&D) tax relief regime has long been a cornerstone for encouraging innovation by allowing companies to reclaim expenditure on qualifying activities. However, recent reforms mean eligibility criteria has tightened and demand careful scrutiny from capital markets participants, including trading desks, quantitative researchers, market data providers and their investors.

What is driving the changes to R&D tax relief?

HM Revenue and Customs (HMRC) now approaches R&D claims with heightened scrutiny having identified cases of fraud and misuse of the regime. The compliance team dedicated to reviewing claims has expanded significantly in recent years, growing to over 500 specialists who can apply this scrutiny. HMRC figures indicate that a substantial portion (20%) of all claims underwent enquiry last year. With financial services firms potentially facing higher scrutiny rates, businesses in capital markets must submit robust documentation and validation. Let’s take a look at some of the recent changes.

A new unified R&D scheme with enhanced SME support

One of the major changes to the scheme took place in 2024. It merged the previous SME and Research and Development Expenditure Credit (RDEC) schemes into a unified ‘above-the-line’ credit at a headline rate of 20%. SMEs experiencing losses but heavily invested in R&D – those dedicating at least 30% of total expenses to R&D – can leverage the Enhanced R&D Intensive Support (ERIS) for an enhanced credit. This change aims to streamline administrative burdens and remove eligibility ambiguities between ‘large’ and ‘small’ businesses, benefitting fintech scale-ups and technology-intensive capital markets firms.

 Expanded R&D tax relief costs approved by HMRC

Acknowledging modern financial innovation practices, HMRC also expanded a range of costs eligible for tax relief. For accounting periods beginning 1 April 2023, the following additional expenses qualify:

• Cloud computing and software licences: expenses related to cloud infrastructure, such as AWS, Azure or GCP can qualify if linked directly to projects addressing technological uncertainty.
• Data and dataset licences: subscriptions to data providers (eg Bloomberg, Refinitiv, ESG datasets) are eligible, provided they exclude resale or publication rights.
• Pure mathematics research: previously restricted, fundamental algorithmic or mathematical advancements now qualify, benefitting quant-focused research and innovation.

HMRC tightens R&D relief for overseas work

For accounting periods beginning 1 April 2024, relief eligibility for subcontracted work and externally provided workers is restricted primarily to activities physically performed within the UK.

Businesses that historically outsourced critical development to international hubs must now either quantify the cost of reduced relief or consider repatriating relevant activities to the UK, except in narrow, justified circumstances.

Procedural enhancements and potential future changes

Since 8 August 2023, submitting an additional information form (AIF) alongside R&D claims has been mandatory, with omission invalidating the entire claim. First-time claimants and businesses that have not claimed within three years must also complete a separate advanced notification form (ANF) within six months of the year end.

Looking to the future, HMRC is consulting on introducing mandatory advance clearances, which would mean businesses need upfront confirmation of eligibility for their proposed R&D activities before incurring expenses. This could shift elements of the R&D tax relief away from operating on a retrospective claim model towards a more proactive validation method, similar to Enterprise Investment Schemes (EIS).

What are the strategic implications for capital markets activities?

For firms who engage in a range of activities, there are some specific areas which may qualify for R&D relief:

• Trading system innovation: development sprints on projects like low-latency order routing engines and FPGA market gateways can potentially include qualifying R&D activities. However, routine implementation and business as usual development activities and their respective costs do not.
• Quantitative research: mathematical modelling, algorithmic development and computational experiments can fall within the new rules. Thorough version control and documentation are essential.
• ESG data analytics: the use of large ESG or climate datasets for advanced predictive modelling is explicitly eligible, though firms must carefully apportion costs.
• Regulatory technology (RegTech): automation of compliance functions through machine learning may qualify, including related computer and data access costs. Offshoring limitations must be considered.

How can your business stay compliant? 

While the revised R&D tax relief continues to offer meaningful financial incentives, making the most of it requires businesses to plan ahead. Investors and boards should make sure they have robust evidence trails for all claimed expenditures and engage early with R&D specialists on complex or uncertain areas.

Businesses should also:

• Conduct independent reviews of longstanding methodologies and claims
• Implement real-time cost tracking in financial systems
• Maintain clear governance records outlining the rationale for initiating R&D projects and selecting subcontractors.

UK R&D rules require close inspection

Innovation remains central to competitive advantage in capital markets. The revised UK R&D regime remains an important asset, but requires significantly enhanced diligence and documentation, aligning R&D tax compliance closely with broader corporate governance and regulatory standards.

For more information, please contact Constantine Costas.