05 September 2022
In July, we saw draft legislation and further guidance published covering changes to the enhanced R&D tax reliefs that are due to come into effect from 1 April 2023. Last month we considered the impact of the effective date that these changes come into the effect and this month we consider the impact of one of the most fundamental changes in the R&D tax relief regime since its introduction – refocussing R&D relief towards innovation in the UK.
Under the current rules, costs incurred by a UK company relating to R&D conducted overseas can qualify for R&D tax incentives in the UK. However, from 1 April 2023, the Government is restricting relief for overseas activity. Therefore, the following expenditure will generally only qualify to the extent that the relevant activities are carried on in the UK:
- subcontracted R&D;
- contributions to independent research (R&D expenditure credit regime only); and
- the costs of externally provided workers (EPWs)
There will be specific exemptions for R&D activities that cannot take place in the UK, either because the R&D requires specific geographical, environmental, or social conditions not present in UK, or because of legal or regulatory requirements that mean it cannot take place in the UK.
HMRC published a statement with the draft legislation, giving examples of activities that can benefit from the exemption such as deep ocean research and clinical trials. Other activities that could benefit include:
- medical trials in specific patient groups;
- international telecoms testing; and / or
- the testing of technology designed for extreme environments.
A key point that the draft legislation makes clear is that companies will not be able to claim for overseas costs under the above exemptions if the work is being carried out overseas simply because of cost constraints or lack of certain skills in its UK workplace.
We expect further guidance to be published before April 2023, and we will also be engaging with HMRC via the R&D Communication Forum, so we will provide further detail on these exemptions in due course.
The draft legislation does not currently make any changes to the treatment of R&D expenditure incurred by an overseas branch of a UK company. At the moment, therefore, we expect that these costs will continue to qualify for R&D tax relief after 1 April 2023 if the relevant requirements are met.
Interestingly, the draft legislation specifically provides that the restriction on R&D tax relief in respect of overseas costs will not affect the R&D ‘nexus fraction’ that must be calculated by those businesses that have elected into the patent box regime, so overseas R&D costs will still increase the proportion of profits that may fall within the patent box scheme.
Affected companies should start to consider the impact of these changes on their tax position, and whether it may be advantageous to ‘onshore’ any current overseas activities. For many, six months will not be enough time to amend existing supply chains, and in some cases the need to preserve business relationships for commercial reasons will outweigh the benefit of any tax relief that may be preserved by switching to UK-based service providers.
Nonetheless, those entering into new agreements with subcontractors or providers of EPWs should certainly consider the tax position when deciding to engage with UK or overseas providers. The commercial requirements of how contracts and research will be structured will often dominate, but it will be important to consider the issues in the round.
If you would like to discuss these changes further, please speak to your usual contact in the specialist Innovation Reliefs group at RSM, or to Sheetal Sanghvi.