22 March 2023
What is the background?
The UK’s healthcare sector has long been a beneficiary of R&D reliefs since their inception in 2000. Pre-budget, these benefits have been worth as much as 33p in the pound for companies operating in this sector.
However, while the government is keen to support innovative industry, it has taken stock of the reliefs in the round to ensure that they are effectively targeted and protected from abuse. As background, HMRC’s annual report of 2022 set out an estimate that nearly 5% of R&D claims had a level of error or fraud. With this representing £469m to Treasury, and the bulk of this originating from small and medium-sized enterprise (SME) claims, there is an understandable drive to tighten up the regimes to ensure that the benefits are being directed to genuine claimants. While the values HMRC set out are estimates based on historic claim data, it is apparent that there is a need for action.
With this backdrop, there are various significant changes afoot that will likely affect every claimant, and while the healthcare sector is known to be a focus for government with its technological and scientific approach to innovation, the industry will not escape unscathed. Read more about the proposed changes.
The key changes are being rolled out over the coming year (with varying enactment dates) and also anticipated is the proposal to merge the large and SME regimes (a topic for a later digest!). A brief outline of these changes and their relevance to the healthcare sector is set out below.
From 1 April 2023, the enhanced tax deduction available to SMEs in respect of qualifying R&D expenditure will decrease from 130% to 86%, and the payable credit for loss-making SMEs generally will be cut from 14.5% to 10%. Consequently, once the increase in the main rate of corporation tax to 25% from 1 April 2023 is taken into account, the SME R&D tax relief will be worth 21.5p for every £1 of qualifying expenditure to profitable companies (down from 24.7p currently) while the cash benefit falls from 33.35p to 18.6p per £1 for loss-making businesses.
For large companies, the Research and Development Expenditure Credit (RDEC) rate will increase from 13%to 20%. With the corporation tax rate changes, this will give an effective 15% net benefit to companies claiming under this regime, which is a significant boost for large companies. It is no accident that the difference in benefit between the two regimes is narrowing – this again is intended to reduce levels of abuse in the SME scheme and more widely.
In recognition of the concern from SMEs about this significant cut to the support, the chancellor has responded with a measure intended to help high-intensity performers of R&D: SME companies with qualifying R&D expenditure constituting at least 40% of their total expenditure will be able to obtain a payable credit of 14.5% of the losses surrendered, rather than the normal rate of 10%.
This high level of R&D intensity will restrict the population of claimants who will be able to access this, with the upside likely to be felt by many in the healthcare space. However, as the 40% ratio will be calculated by considering the aggregation of connected companies, understanding the ratio will require companies to undertake further analysis and supporting calculations. And pertinently, as the legislation for the 14.5% payable credit is not due to be in place until a future date (potentially Spring 2024), this leaves companies with a conundrum: submit R&D claims promptly to access the lower 10% credit at the earliest opportunity, and then resubmit later to ‘top up’ the additional 4.5% or wait until the legislation is in force and submit claims at this juncture.
Neither option is ideal and leaves companies needing to assess the balance of resubmission costs and additional admin, versus the delay of access to the payable credit. With cashflow so important in the sector, the decision is likely to be stacked in favour of resubmission, so having this conversation with your advisers or finance team in advance will help smooth the process.
Notably for pharmaceutical companies and CROs, the technical changes to the R&D regimes will likely have a significant impact. These can be broadly summarised into three categories:
The good: Some additional cost categories will be able to be included for accounting periods beginning on or after 1 April 2023; this will include expenditure on data and cloud computing costs. The inclusion of both cost categories for this sector could well increase claim value, especially as use of data processing and analytics becomes commonplace.
The delayed: The intended restriction on most overseas expenditure will now come into effect a year later, ie for accounting periods beginning on or after 1 April 2024. This delay will give two positive outcomes: it will allow the government to consider the interaction between this restriction and the design of a potential merger of the two R&D regimes; and will also give some breathing space for companies to consider how they procure and distribute their R&D activities. For healthcare and life sciences, the allowable exceptions may be relevant if, for instance, the clinical trial population or other required conditions are not present in the UK, or this is mandated by regulatory requirements. However, the exceptions are narrowly defined and could significantly impact the sector; with strong relationships between the UK and US for clinical trials, the location of the trials may need to be closely considered if the costs are to remain eligible.
The admin: For claims submitted after 1 August 2023, a new digital submission (via a web-based form) must be provided in support of all claims. For many in the healthcare sector, this is likely to represent a significant additional requirement. While in the adviser community, the provision of supporting documentation alongside an R&D claim has always been good practice, this is not so widespread for in-house claims preparation that occurs in this sector.
With many companies in the healthcare sector presenting ‘obvious’ R&D, the need for preparation of project-based documentation will likely be considered a burden on technical staff resources; but with consequential financial benefit at stake, it will need to become a necessary and embedded task. This is coupled with the need to disclose costs incurred, the identity of any agent that has advised on the claim, and the employee or officer of the company responsible for it. These additional filing requirements will meet HMRC’s purpose of getting companies to put a magnifying glass to their R&D claims, undertake more diligent scrutiny and root out less scrupulous claims.
What should healthcare businesses be thinking about now?
With all these changes, there is a lot to digest for all R&D claimants. But what are the key considerations for the sector?
Many of these changes came into effect at the beginning of April 2023, making considering the impact of these on your life sciences business an immediate priority. Headline considerations include:
- Timing of R&D claims filing, and support to do so. With claims submitted after 1 August 2023 needing an ‘additional information form’ submitted via the tax return portal, companies should consider who in the organisation has to be involved and whether they have capacity to do this? Completion of the form is not an insignificant task, adding cost and complexity to your claim. Expediting claims submission before this date may be a viable option but may also need to be weighed up against the effective legislation date if the company will qualify for the ‘R&D intensive’ higher rate of payable credit. Our recommendation would be to seek reputable specialist support to get this right the first time.
- Re-evaluation of overseas operations and contracts; if not caught by the narrow exemptions, how will the removal of eligibility on overseas costs impact R&D benefits. This will need to be reviewed widely with reference to costs, availability of capability and convenience and appropriately modelled.
We anticipate draft legislation in Summer 2023, so watch this space for our further updates.