The new merged R&D expenditure credit regime – how will it impact you?

The merger of the current research and development (R&D) tax relief regime for small and medium sized entities (SMEs) and R&D expenditure credit (RDEC) regime for large companies was confirmed in the chancellor’s Autumn Statement 2023. The merged regime takes effect for accounting periods beginning on or after 1 April 2024 and for many claimants this could significantly impact their future R&D tax relief claims. 

This article outlines the key changes and explores whether the impact may be positive or negative, depending on a company’s particular circumstances.

Key changes

There are a large number of changes in the new merged regime. The most significant are outlined below.

• The new merged regime provides an ‘above-the-line’ RDEC of 20%. The RDEC is taxable, meaning a net benefit of 15% of qualifying expenditure for claimants paying the 25% main rate of corporation tax. For those paying tax at the 19% small companies’ rate or in a tax loss position, the net benefit is 16.2%.
• A separate more generous regime is available for loss-making ‘R&D intensive’ SMEs, which retains the current enhanced deduction of 86% and ability to surrender current year tax losses for a payable 14.5% credit, based on the lower of the tax loss or 186% of qualifying expenditure. To be ‘R&D intensive’, an SME’s qualifying R&D expenditure must be 40% or more of its total expenditure (reducing to 30% for periods beginning on or after 1 April 2024).
• The subcontracted expenditure rules are significantly changed. Broadly, relief is available to the company that takes the decision to initiate the R&D and bears the risk of failure.
• The existing subsidised expenditure rules for SMEs are removed entirely.
• New overseas expenditure restrictions mean that companies subcontracting R&D activity to third-parties can generally only claim relief if that activity is performed in the UK. Similarly, companies utilising externally provided workers can usually only claim relief where they are paid through a UK payroll. Exceptions exist for situations where it is ‘wholly unreasonable’ or impossible to undertake the required activities in the UK.
• A PAYE/National Insurance contributions cap on claims is retained, adopting the more generous rules from the existing SME regime.
• For claims submitted after 31 March 2024, claimant companies can no longer nominate third-parties to receive payable R&D tax credits.

Reasons to be cheerful

• The incremental increases to the RDEC rate in recent years, combined with the ability to claim subcontracted expenditure in certain situations, mean large companies are the main beneficiaries of the new regime.

The new subcontracting rules also favour larger companies and those at the top of their supply chain, meaning many large companies could find they are able to claim more tax relief for R&D activities whilst SMEs, whom the rules favoured previously in such situations, could often be left with less.

• Companies receiving grant funding in respect of their activities were previously prevented from claiming tax relief under the SME scheme. This will no longer apply, which is good news for innovative start-up SMEs and/or claimants in industries where grant funding is common, such as life sciences or green technologies.
• Loss-making companies can benefit from R&D claims to a greater extent than most profitable companies. However, in reality the difference between 15% and 16.2% is negligible.

Similarly, loss-making R&D intensive SMEs may be pleased with the higher level of relief available to them, but the reality may be different due to the added complexity of navigating the SME size-testing rules, the R&D intensity rules and a different relief mechanism. Overall, their level of benefit is still significantly lower than what was available under the SME regime prior to 1 April 2023.

Reasons to be concerned

• SMEs collectively are clearly losing out. The rates of relief for non-R&D intensive SMEs decline from the comparatively lofty heights of up to 33.35% in the pre-1 April 2023 SME regime, to a 15% net benefit. 

In addition, many SMEs that claim for subcontracted-in R&D activities under the existing RDEC regime may find they have no claim at all under the new subcontracting rules.

Until 1 April 2023, a claim for £100,000 of qualifying expenditure by a loss-making SME could generate a benefit of up to £33,350, whereas under the new regime the benefit reduces to £15,000. After factoring in the effort required to make a claim, new administrative requirements and the risk of HMRC enquiry, it’s not hard to envisage some smaller SMEs giving up making R&D claims altogether.

• Companies using overseas resources, usually for entirely appropriate commercial reasons (eg lower cost) will in most cases lose out. Our expectation is that most companies will not change their business model or contractual arrangements but simply forgo the tax relief, as it is either not possible or commercially sensible to do otherwise.
• Companies specialising in clinical trials or other R&D services may see their claims eliminated due to the new subcontracting rules. Clinical research organisations (CROs) and other incorporated research organisations are unlikely to be eligible for relief unless their customers fall outside the UK corporation tax net (for example, where a CRO conducts trials for an overseas customer).

Summary

Overall, the new regime appears to shift the balance towards large companies at the expense of SMEs. This may initially seem like a strange government policy choice, but perhaps reflects HMRC’s current views on the level of fraud and error in the SME regime. 

There will be specific fact patterns that mean some businesses gain or lose disproportionately and therefore all companies should look at their own situation and assess the potential impacts, noting that for some claimants there will be up to two more accounting periods to apply the existing rules before the above changes impact claims.

For more information, please get in touch with Graham Steele or your usual RSM contact.