Significant changes to R&D tax reliefs to apply from April 2023

HMRC recently published draft tax legislation to amend the enhanced research and development (R&D) tax reliefs regimes, following a consultation process that started in 2020. There were few surprises in the details released, but the changes are due to come into effect for accounting periods beginning on or after 1 April 2023, so businesses now have little time to prepare. The changes fall into four main areas.

Data sets, cloud computing and pure mathematics

In positive news, the categories of qualifying expenditure will be extended to include certain expenditure on data sets and cloud computing. This has been a long time coming and will be welcomed by many companies, particularly by those in the technology sector and other heavy users of cloud computing and hosting services. The Government has also confirmed that the guidelines setting out the definition of R&D for tax purposes will be amended to remove the current exclusion for projects seeking advances in pure mathematics.

Focus on UK innovation

In a significant restriction to previously qualifying expenditure, relief is to be restricted to R&D ‘undertaken in the UK’ and ‘qualifying overseas expenditure’. In practice, this means that externally provided workers (EPWs) will generally have to be paid via a UK payroll and eligible activities subcontracted to third parties by small and medium sized enterprises (SMEs) will generally need to be carried out in the UK for the associated costs to qualify for enhanced R&D tax relief. However, eligible activities of UK companies undertaken by their own employees overseas would still appear to qualify for enhanced relief under the published draft legislation.

Interestingly, under the R&D expenditure credit (RDEC) regime applicable to larger companies and certain SME costs, a similar change will be made in respect of contributions to independent research. This will impact RDEC claimants making payments to overseas universities (or other qualifying bodies).

For expenditure on overseas R&D activities that are subcontracted or carried out independently to represent qualifying overseas expenditure, the activities must be undertaken outside the UK due to the necessary geographical, environmental or social conditions, or legal or regulatory requirements, to be tested not being present in the UK. This means, for example, that expenditure on sub-contracted deep ocean research may still qualify, as would certain clinical trials operated by drug development companies.

Cost or the availability of workers are specifically excluded as reasons for R&D activities being carried out overseas, and the associated expenditure will therefore be ineligible for the enhanced R&D tax reliefs. We understand from discussions with HMRC’s technical specialists that the approach is based on the premise of allowing expenditure carried out overseas to qualify based on ‘necessity, rather than convenience or preference’.

These changes will clearly have a significant effect on many businesses and immediate action should therefore be taken to assess the impact. For many, there will not be time to amend supply chains; indeed, based on our research, most may prefer to maintain existing relationships for commercial reasons, despite the loss of enhanced relief for such costs.

Tackling abuse

Several changes to the R&D claims submission process will be introduced, including requirements that:

1. claims must be made digitally;
2. the categories of qualifying expenditure incurred should be disclosed and brief details of the R&D activities provided;
3. claims must be endorsed by a named senior company officer;
4. companies must inform HMRC in advance of their intention to make a claim within six months of the end of the accounting period to which the claim relates; and
5. details of any agent that has advised the company in making the claim must be provided.

Point 4 is of key importance as it could exclude a significant number of new entrants to the regime if they fail to notify HMRC of their intention to claim by the deadline because of a lack of awareness of either the R&D relief regime or that their activities may qualify.

While it is clear more needs to be done to prevent substandard R&D claims being submitted to HMRC and we support appropriate targeted efforts to crack down on abuse of the system, the potential consequences of this particular new rule could be a bitter pill to swallow for start-up and fledgling companies. Companies inadvertently adversely impacted could find that a valuable tap for cash flow is turned off, stunting their ability to grow, develop intellectual property, and create jobs.

Addressing anomalies and unforeseen consequences

The draft legislation also includes various measures to address anomalies and unforeseen consequences, thereby ensuring that the R&D tax reliefs operate as intended. Perhaps most notably, it ensures that employer’s health and social care levy costs may qualify for relief, and ensuring that companies that have transferred their trade intra-group are not prevented from making certain claims simply because of the transfer.

Summary

It remains to be seen whether these changes will have the desired effect, or whether an opportunity has been missed for more wide-reaching reforms to help ensure the R&D tax regimes remain fit for purpose in a rapidly changing scientific and technological environment.

With the current political turmoil to factor in too, could there be further reforms to R&D tax reliefs in the not too distant future?

For more information, please get in touch with James Tetley, Graham Steel, Sheetal Sanghvi or your usual RSM contact.