22 April 2022
Following consultation in 2021 and early 2022, the Chancellor of the Exchequer’s Spring Statement confirms that the Government intends to make changes to the enhanced research and development (R&D) tax reliefs, to take effect on 1 April 2023. The changes will affect both the R&D tax relief regime for small and medium sized enterprises (SMEs) and the R&D expenditure credit (RDEC) regime aimed primarily at large companies, and may have consequences for a variety of companies, including those that subcontract R&D to third parties or engage externally provided workers (EPWs), and those that incur particular types of R&D related expenditure.
Subcontracted R&D and EPWs
R&D tax relief for subcontracted activity will generally only be available where the third party performs the work in the UK, with this change most relevant to SMEs as relief for such expenditure is already extremely limited under the RDEC scheme. For EPWs, relief will only generally be available where these workers are paid via a UK payroll.
The aim in both cases is to ensure enhanced relief is properly targeted at encouraging innovation within the UK, and avoid incentivising R&D that takes place overseas. The reality, however, is that these changes are likely to negatively impact many businesses that choose to access a global knowledge base, leading to a reduction in the value of R&D tax relief claimed.
The proposed changes appear predicated on the assumption that businesses have the opportunity and commercial flexibility to change the way they engage with external suppliers and move towards UK-based resources. For many, this won’t be the case. Key barriers faced by businesses include:
- lack of UK resources - as a result of skills shortages, particularly in R&D intensive sectors such as engineering, software and manufacturing, businesses may not have the choice to either buy British or buy overseas, and instead they have to access the resource wherever they can find it at the time it is needed; and
- Brexit/migration – the UK’s withdrawal from the European Union (EU) has led to many workers returning to the EU, simultaneously deterring migration into the UK from the EU, further exacerbating the skills shortage.
The ultimate impact of this policy change may be that some innovative companies choose to relocate activities overseas counter to the purpose of the R&D tax reliefs. A small concession announced in the Spring Statement is therefore welcome, with the Government confirming that expenditure on overseas R&D activities can still qualify where there the R&D cannot take place in the UK due to:
- geographical, environmental, population or other conditions not present in the UK (for example, deep ocean research); or
- regulatory or other legal requirements (for example, clinical trials that must take place outside the UK).
Expenditure on particular R&D activities
A more welcome change is that the Government is pressing ahead with expanding the scope of qualifying costs to encompass, from 1 April 2023, expenditure on data sets and on cloud computing, as has been mooted for some time. Pleasingly, the Government has relented on proposals to exclude the storage element of cloud computing costs from relief, ensuring this increasingly common and significant cost of undertaking innovative activities will be appropriately incentivised.
The Spring Statement also included an unexpected boost for those seeking to commercialise advances in pure mathematics, with the news that the definition of R&D for tax purposes will be expanded to include such activities, so that associated costs can attract relief.
What to do now
Although these policy changes are not yet on the statute book and definitions are yet to be finalised, we can be reasonably confident of what the R&D tax relief regimes will look like from 1 April 2023. SMEs that currently outsource R&D activities to overseas subcontractors, and companies of all sizes that utilise overseas EPWs, should seek to quantify the expected impact on their tax position and consider whether the loss of R&D tax relief provides sufficient incentive to bring these activities onshore. Those entering into new EPW or subcontractor arrangements should consider the tax implications when choosing between UK and overseas providers.
Meanwhile, companies incurring R&D expenditure on data sets, cloud computing and pure mathematics research should ensure they have the appropriate procedures in place to identify this expenditure and include it in claims for R&D tax relief from 1 April 2023.
For more information please get in touch with James Tetley or your usual RSM contact.