Perhaps your current adviser has already updated you on this, however in case they have not, we wanted to share with you several changes to research and development (R&D) tax reliefs that will take effect from April 2023.
Key changes are:
- Exclusion of overseas R&D spend
- Inclusion of cloud computing and data costs
- Pre-submission notification to HMRC
- Changes to the enhancement rate and tax credit relief rate for the SME scheme
- Increasing enquiry rates
- Changing interpretation of eligibility of “subcontract R&D”
We thought you’d like to know what the announced changes are and what they might mean to you and your business. Now is the time for you to familiarise yourself with these changes and understand how they might impact on your R&D strategy over the next two years.
The changes are outlined in this booklet, and we have also noted some of the ways you can minimise the potentials impacts.
1. Overseas R&D Ban – Will it Affect Your R&D Tax Relief Claims?
Under the current rules for both schemes, companies can claim relief on R&D activity that is conducted overseas. Going forward, expenditure on subcontracted R&D and the cost of EPWs employed on R&D projects outside the UK would no longer be eligible for UK R&D tax relief.
There will however be some circumstances when it will be impossible for companies to conduct research within the UK, and under these exceptional conditions claimants will still be allowed to claim relief on R&D expenditure incurred outside the UK. For example, in some instances material factors such as geography, environment, population or other conditions that are not present in the UK but are indispensable to the research, may dictate that a research project is carried out overseas.
Similarly, HMRC is willing to accept extenuating circumstances involving regulatory or legal requirements, in relation to aspects such as clinical trials or treatment regimes, which may mean R&D projects will need to take place outside the UK.
On the bright side, materials sourced overseas, and costs related to data and cloud computing sourced overseas can still be claimed for if these are an intrinsic part of R&D carried out in the UK. We encourage you take external advice in order to recalibrate the way you are making claims, as you might need to consider how your R&D activities are structured to ensure the costs remain allowable in the UK.
2. R&D Tax Credits To Include Data And Cloud Computing Costs
Manufacturers using digital twinning to aid digital simulation & prototyping projects, or those using big data to analyse and resolve issues (aerodynamics, performance of materials under stress, etc) will be pleased to hear that companies claiming R&D tax relief will be able to claim relief against all costs associated with data, cloud computing and mathematics.
Companies will be able to claim relief against the costs associated with using third party resources and services in the acquisition, analysis and storage of big data, making greater use of digital twinning, simulation and prototyping. Businesses will also be able to claim relief for pushing the boundaries of pure maths – for example in mathematical modelling projects which help to better understand vibration patterns in electrical equipment to effect better dampening strategies or to improve the performance of optical identification systems on inspections lines.
The inclusion of such costs to the R&D tax relief schemes will bring huge benefits to the “modernising manufacturing” agenda, which relies heavily on the use of data throughout R&D, design and innovation, including digitalisation and automation projects.
Furthermore, the ability to claim relief against costs for the use of third-party facilities and services makes these resources more accessible for smaller companies that may previously have been excluded due to high costs of entry, levelling the playing field in the digitalisation of R&D.
3. Pre-Submission Notification to HMRC
HMRC recently confirmed that from April 23rd 2022, companies considering applying for R&D tax relief will need to give advanced notification of their intention to claim within six months of the period-end for which they are planning to submit a claim. Companies that have already submitted a claim on any of the three previous periods will not need to give prior notification.
While this new process will serve to give HMRC staff greater visibility of upcoming work in the pipeline, it also creates an unexpected obstacle for companies new to the R&D tax relief scheme and with no previous track record of claims, requiring them to be much more agile in identifying and assessing the size of the opportunity before them, e.g:
- Is the work they have undertaken eligible for relief?
- Is there sufficient spend to make a claim worthwhile?
- More importantly, can they undertake this assessment within the six-month timeframe.
There is likely to be, in April 2023, a stampede of companies seeking to submit pre-notifications within the 6-month deadline, driven largely by zealous R&D providers. It may be more prudent to submit a claim prior to March 2023, for one of the two previous periods, thereby avoiding the rush for pre-notification next year.
Alternatively, establishing a relationship with an R&D tax provider now, will facilitate the on-going analysis of R&D activity and expenditure, ensuring early confirmation on whether there is a legitimate claim and subsequent prenotification.
4. Changes To The Enhancement Rate And Tax Credit Relief Rate For The SME Scheme
Unfortunately, in an apparent effort to reduce fraud, there has been a significant cut to the rate of SME additional tax relief from 130% of the R&D expenditure to 86% from 1 April 2023. The effect of this will be to reduce the tax benefit for a tax paying company from 24.7% currently to 21.5% on eligible expenditure incurred from 1 April 2023.
However, it will be loss-making companies who suffer the most as currently they can surrender losses for a cash R&D tax credit at a rate of 14.5% but this is being reduced to 10%. The effect of this will be to reduce the potential tax benefit from 33% currently to 18.5% on expenditure incurred from 1 April 2023.
Whilst we agree that measures should be introduced to address the concerns that the SME regime has been subject to abuse and error, we feel that the cuts to the SME regime have gone too far. These changes will have a significant impact on the resources available to SMEs for reinvestment in their businesses, creating a hostile environment, endangering management teams’ commitment to on-going investment and ultimately compromising businesses’ competitiveness.
As you would expect, there has been a significant outcry regarding the cuts to the SME regime rates with recent articles in the press (including the Times) demonstrating this.
The Government has stated its intention to move to a single simplified R&D tax claim regime and to look at providing additional incentives to R&D intensive SME companies. Therefore, as with any Government announcements, there is the possibility that these may change before the date of implementation, and we will keep you up to date with any news on this.
5. Increasing HMRC Enquiry Rates
In the last two years, HMRC has increased the rotation of inspectors around HMRC units and are now employing additional inspectors specifically within their R&D tax relief claims unit. This has led to a significant increase in R&D tax relief compliance checks, also known as “enquiries”.
While enquiries take up valuable time, the ultimate consequence is a delay in HMRC settling the claim, which in turns hinders the injection of funds back into the claiming company. Worse still, there could be a reduction to the benefit being offered by HMRC or a total rejection of the claim!
So, what are the three steps companies must follow to ensure they minimise the likelihood, and impact of an enquiry?
- It’s vitally important that businesses provide crystal clear supporting documentation for their claims. When it comes to justifying the claim, there should be an explicit statement of the baseline of knowledge at the start of the project, along with where the team hoped to advance the baseline, identifying the technical uncertainties which were addressed in the process of making the advance, as well as the work done to resolve these uncertainties.
- The claiming company then needs to be accurate in the reporting of costs and expenditure.
- Finally, the company needs to clearly identify the credentials of individuals being cited as “competent professionals” in relation to the eligible R&D carried out, as well as those of their chosen agent preparing the R&D tax relief claim. Being able to prove you have followed the above there steps whilst compiling your claim should satisfy HMRC inspectors that the claim is justified, accurate and robust.
6. Finally, Is Your Subcontracted R&D Putting You At Risk Of An HMRC Enquiry?
Like many R&D tax relief practitioners over the last few years, we have become increasingly aware of a significant increase in R&D tax relief related audits and enquiries.
Most of it is due to HMRC’s increased crackdown on non-compliance and their efforts to drive provision of accurate information in tax relief claims and fraud.
An area of confusion is the interpretation of the rules related to claiming R&D tax relief in subcontract scenarios. A prominent case in 2021 (Quinn v HMRC) demonstrated that HMRC considered the R&D to be subsidised by the commissioning
company, as the claimant did the work while completing a commissioned contract. HMRC concluded the company making the claim would need to claim through the RDEC scheme for subsidised work and the SME scheme for non-subsidised elements.
In order to ensure that they stay on the right side of HMRC’s interpretation of the rules and reduce the likelihood of an enquiry, it is critical that claiming companies are clear on a number of points:
- Are the technical challenges intrinsic and critical to the completion of a contract or could the contract be completed without addressing the technical challenges? Meaning the eligible R&D activity is beyond the remit of the contract.
- Similarly, did the financial compensation for the contract include a payment specifically for any R&D work packages carried out or was R&D expenditure at the discretion of the subcontractor and paid for from its own resources? The answers to these questions give a strong indication as to where both the technical and financial risk might lie within a contract and, consequently, which party has the strongest claim over a potential R&D tax relief claim.
Mindful that innovation is key to economic recovery, the Government will continue to provide innovation incentives, but will double-down on ensuring that tax reliefs only go to those who are eligible.
It’s easy to see that whilst many companies will have applied for R&D Tax Relief for many years or have a good understanding of the scheme, continued reform of R&D tax credits by HMRC means that extra caution is needed.
That’s why it’s always a good idea to have and R&D tax expert such as ABGI help you though the process to ensure your claims are compliant, maximised and risk-free.
If you have any questions relating to R&D tax relief or wish to discuss the implications of recent changes to the R&D tax relief scheme on your own claims, please contact ABGI and a representative will get back to you to discuss your unique needs and explain how we can assist.
Call: 0203 984 0321
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