Research and development tax relief reforms – who are the winners and losers?

The government announced further reform to Research and Development (R&D) tax relief in its Autumn Statement in November 2023.

Our initial thoughts and commentary can be found here, but to summarise, the current Research and Development Expenditure Credit (RDEC) and R&D Small and Medium Enterprise (SME) schemes will be merged for accounting periods beginning on or after 1 April 2024.

These reforms are the latest in a number of measures that the government and HM Revenue & Customs (HMRC) have introduced to change the landscape for companies carrying out R&D, including changes to the rates of relief available from April 2023, further compliance requirements in order to qualify for relief and increased HMRC scrutiny of R&D claims.

It is our hope that these are the final measures implemented in the medium term so that companies can adequately plan their R&D activities with relative certainty for the coming years.

With this in mind, who are the winners and losers from the recent reforms?

Small and Medium Enterprises

Unfortunately, most SMEs will consider themselves to be in the ‘losers’ category. Profit-making SMEs have seen reductions in tax relief from 24.7% of expenditure pre-31 March 2023, to a likely 15% of expenditure from 1 April 2024 as a result of the upcoming merger with the RDEC scheme. In the interim, the rate of relief is 21.5%.

The picture is potentially even worse for loss making SMEs, with relief reducing from 33.35% of spend to 16.2% in the same periods as above, with 18.6% available in the interim. However, for SMEs who are considered ‘R&D intensive’, the rate of relief will be 26.97% from 1 April 2023. Companies are considered R&D intensive if their R&D spend is at least 40% (from 1 April 2023) or 30% (from 1 April 2024) of their total annual spend.

In addition to the changes to the effective rates of relief, the method of calculating and reporting R&D tax relief will change for SMEs. The small upside is that for profit making or non-R&D intensive SMEs, as part of the merger of the two R&D schemes, the tax relief will be reported ‘above the line’. This means that a taxable income is reported in the company’s accounts and is generally considered a positive change as it gives greater visibility to companies claiming R&D tax relief.

Companies Qualifying for RDEC

Companies, which are not SMEs, making claims under RDEC can generally consider themselves as being in the ‘winners’ category as the rate of relief available has increased from 10.53% pre-31 March 2023 to 15% thereafter.

Furthermore, for RDEC claimants with small UK based payrolls, the cap that applies to the amount of repayable credit will change to the more generous version that applies under the SME scheme, being 300% of PAYE and NICs due plus £20,000.

The merging of the schemes will also allow RDEC claimants to have greater ability to claim for contracted out R&D, as the more generous rules that applied to SMEs will be available going forwards, lifting the restriction that payments must be made to individuals or ‘qualifying bodies.

However, SMEs claiming RDEC because, for example, they undertake R&D that has been contracted to them by a large company, will lose out. This is due to the general aim of the measures being that contracting parties should be claiming relief, as ultimately they are making the decisions and bearing the risk of any R&D activities. However, if a company is contracted to carry out R&D by an overseas company, it may be possible to still claim tax relief under the merged scheme.

Companies with overseas expenditure

From 1 April 2024, expenditure must either be ‘UK expenditure’ or ‘qualifying overseas expenditure’ undertaken outside the UK because the necessary conditions are not present in the UK due to geographical, environmental, social or legal factors. HMRC have confirmed that costs or availability of workers will not be sufficient reasons to make overseas expenditure qualify for relief. Therefore, for companies with significant overseas spend, there could be a significant restriction in the amount of expenditure that qualifies for relief.

Summary

According to HMRC’s latest figures, SME claims make up the vast majority of total R&D claims, both in terms of number of claims (87.7% of the total) and the tax relief claimed (63.2% of the total). The reduction in rates of relief, together with increased compliance costs and scrutiny from HMRC will surely affect both the number of SME claimants and the amount of relief available to those who do claim, albeit this may be offset by an increase in RDEC claims.

If your company is considering a claim, or already claims R&D tax relief and you would like to know how the recent and upcoming changes will affect its tax position, please get in touch with your usual Kreston Reeves contact or contact us here.