Overview:
- 2021 Spring Statement introduced the PAYE Cap which would limit the payable tax credit to a maximum amount of £20,000 plus 300% of the company’s total PAYE.
- 2022 Spring Statement focused on expanding R&D tax relief to cover data and cloud computing costs and elaborating on the ‘overseas expenditure’ rule.
- 2022 Autumn Statement saw SME reduction from 130% to 86% for the enhancement rate and 14.5% to 10% for the payable tax credit rate. Conversely, the RDEC scheme saw an increase from 13% to 20% equating to a 42% increase after tax from 10.5% to 15%.
- 2023 Spring Statement introduced the R&D intensity ratio for companies investing 40% of their total expenditure on qualifying R&D, retaining the existing R&D tax credit rate for loss-making SMEs. The statement also introduced the additional information form (AIF) for claims filed after the 8th of August 2023 and the advanced notification form for new claimant companies for trading periods starting from 1st April 2024.
- 2023 Autumn Statement announced the new merged R&D scheme, following the consultation in Q1 of 2023.
- 2024 Spring Budget established an expert advisory panel by HMRC to support the administration of R&D tax relief with insights into cutting edge R&D across key industry sectors.
The R&D tax credit regime first appeared in the UK in 2000; since then, it has become a mainstay of the UK tax incentive system, providing invaluable relief for many small and large businesses. The credit has also served as a source of funding for many scale-up companies, particularly those in innovative sectors such as life sciences.
In 2021, the system became a political hot potato as the once stable regime had become significantly complicated over the years. The regime included two separate schemes – one was only open to SMEs and the second (less generous) RDEC regime was open to both SMEs and large companies. The policing of the regime left it open to abuse with ill-informed or unscrupulous companies and advisors making spurious claims.
What followed was a period of unprecedented change, with significant reforms announced at every fiscal event (i.e., Spring Budgets and Autumn Statements) from early 2021 to the end of 2023. Many of the changes were fundamental to the operation of the regime; occasionally, changes were announced only to be reversed within a matter of months. These changes came with a range of different implementation dates and methods, while the legislative announcements were followed by guidance from HMRC on how the new rules would be applied, though often delayed. We also witnessed a clear shift in HMRC’s approach, including greater scrutiny over qualifying activities.
Inevitably, this has led to confusion and uncertainty. In this article, we’ll summarise the newly introduced changes and set out the corresponding implementation dates. While we are still awaiting guidance on some areas, it appears the major reforms have been set for now.
Spring 2021
The 2021 Spring Budget took the first significant step in the reform of the R&D tax relief system, introducing the PAYE Cap to the SME scheme. This cap limited the payable tax credit for loss making companies to a maximum amount of £20,000 plus 300% of the company’s total PAYE and NIC liabilities for the claim period, unless certain exemption criteria were met. The exemption criteria are as follows:
- Intellectual property (IP) is actively being created or managed by the company’s employees and
- No more than 15% of a company’s qualifying R&D expenditure is spent on work contracted to (or provided by externally provided workers (EPWs)] connected parties such as overseas parents or subsidiaries.
Spring 2022
From the time of the COVID-19 pandemic, the Government has acknowledged the need to focus on incentivising and supporting modern computational research that relies heavily on data analysis and cloud computing. Tech companies and R&D specialists have long advocated for expanding the scheme to cover these key areas of expenditure. This Budget reclassified those categories of expenditure as qualifying for R&D tax relief for accounting periods beginning on or after 1 April 2023. Additionally, the Government elaborated on its proposed “overseas expenditure” rule, making it clear that expenditure incurred “for R&D activities undertaken overseas” could not be claimed unless it met a narrow exemption; essentially, expenditure would only be allowed when the company had no choice but to carry out such R&D work outside the UK. The introduction of the overseas expenditure limitation was subsequently postponed, but HMRC has now provided meaningful guidance and closed consultation on the draft guidance.
Autumn 2022
In Autumn 2022, we saw the first meaningful rate changes for both the SME and RDEC schemes. The reductions for the SME scheme were significant, as the enhancement rate dropped from 130% to 86% and the payable tax credit rate was cut from 14.5% to 10%, which halved the value of the tax relief available to those most in need. This led to a general questioning of the Government’s support for R&D in small businesses, and the ensuing outcry led to a U turn of sorts – the change was postponed from its original 1st April 2023 commencement date and a consultation opened into the introduction of a new merged, single R&D scheme.
Conversely, the announcement further entailed an increase to the RDEC credit rate (from 13% to 20%). This improvement in the RDEC regime was intended to ease the impact of the new overseas expenditure rules and reduce the impact on multinational enterprises (MNEs) with domestic skill shortages. Public perception was that the Government was attempting to narrow the gap between the two old schemes in preparation for the proposed single scheme.
Spring 2023
The Spring Budget of 2023, dubbed the “Back to Work Budget,” included important modifications to the Autumn 2022 announcements. Following extensive lobbying (most notably by the bioindustry sector), enhanced benefits for SMEs would now be available if the company was an “R&D-intensive loss-making SME”. To be considered R&D Intensive, a company needed to have at least 40% of its total group expenditure as qualifying R&D. It would then be eligible to claim a payable credit rate of 14.5% of the surrendered loss for expenditure incurred from 1 April 2023. Following further consultation, the 40% threshold was subsequently lowered to 30% in the Autumn Budget, as below detailed.
Additionally, the Government announced two new compliance measures for R&D claimants. Foremost, first-time R&D claimants would be required to submit an advanced Claim Notification Form for any accounting period starting on or after 1 April 2023. This would need to include information about the specific R&D projects and the expected expenditure for the claims they were making. The parameters were becoming clearer, including companies knowing in advance that they were about to undertake R&D rather than having advisors come along afterward to help companies make speculative claims.
Secondly, all claimants would be required to submit an Additional Information Form (AIF) providing in depth descriptions of the project work undertaken and detailed calculations for the expenditure incurred. Following some delays, this rule came into effect for all claims filed after 8 August 2023. This presented a significant new challenge for companies requiring comprehensive information which can be easily rejected by HMRC if standards are not met.
In addition to the compliance measures, the Government formally announced the postponement of the restriction on overseas expenditure from its intended start date of 1 April 2023, pending the outcome of the consultation for a single, merged R&D scheme.
Summer 2023
In July 2023, HMRC released the results of its Mandatory Enquiry Process (MEP) in an attempt to understand the true level of non-compliance. MEP’s estimates of incorrect/spurious R&D tax credit claims went up from £336m to £1.14bn for the 2021 tax year alone. This led to a significant increase in compliance activity and sweeping changes in the way HMRC assessed and measured the quality of R&D tax relief claims.
Autumn 2023
The rolling changes to the R&D tax credit system continued with the Autumn Statement 2023. The most significant announcement was the introduction of the new single R&D scheme to replace the old RDEC and SME schemes. The new scheme applied for accounting periods beginning on or after 1 April 2024. This was met with general approval by the business community and broadly followed the outcome of the consultation undertaken in early 2023. The previous dual scheme approach had led to confusion, with claimants often having to make claims under both schemes during a single trading year (e.g., when a company had received InnovateUK grant funding toward one particular project). The prior approach also led to significant disparity between the value claimants realised with the SME scheme compared to the less generous RDEC scheme. A single, merged scheme presented a solution to this complicated dichotomy by simplifying the overall procedure and creating unified, easier to follow guidelines. As a result, companies were starting to see a more level playing field for businesses engaged in R&D work in the UK.
Other key announcements in the Autumn Statement included the relaxation of the R&D intensity threshold from 40% to 30% and the introduction of a year of grace for claimants that fall outside the threshold (allowing them one final year at the enhanced level). A further benefit was given to loss-making companies that were only eligible for the RDEC scheme; the effective rate of tax on the RDEC credit was reduced from 25% to 19% for these companies, meaning more cash was retained as part of the claim.
Key Highlights from the Merged Scheme
The new merged scheme aligns with the principles of the RDEC scheme, offering a tax credit of 20% on qualifying expenditures, which is treated as trading income before deducting a notional corporation tax charge. This new regime applies to businesses of all sizes, with the exception of R&D-intensive, loss-making SMEs, for which a more generous parallel scheme exists.
The impact on loss-making SMEs that don’t meet the R&D intensity ratio is that their tax benefit is reduced to 16.2% of their qualifying R&D spend, compared to previous amounts of up to 33.35%. These SMEs must also now reflect the RDEC credit as an “above the line” credit in their accounts.
For loss-making SMEs that do meet the R&D intensity ratio, enhanced R&D intensive support (ERIS) is available. Effectively this operates as a separate scheme with rules similar to the old SME scheme. ERIS provides an effective tax benefit of 26.7% of claim expenditure, compared to 16.2% under the merged scheme, and there is no requirement to include the credit as an “above the line” item.
- The available credit under ERIS is still subject to a PAYE cap of £20,000 plus three times the company’s PAYE and NIC liabilities for the year. Any excess credit is carried forward to the next period. The exemptions from the historic PAYE cap remain in place.
- There is no restriction on claiming subsidised expenditure under the merged scheme or ERIS, unlike the previous SME restrictions.
The new scheme and guidance clarify which company is eligible to claim R&D relief when companies and their subcontractors work on the same scientific or technological uncertainty. Now, the party that “intended or contemplated” to initiate or undertake the R&D can make the claim. HMRC has published extensive draft guidance on this, and careful attention is needed to ensure correct claims.
From April 2024, expenditure on R&D activities conducted overseas will generally not qualify for the credit unless it meets specific exceptions. The exceptions apply if:
- The necessary conditions for R&D are not present in the UK;
- The conditions are present at the overseas R&D location;
- It would be wholly unreasonable to replicate these conditions in the UK.
Notably, HMRC has published extensive draft guidance on this matter, and it should be carefully reviewed to ensure claims are accurate.
Spring 2024
The fast-paced evolution of the R&D tax relief scheme introduced a new set of challenges for HMRC as well as for taxpayers and their advisors. The tax authorities needed to rewrite their guidance, improve administration and address the complex compliance issues of error and fraud. Key news involved the establishment of an expert advisory panel within HMRC aimed at supporting the administration of the R&D tax relief system and providing insight into cutting-edge R&D across key industry sectors such as technology and life sciences. The expert panel will work with HMRC to review relevant guidance, ensuring it remains up to date and provides clarity to claimants.
Where We Are Now
The government continues to be rightly ambitious with its R&D tax objectives, seeking to promote stronger innovation within its borders, giving the UK a competitive advantage economically; however, the complicated history and frequent legislative changes have led to inconsistent application of the rules governing the reliefs. The piecemeal approach has demonstrated that the government has struggled to make sense of how R&D tax structure should function amidst a complicated and everchanging economic and social climate, which may explain its inconsistent and complicated character.
The introduction of the new single R&D tax relief scheme marks a significant milestone in the evolution of the UK’s R&D tax landscape, offering a much-needed period of stability and clarity for claimants and advisors. Following years of continuous changes and overlapping consultations, the establishment of a unified scheme effective from April 2024, promises a more streamlined and coherent approach to R&D tax relief. This new scheme simplifies the claims process, reduces the disparities between the former SME and RDEC schemes, and aligns qualifying expenditure categories, thereby fostering a more level playing field for all companies engaged in R&D activities.
It is hoped that this period of calm and consolidation is expected to restore confidence in the R&D tax relief system, encouraging more businesses to invest in innovative activities without the fear of sudden, disruptive policy shifts. The new single scheme represents a positive step towards a more efficient and supportive R&D tax environment in the UK, aligning with the broader goals of fostering innovation and economic growth; however, it remains to be seen how the recent election result will impact the scheme going forward.
For more information, please contact:
Thomas Wells, Senior Manager, R&D Tax | thomas.wells@frazierdeeter.com
Malcolm Joy, UK Managing Partner | malcolm.joy@frazierdeeter.com