On 20 July 2022, HMRC published draft legislation for R&D tax relief changes announced in the 2021 Autumn Budget. These changes will affect companies claiming under either of the two schemes (SME or RDEC), and will take effect for accounting periods beginning on or after 1 April 2023.
Extending costs that qualify for R&D relief
R&D expenditure categories will be extended to include the costs of datasets and cloud computing. However, as expected, such costs cannot be included in R&D claims on an all-embracing basis – for example, where such costs relate directly to R&D activities, they can be included, but not where they relate to a “qualifying indirect activity” (eg where you are including a small proportion of non-technical personnel time attributable to qualifying R&D projects).
R&D in pure mathematics will also qualify for relief and can form part of the qualifying R&D activities of the claimant from accounting periods beginning on or after 1 April 2023, although the term “pure mathematics” is not yet defined in legislation.
To provide clarity, the legislation is to be amended to specifically allow that the new Health and Social Care Levy (that takes effect from 6 April 2023), will be included in the qualifying components for R&D staff costs (and payable credit caps), in the same way that National Insurance Contributions currently do.
Refocusing relief to UK activities
One of the most fundamental changes in the Autumn 2021 Budget was to refocus the R&D reliefs provided to activities performed in the UK: for accounting periods beginning on or after 1 April 2023, subcontracted R&D work and the cost of externally provided workers (EPWs) will be limited to work undertaken in the UK.
As previously announced, there will be specific exemptions where work outside the UK is permitted for geographical, environmental, social, or regulatory/legal requirements. HMRC’s statement published with the draft legislation gives examples such as deep ocean research and clinical trials, and, by inference, could include medical-tech trials in specific patient groups, international telecoms testing, or technology designed for extreme environments.
We expect further guidance to be published on the exemptions before April 2023, and the new legislations gives HM Treasury power to issue regulations to set out more detail on what falls within these exemptions. BDO will be engaging with HMRC (through the R&D Communications Forum) on the drafting of these regulations, so watch this space for more clarity on the exemptions.
In addition, there is still some uncertainty for companies with overseas branches: currently there is nothing in the draft legislation relating to work carried out by staff of an overseas branch of a UK company – so it is not clear if such costs will qualify for R&D relief in future.
A key point that the new legislation does make clear is that companies will not be able to claim that overseas costs fall within the exemptions where the main reason that the work is being carried out overseas is due to cost constraints (ie lower overseas staff costs) or that the business does not have suitable workers in the UK.
Interestingly, the draft legislation specifically excludes the new restriction on overseas costs from the R&D ‘nexus fraction’ required to calculate patent box relief – so overseas R&D costs will still increase the proportion of tax relief that can be claimed under the patent box scheme.
New administrative requirements to help “tackle abuse”
In order to support HMRC’s fight against abuse of the R&D schemes, new due diligence and filing processes will be required through a digital system. Although regulations for these have yet to be published, HMRC has announced that all claims will be required to be made digitally (except from those companies exempt from the requirement to deliver a Company Tax Return online). These claims will require a breakdown of costs across category and the inclusion of a brief summary of the R&D activities performed.
In addition, claims will require the endorsement of a named senior officer of the company and will also need to include details of any advisory agent used as part of the submission.
Finally, the draft legislation already includes a requirement for companies to inform HMRC of their intention to file a claim within six months from the end of the period to which the claim relates. Notification of this kind will not be required where a company has claimed in one of the preceding three periods.
Tidying up unfair elements of the R&D rules
It is clear that the government plans much tighter controls over R&D claims in the future. For example, it is now legislating to give HMRC a specific power to collect overpaid R&D tax relief or expenditure credit under the self-assessment tax laws (rather than relying on its common law rights). However, as a result of this general updating of the R&D rules, the government has included a number of small administrative changes that will prevent companies from losing out in unexpected ways when enforcement action is taken.
For example, the rules will be changed to ensure that where HMRC rejects a claim under the RDEC rules, or determines a tax assessment on RDEC against a company, it will be possible to submit an amended claim within 30 days. This ensures that making an error in a claim will not mean that the right to make a corrected claim is lost.
Similarly, where an R&D claim was incorrectly made under the R&D SME scheme, where HMRC rejects the claim and the time limit for amending claims has expired, it will still be possible for the company to make a claim under the RDEC scheme. This is a welcome development, as testing whether a company qualifies under the SME rules can be complex, and it is frequently an area where mistakes are made.
Currently, where a company breaches the SME size tests, it is allowed to continue to claim under the SME scheme for one additional year, but other members of its group lose SME status. This one-year extension to SME claims will be made available to all group companies from April 2023.
Another potentially unfair rule is that R&D relief cannot be claimed where a company is not a ‘going concern’ – which can currently occur for a number of reasons. In future, if a company ceases to be regarded as ‘going concern’ solely because of the transfer of a trade out of the business, but it is otherwise financially viable, the company will still be able to claim R&D relief.
Help with your future R&D claims
There is clearly much to be finalised in the forthcoming regulations, draft legislation and in, hopefully, further guidance from HMRC on how claims will need to change from 1 April next year. However, it is clear that there will be much greater scrutiny of claims, and that businesses outsourcing their R&D project work overseas will need to review their financial projections and arrangements for future years.
BDO can help you rethink both your strategic and practical approach to claiming R&D relief and provide the high-quality support you need to give certainty over your future claims and funding. Please get in touch with Carrie Rutland or Steven Levine for help and advice.