R&D tax relief changes

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Research & Development (R&D) tax relief changes – how they work in practice

Research & Development (R&D) tax relief changes – how they work in practice

Find detailed analysis of how the merger of the two R&D tax relief schemes in 2024 will work and what they might mean for your business here.

Research & Development (R&D) tax relief can provide valuable financial support if you are a business that is investing in innovation and developing new processes, products or services. However, a series of recent reforms to the rules means that understanding exactly how the R&D tax relief regimes work and when the many different changes come into force may be of critical importance to your financial projections.

Important changes to the way R&D claims must be made also came into effect from 8 August 2023, requiring companies to provide an Additional Information Form – get the full details.

Why is the R&D tax relief regime changing?

The government has a target to raise investment in R&D to 2.4% of UK GDP by 2027. R&D tax relief contributes to that goal by reducing the cost of innovation for UK companies and the Government wants to make it more effective to increase “additionality” – the extra R&D spend that companies claiming the relief make. It is also introducing changes to the claims process in order to tackle errors and suspected abuse of the R&D tax relief regime – see above.

As of April 2024, the two separate RDEC and SME tax credit schemes will be merged, both to streamline the relief and help control its overall cost.

Find full analysis of the merged R&D tax relief schemes here.

R&D tax relief rates changing

The Government has announced changes to the rates of relief in the past few Autumn Statements and Budgets – the latest position is shown below:

	SME Scheme		RDEC Scheme		Merged Scheme
	Up to 31/03/2023	From 01/04/2023	Up to 31/03/2023	From 01/04/2023	From accounting periods starting on or after 01/04/2024
Profitable company	130% uplift on costs = 24.7% net benefit	86% uplift on costs = 21.5% net benefit	Headline rate 13% = 10.5% post tax	Headline rate 20% = post tax rate between 14.7% - 16.2%*	Headline rate 20% = post tax rate between 14.7% - 16.2%*
Loss making company	Costs plus 130% uplift = 230 x 14.5% repayable credit = 33.4% subsidy	Costs plus 86% uplift = 186 x 10% repayable credit = 18.6% subsidy	10.5% subsidy	15% subsidy	16.2% subsidy
Loss making R&D intensive company**	NA	Costs plus 86% uplift = 186 x 14.5% repayable credit = 26.97% subsidy	NA	NA	NA

* The post tax RDEC/Merged scheme rates from 1 April 2023 will vary depending on the level of taxable profits a company has and corporation tax rate applied to those profits. The Net RDEC at the main rate of CT (25%) is 15%, for the small companies rate (19%) is 16.2% and for companies paying tax in the marginal rate band (26.5%) is 14.7%.

**Loss-making R&D intensive companies are those whose qualifying R&D expenditure constitutes at least 40% (from 1 April 2023) or 30% (from accounting periods starting on or after 1 April 2024) of total expenditure (splitting accounting periods as required). Total expenditure for this purpose will be calculated from the total expenses figure in the profit and loss (P&L) account, adjusted by adding any amount of expenditure used under s1308 Corporation Tax Act (CTA) 2009 and by subtracting any amount not deductible for CT purposes.

Many R&D costs can be claimed when they are incurred but this does not always apply. For example, costs covering a period of time, such as employee bonuses, will need to be apportioned on the accruals basis.

For the 2022/23 and 2023/24 tax years, if you have a year-end that straddles 1 April, you will need to do a split period calculation for R&D costs to ensure you apply the correct rates of relief. In some cases, where apportioning costs is challenging, HMRC may accept a blended rate of relief for a period that straddles a rate change, if it doesn’t materially impact your claims.

It has been confirmed that the repayable credit available under the merged scheme will be based on the more generous PAYE/NIC cap rules under the existing SME scheme Read more on the SME cap.

Technical changes to the R&D tax relief regime

In addition to the rate changes, a number of technical and administrative changes are on the way, but these apply for accounting periods starting on or after 1 April 2023 or April 2024.

HMRC has broadened the scope of who can apply for Advanced Assurance of their R&D claims. All SMEs are eligible to apply for Advance Assurance for R&D they are planning to do (or have already done) as long as the company is not part of a group and none of the companies linked to the claimant entity have previously made a claim.

From a process standpoint, application remains relatively straightforward with the submission of an online form. However, before the company can proceed to claim for R&D tax relief for accounting periods beginning on or after 1 April 2023, a claim notification form to notify HMRC must be completed. HMRC will also contact companies seeking Advance Assurance to arrange a telephone call discussing the R&D in more detail. This is normally a short telephone call, but it may involve a longer discussion or a visit to the company in complex cases. We would recommend professional advice is sought prior to making an Advance Assurance application in order to streamline the process and minimise the time required by the business seeking it.

The Guidelines on the meaning of research and development for tax purposes (issued by the Secretary of State for the purposes of Section 1006 Income Tax Act 2007) were updated on 7 March 2023.  Paragraph 1 now states that ‘For the purposes of research and development allowances (Part 6 Capital Allowances Act 2001) this definition is extended to include oil and gas exploration and appraisal as defined in Section 1003 of Income Tax Act 2007.  The new Guidelines also clarify the position on qualifying indirect activities (QIAs). The original footnotes 2 and 3 to the 2004 Guidelines have been removed because they stated that the QIAs listed in para 31 are R&D, but do not attract R&D tax credits. In fact, whether or not expenditure on the QIAs qualifies for R&D tax relief depends on a number of factors, and there never has bene a blanket exclusion of them.

R&D expenditure categories have been extended to include the costs of datasets and cloud computing. However, there are exceptions such as when these relate to a “qualifying indirect activity” 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. The Guidelines on the definition of R&D now state:

‘Mathematical techniques are frequently used in science. From April 2023 mathematical advances in themselves are treated as science for the purposes of these Guidelines, whether or not they are advances in representing the nature and behaviour of the physical and material universe’.

This definition is, perhaps, rather wider than previously expected. For example, the development of new mathematical models, the study of mathematical structures and symmetries may qualify alongside the exploration of new mathematical concepts and the foundations of mathematics itself.

Changes originally announced for accounting periods beginning on or after 1 April 2023 are now to take effect for costs incurred in accounting periods starting on or after 1 April 2024. R&D activity will have to be physically located in the UK for the costs to be included in R&D tax relief claims. UK companies who currently claim R&D costs paid to overseas group companies or third parties may no longer be able to include these costs in their claims. The costs of externally provided workers (EPWs) will be limited to work undertaken in the UK where workers are paid a salary under the PAYE/NIC scheme.

There are 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 therefore, by inference, this would include medical-tech trials in specific patient groups, international telecoms testing, or technology designed for extreme environments.

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 or that the business does not have suitable workers in the UK.

There are also many issues to consider when it comes to the international structures of businesses carrying out R&D. For example, a UK group may have a branch in another company where work on UK R&D projects is undertaken. If all the IP from the project is retained in the UK and profits from the overseas branch are taxed in the UK, the staffing costs of the ‘overseas’ work will continue to be allowed for UK R&D relief purposes.

Conversely, if an overseas company seconds a worker to a group company in the UK to carry out a UK R&D project, but the worker is paid by the overseas company (recharged to the UK company at a mark-up), those salary costs will not qualify for UK R&D relief. The worker must be liable to UK PAYE and NIC for the costs to qualify.

The new restriction on overseas costs does not apply to 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.

Timing example

ABC Limited’s accounting year end is 30 September, it has several ongoing R&D projects, and qualifies as an “non-R&D intensive" SME. It is outsourcing some of its software development to a third party in India, and incurs cloud computing costs in running test routines for products and services in development.

The apportionments ABC Limited will have to do to compile its R&D claim for the accounting year to 30 September 2023 will at least include:

Software development costs outsourced to India – these will be allowable for this accounting year based on the work actually done in the periods:
1 October to 31 March – claim relief on 65% of costs, with 130% uplift
1 April to 30 September - claim relief on 65% of costs, with 86% uplift
UK direct costs for project – claim 100% of the amounts attributable to the qualifying R&D, and apportion before and after 31 March to apply 130% and 86% uplifts or, if consistent through the year, agree with HMRC that a blended uplift rate of 108% can be applied.

ABC Limited will not be able to claim for its cloud computing costs for the year ended 30 September 2023, as this year commences prior to the 1 April 2023. By comparison, ABC Limited will be able to claim for its cloud computing costs for the year ended 30 September 2024. For the year ended 30 September 2025, it will see its R&D relief restricted to RDEC rates under the new merged scheme and will be prevented from claiming overseas development costs.

R&D tax relief claim process

All claims are required to be made digitally, except for companies exempt from the requirement to deliver a Company Tax Return online, and include an Additional Information form to be submitted through a new online portal (ie separately from the main Corporate Tax Return). An Additional Information form will be required for every R&D claim made on a tax return and all details must be entered (even if you are making a second or later year claim on the same project) – it has even confirmed that HMRC Customer Compliance Managers do not have the authority to dispense with the form for specific clients where they already have details of the claim.  Each Additional Information form must be signed by a named senior officer of the claimant company and must contain detailed information on the R&D project - including the name of the agent who has advised the company on compiling the claim. The form must also include a breakdown of costs across categories. However, the from does not, in many instances, completely replace the R&D report that is currently submitted by good R&D advisors. Indeed, HMRC recommend that large businesses in particular submit an R&D report along with their R&D claim to explain the methodology and cost sampling techniques used to prepare the claim. If the ‘Additional Information Form’ has not been completed, that this renders the R&D claim invalid and HMRC will have the power to remove the R&D claim from the company’s tax return where it believes a claim was made “in error".

Companies are required to inform HMRC of their intention to file a claim at any time from the start of the accounting period to six months after the end of the accounting period to which the claim relates. The aim of this rule is to prevent last minute ‘speculative’ claims made after the relevant accounting year: it took effect for accounting periods starting on or after 1 April 2023. HMRC have confirmed that if the 'Advance Notification Form' is needed but not completed that this renders the R&D claim invalid and, if shown in the corporate tax return, it will be removed by HMRC as an "error".  There are exceptions to the Advance Notification requirement – for example, you do not need to make advance notification for every single project in an accounting period. In addition, where claims are made within six months of the end of the accounting period, provided you have claimed in the three years preceding the end of the claim notification period there is no need to notify.  When making an Advance Notification, a company must submit "a summary of the high-level planned activities, for example if you’ve developed software what it will be used for to show that the project meets the standard definition of R&D". However, it is not necessary to submit proof or documentation at that stage. The Advance Notification form is available here.

Where HMRC challenges a claim under the RDEC regime or determines a tax assessment on RDEC against a company, it is 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.

Where a company breaches the SME size tests, it is allowed to continue to claim as an SME for one additional year, but other members of its group lose SME status. This one-year extension to SME claims was made available to all group companies for accounting periods starting on or after 1 April 2023.

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. This has been applicable for accounting periods starting on or after 1 April 2023.

Making successful R&D tax relief claims

The process of making an R&D tax claim can be complicated but there are some simple things you can do to improve the accuracy and the effectiveness of your R&D claims. Follow some basic best practice advice, get expert advice and consider using our R&D tax claim tool to calculate and risk assess your claim.

There are simple steps you can take to minimise the risks of a having an R&D tax relief claim reviewed or challenge with all the associated costs and delays.

When submitting a claim, make sure you clearly define your case and how you arrived at that decision, to prevent any potential challenges on HMRC’s part, completing all entries on the R&D section of the corporation tax return (CT600 form).

Ensure you submit a well-structured, technical report to support your R&D claim, with HMRC stating that 'submitting additional information to support any claim, such as an R&D report, will also help HMRC to process claims quicker'. This will also leave HMRC in no doubt about the reasons behind the submission.

HMRC has set out 13 expectations for steps that should be taken before an R&D claim is submitted in it's "Guidelines for compliance". Working with an experienced R&D tax specialist, who will guide and support you through the process, can be invaluable in meeting these expectations. HMRC has warned that if a claim is incorrect, inflated, or fraudulent then a penalty could be issued. An R&D tax specialist or consultant will ensure that your claims are accurate and submitted correctly.

To ease any pressure on cashflow, submit your R&D claim as soon as possible to mitigate any delays in payment.

It is clear that there will be much greater scrutiny of R&D tax relief claims. If R&D claims prepared for you, or that you have submitted, do not go into a forensic level of detail, it is quite possible that HMRC may challenge your claim, leading to a tax enquiry.

Businesses currently outsourcing their R&D project work overseas in order to reduce costs will need to review their financial projections and arrangements for future years. The changes to the claims regime may make it more cost effective to undertake R&D in the UK.

Our specialist R&D and Tax Dispute Resolution teams can work hand in hand with your technical teams to test and validate your claim and come to a resolution with HMRC before the dispute escalates into other areas of your tax compliance. For help and advice please contact Carrie Rutland or Dawn Register and read more about our R&D HMRC Enquiry Resolution services.