R&D tax relief is changing – here’s what you need to know
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Greg Howe, Associate Director, and Ross Northall, Partner
Research and Development (R&D) has the potential to provide companies with thousands of pounds worth of tax savings on innovation projects. However, a series of upcoming changes in the Autumn Budget and outcomes from recent Tax Tribunal cases could have wide ranging implications for claims.
From 1 April 2023, we’re expecting a number of changes to the UK R&D scheme to be implemented as a result of the 2021 Autumn Budget. Some of these changes will affect businesses in positive ways, while others could have significant impacts on the total sum a business can claim back in tax credits.
The two most significant changes are:
- upcoming restrictions for businesses conducting R&D activities overseas, and
- the new inclusion of cloud computing and data costs in qualifying R&D expenditure.
Businesses will need to assess the potential implications of these changes to understand how they might impact their ability to claim R&D tax credits in the future and to ensure they remain compliant under the new rules.
BDO’s resident R&D experts, Greg Howe and Ross Northall, discuss in more detail.
Changes to R&D tax credits for overseas activities
From 1 April 2023, we’re expecting R&D tax relief to be restricted to activities undertaken in the UK. Under current rules, overseas R&D costs recharged to a UK claimant company qualify for relief. However, from the 2023/24 tax year, R&D activity will have to be physically located in the UK in order for the costs to be included. UK companies who currently claim R&D costs paid to, for example, overseas group companies or overseas third parties may no longer be able to include these costs in their claims.
There are many examples of overseas R&D hubs in the tech and media space, where a lot of companies will leverage R&D centres in Asia, the Americas and parts of Europe. Software development and engineering resource costs are then charged back to the UK company and in many cases form a significant portion of the qualifying costs in the R&D claim.
"When announcing the changes, ONS figures estimated approximately £25.9 billion of the £47.5 billion of R&D investment in 2019 was in the UK with the remainder spent overseas."
The impact of this change will largely depend on the size of your business and the amount of R&D taking place outside the UK.
Where it makes commercial sense, what can businesses do to help maintain their R&D tax relief benefits?
Businesses that maintain all or part of their R&D activities overseas will need to re-evaluate their potential R&D claims. They will need to consider the practical, commercial and cost implications of maintaining their current structure versus onshoring to the UK.
Naturally, there are pros and cons. Let’s take a closer look at each scenario.
- Scenario 1: Keeping your R&D activities overseas
The obvious benefit of keeping your R&D activities where they are largely revolve around commercial needs, expertise and other practical business requirements. Depending on your circumstances, this could also be the most cost-effective option. Your infrastructure and processes are already established, you’ve got the right people in place and your deliverables are optimised. Why change what isn’t broken?
The obvious sacrifice is that currently qualifying overseas R&D will be disqualified from 1 April 2023. The impact of this will depend on the amount of overseas R&D spend at risk and whether your claim is made under the more lucrative SME Scheme or the RDEC Scheme (or Large Company Scheme). If you are an R&D intensive business with the majority of these costs currently coming from overseas activities, you should expect to see a substantial reduction in your R&D tax relief claims and may wish to consider relocating these activities to the UK in order to continue to benefit from the relief.
- Scenario 2: Relocating your R&D activities to the UK
Relocating your R&D activities will look different for each business. For some, this may simply be a matter of finding new suppliers within the UK. Of course, this will depend on whether the required skillsets are available and within budget (taking into consideration savings made through inclusion of future UK supplier costs in your R&D claim).
Some businesses will have overseas R&D resource that is connected to the UK claimant company (e.g. employees of a group company). Along with the obvious cost/benefit implications of relocating to a UK R&D hub, businesses will have to consider a whole host of other non-R&D related issues. These could include restructuring, new hires, staff relocation, training and support – along with all the associated legal and tax considerations for both the company and any employees relocating.
Claims for cloud and data expenditure
Currently, costs related to cloud computing and data cannot be included in claims for R&D tax relief. However, from 1st April 2023 these costs will form part of the suite of qualifying costing categories. Many will benefit from this change, particularly in tech & media, and could mitigate losses from the restrictions to overseas R&D costs.
This new addition will mean businesses that, for example, pay licence fees to rent cloud computer space, or pay for data costs in the context of R&D will now be able to incorporate these costs into their claims.
The HMRC crack-down
HMRC recently hired an additional 100 inspectors in order to deliver more robust and consistent reviews of R&D submitted claims. The result has been a noticeable uptick in the number of R&D-related enquiries.
"It has never been more important to keep on top of your due diligence and reporting obligations to ensure the best possible evidence to support your R&D claim."
In addition, the results of recent Tribunal cases have both informed and created some uncertainty around the following topics:
- Attributes of a “competent professional” and the evidence needed to qualify a project and its activities as R&D.
- The link between customer payments and the underlying R&D costs to inform subsidised R&D considerations.
- Ownership of R&D tax relief in the context of the independence of the R&D performer for customer-driven R&D projects.
- A re-write of HMRC’s R&D guidance on the interpretation of subcontracted R&D in the context of which party is entitled to claim relief.
It is likely that HMRC will continue to scrutinise these areas and that we will see further challenges from HMRC in respect of subcontracted and subsidised R&D costs.
HMRC are also looking closely at claims of portfolio companies backed by private equity investment and so businesses should be ensuring, as always, that their claims are accurate, robust and have sufficient supporting documentation to stand up to HMRC scrutiny.
Need help calculating your tax credits?
The new restrictions to overseas costs and the inclusion of cloud computing and data costs is very pertinent to many of our clients. As an international multi-disciplinary firm, BDO are better placed than many to advise on the wide-reaching implications of these changes.
About our team
- R&D reform modelling - based on the draft legislation as it emerges so that you can forecast the impact of the changes on your claims and message this to key stakeholders
- International expertise – a strong international network of R&D specialists who can help you claim for R&D costs incurred overseas if they no longer qualify for UK R&D tax relief
- BDO Proprietary Technology
- Global Client Portal – a secure location with milestone service delivery
- R&D Benchmarking Tool – benchmark and risk profile your R&D claim
- R&D Production Dashboard – collaborative mobile ready claim preparation tool
For advice about how these changes might affect your R&D projects, get in touch with one of our expert BDO advisors.
Do you need support with digital strategy? Get in touch with your local BDO advisor at [email protected].