The R&D reliefs available to SMEs are changing. What does this mean for you?

The R&D reliefs available to SMEs are changing. What does this mean for you?

20th December 2023, 1:59 pm

Over 90,000 R&D claims are made annually providing £8bn of relief. With this apparent success has come greater scrutiny, and HMRC now estimates that over £1bn of relief was attributable to “error and fraud” – largely among SME claimants who may have been guided by unscrupulous advisers. HMRC are introducing various measures to reduce the potential for abuse and to simplify the regimes, including:

· A move to a single merged scheme, which also reduces the level of cash credit available to SMEs*

· Mandatory notification and project documentation requirements

· Restriction of third-party costs that can be included in R&D claims to amounts that are related to UK activity

· HMRC have taken on more staff to review claims. The increased scrutiny has led to more claims being rejected outright, at times wrongly, and other cases are being taken to Tribunal.

Firstly let’s look at what hasn’t changed

The definition of R&D for these purposes has remained largely unchanged for many years – in simple terms, activities that seek to make an advance by resolving scientific or technological challenges may be in scope, regardless of the sector in which the company operates. Staff costs, payments for third party resources and consumables can continue to be claimed on the same basis as in the past provided the costs relate to UK expenditure or fall within very specific exemptions.

HMRC have always expected companies to describe their R&D projects; however, there is now a requirement to include these descriptions in an “additional information form”, which also captures other claim details including whether an R&D adviser supported the claim preparation. Any claims filed before the additional information form has been submitted will now be rejected.

What does the move to the single merged scheme mean for SMEs?

Currently companies can claim an additional tax deduction of 86% of R&D expenditure, which can either be:

· Deducted from taxable profits saving 21.5p tax for each pound of R&D spend or

· The enhanced R&D expenditure (being 186% of the spend) can be surrendered for a cash payment of 18.6p for each pound of R&D spend.

The existing additional deduction will not be available from the first accounting period starting on or after 1 April 2024, and most SMEs will then make their claims under the new merged regime. The merged scheme has taken on most of the characteristics of the existing RDEC regime, including being treated in the same way as a taxable grant, so will impact earnings before tax. Currently the existing RDEC regime is used by SMEs where the R&D activities have been subsidised or funded, so many will be familiar with it. The rate of RDEC benefit will continue to be 15 pence for each pound of R&D spend, except for those companies without taxable profits where the benefit may increase to 16.2 pence.

A separate scheme for loss-making SMEs whose R&D expenditure is more than 40% of their total expenditure (falling to 30% after April 2024) is also being introduced. This alternative R&D intensive SME scheme has retained the characteristics of the existing SME scheme noted above and provides enhanced levels of benefit that continue to be reflected in the tax line.

Treatment of subcontracted costs is a big change

The merged scheme is distinct from both the existing SME, the new R&D intensive SME regime and the existing RDEC regime in its treatment of R&D costs that are subcontracted by the R&D claimant company to another party. Broadly the company directing the R&D activity will now be able to include these costs in its claim. Only where the R&D was initiated in-house by the subcontracting party without discussion with the commissioning company, or where the commissioning party was outside the UK tax net, will the claim rest with the subcontractor. This is an area that is expected to lead to discussions when contracts are being negotiated. It is also likely to be an area of discussion with HMRC as the draft legislation includes the phrases “reasonable to assume” and “intended or contemplated”, both of which may be difficult to prove conclusively.

Actions to take

It is difficult to assess in every case which companies will benefit from the changes and which will see a reduction or loss of their R&D benefits due to the level of complexity introduced by these changes. All claimant companies will now benefit from a review of their existing claims methodology to ensure that opportunities to claim are identified and future contracts are negotiated appropriately. It is recommended that companies seek practical advice from an experienced adviser to ensure that their claims will stand up to HMRC scrutiny.

*For R&D tax relief purposes, an SME has up to 500 staff and turnover or gross assets of less than €100m or €86m respectively (these metrics include group companies and most stakeholders with significant ownership/control).


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