L-Day: Merged R&D tax relief scheme proposed

Single R&D tax relief scheme proposed for all companies, broadly modelled on the existing RDEC scheme

Single R&D tax relief scheme proposed for all companies, broadly modelled on the existing

The Government published draft legislation on 18 July 2023 introducing a single merged Research & Development (R&D) regime that is broadly modelled on the existing Research & Development expenditure credit (RDEC) scheme. All companies, regardless of their size, would claim under a single scheme effective from 1 April 2024, if the legislation is enacted as published. Whilst many SMEs may welcome the opportunity to recognise the R&D incentive as an above-the-line credit in the financial statements, there are a number of notable differences with the existing RDEC scheme, which may have a significant impact on many claimants, discussed further in this article. Furthermore, the restrictions on overseas R&D expenditure, that were anticipated following their postponement earlier this year, will also be introduced for expenditure incurred on or after 1 April 2024. With few exceptions, expenditure on overseas R&D will no longer be qualifying.

Merged R&D tax relief scheme

Subject to one exception for R&D intensive SMEs (discussed below), the draft legislation proposes that all companies would claim under the single scheme for qualifying R&D expenditure incurred on or after 1 April 2024, and the existing SME R&D tax relief scheme would cease to exist.

One notable difference to the existing RDEC scheme is the treatment of contracted out R&D expenditure in the draft legislation. The reforms appear to enable all claimant companies, including Large companies, to claim for expenditure incurred on contracted out R&D activities, regardless of the type of entity this is contracted out to. This is similar to the existing SME regime rules on contracted out R&D. As a result, the draft legislation also seeks to prevent ‘double claims’ for the same activities, as companies will no longer be able to claim for expenditure incurred on R&D activities contracted out to them. These draft rules on subcontracted R&D determine who has the claim to R&D tax relief and is perhaps the most contentious issue that is likely to be subject to further debate. As it stands it would appear it is the company subcontracting out R&D activities that would be entitled to the incentives as opposed to the R&D supply chain.

The draft legislation also appears to exclude expenditure on projects which has been ‘subsidised’. The latter may significantly restrict the availability of R&D tax relief on projects undertaken under customer contracts and, potentially, where funded by other group companies. The UK Government has specifically highlighted that this aspect of the draft legislation is under consideration, and we expect that this, along with the subcontracted rules mentioned above, will generate a significant amount of responses to the consultation, given the impact that this would appear to have on Contract Research Organisations, Tier 1 and 2 suppliers, and any claimant who undertakes R&D activities at the behest of customers.

Additional relief for R&D-intensive SMEs

The draft legislation does, however, make an allowance for R&D-intensive SMEs which will be entitled to a higher rate of relief where the ‘R&D intensity’ condition is met; broadly, where the company’s relevant R&D expenditure is at least 40 percent of the company’s total expenditure for the purposes of calculating the company’s profits subject to corporation tax. This measure will be effective from 1 April 2023, allowing eligible claimants to access the SME payable credit at an increased rate of 14.5 percent (rather than 10 percent).

Restrictions on overseas R&D expenditure

As anticipated, the previously proposed reforms to overseas R&D expenditure announced last year, have been reintroduced. As a result, the extent to which expenditure on overseas R&D activity is claimable will be significantly restricted from 1 April 2024. Reflecting the reforms announced last year, expenditure on R&D activities undertaken outside of the UK will no longer be claimable, unless the expenditure falls within the boundaries of ‘qualifying overseas expenditure’. Overseas expenditure may qualify when undertaking the R&D activity overseas is ‘necessary’ due to geographical, environmental or social conditions that are not present or replicable in the UK. Where R&D is undertaken overseas due to cost considerations or as a consequence of the availability of the appropriate skills only then will it be specifically excluded from qualifying overseas R&D.

Further reforms were also announced in respect of a more generous version of the PAYE/NIC cap, as well as the going concern requirements upon claimants and other consequential amendments.

What should claimant companies consider?

Whilst the reforms remain subject to consultation, the fact that draft legislation has been written and published would suggest that the Government is committed to reforming the R&D tax relief schemes. Claimants should consider the extent to which these reforms would affect their claims if enacted as drafted, given the restrictions on overseas R&D expenditure, and subcontracted and subsidised R&D activities. Claimants who may be negatively affected may wish to respond to the further technical consultation announced alongside the published reforms. The deadline for responding on the draft legislation is 12 September 2023.

Should you wish to discuss the implications of the proposed new rules on your companies or provide any feedback for us to consider for our consultation response, please contact the authors or your usual KPMG in the UK contact.