The objective of the merged scheme is to simplify the UK’s research and development (R&D) regimes by having a single set of qualifying rules. But with little time until the single scheme is implemented, there's no respite for businesses who'll need to act quickly to be ready for the changes.
New merged R&D tax relief scheme
Draft legislation for the merged scheme was published in July 2023 and would have applied the changes to expenditure incurred on or after 1 April 2024. However, the
Finance Bill 2023-2024 [15.1 MB] (subject to Royal Assent), which was released shortly after the Autumn Statement, confirms that the merged scheme will come into effect in respect of accounting periods commencing on or after 1 April 2024. This will give some businesses more time to prepare for the changes than originally envisaged, depending on their accounting period start dates.
The merged scheme will broadly follow the existing R&D expenditure credit (RDEC) rules. This means that all companies, including those who previously claimed under the small and medium-sized enterprises (SME) scheme, will benefit from the receipt of a 20% tax credit that can be recognised ‘above the line’ as taxable income, providing better visibility in their accounts.
Under the existing RDEC scheme, a notional tax at the main rate of corporation tax (currently 25%) is applied to the RDEC for loss-making companies. Under the new scheme the rate will be reduced to 19%, accelerating the RDEC cash benefit for loss-making businesses. The net RDEC benefit for loss-making companies will therefore be up to 16.2% for every qualifying R&D £1 incurred (compared with 15% for profitable companies).
However, the new merged scheme rates pose a disadvantage for SMEs overall. The rates are lower than those in the existing SME scheme, which for expenditure incurred from 1 April 2023 are between 18.6% and 21.5%, depending on whether a SME is loss- or profit-making.
Additional tax relief for R&D-intensive SMEs
A second scheme for R&D-intensive SMEs will run alongside the main, merged scheme for expenditure incurred from 1 April 2023. It offers enhanced rates of relief for certain loss-making SMEs, providing a cash benefit of up to 26.97% for every qualifying R&D £1 incurred.
While it was previously announced that a company would be considered R&D-intensive where its R&D expenditure accounted for 40% of its total deductible expenditure in a period, at the Autumn Statement the Government announced that the intensity threshold would be reduced to 30% for accounting periods commencing on or after 1 April 2024. This reduction is expected to extend eligibility to an additional 5,000 UK companies for enhanced relief rates.
The Government has also confirmed that to protect the R&D-intensive scheme for genuine loss-making R&D-intensive companies, new rules will introduce a one-year grace period to apply where a company has fallen below the 30% threshold in the following accounting period. This will help provide some certainty to claimants where their spend fluctuates year on year, together with anti-avoidance rules to prevent business from manipulating their intensity by using short accounting periods.
Contracted-out R&D
A key concern following July's draft legislation was the proposed restrictions to R&D contracted out to companies under the merged scheme, with businesses seeking certainty and clear guidelines.
The Autumn Statement provided some welcome clarity with further detail provided in the Finance Bill 2023-2024. It was confirmed that, under the merged scheme, the intention is that the party that decides to do the R&D and bears the risk should get the benefit from making a claim.
Specifically, the Finance Bill 2023-2024 states that where it's intended that a contractor may need to undertake R&D activities as part of meeting the obligations of a contract this would constitute contracted-out R&D. In this event, the payments for the contracted-out R&D would be qualifying expenditure for that person, ie, the person who contracted out the R&D to the other party. There may, however, be exceptions where the contracted-out activities don't form part of an R&D project, and R&D is instead initiated by the contractor.
When considering whether R&D has been contracted out, this is likely to be determined by the unique contract terms and factual circumstances. This underscores the increasing importance of reviewing and understanding contracts before work begins in order to avoid overlooking the potentially available benefits.
Subsidised expenditure
The Finance Bill 2023-2024 will remove the subsidised expenditure legislation currently in place for the SME scheme (and that was proposed for the merged scheme), where expenditure is met directly or indirectly by another person.
This simplification will apply to both the revised SME intensive and merged scheme, which is favourable for those companies in receipt of grant monies or other third-party funding. The contracted-out R&D rules above, however, will continue to apply.
Fraud and compliance
The Government also touched on the still high levels of non-compliance within the R&D regimes and stated that further action may be needed to address this. Given that HMRC’s latest statistics estimate error and fraud across the R&D tax regimes to be £1.13 billion (16.7% of claims), it's little surprise that this remains a priority.
A number of measures have been brought in to tackle this, including the recently introduced Additional Information Form (AIF) requirement for all R&D claims made on or after 8 August 2023. It's clear, however, that many businesses still aren’t fully aware of the impact of the AIF, with HMRC noting a 50% surge in rejected claims in the four weeks following its introduction.
What is clear is that getting R&D tax claims right first time is paramount. At the same time, it has never been more challenging for businesses than in this environment of legislative change and high HMRC scrutiny, and the additional changes announced above will only add to the administrative burden for all R&D claimants.
How to prepare for R&D changes
With these significant changes incoming – together with a host of other changes previously announced, eg, data and cloud computing expenditure extension, overseas expenditure restriction – this is a key time for companies to review their R&D claims, both in terms of the methodology used and also forecasting the benefit they expect to receive.
The need to understand the new merged scheme mechanism for relief is likely to cause some operational headaches for those not used to the RDEC scheme, so it's essential for companies to work with advisers who are experienced in preparing RDEC claims.
SMEs that wish to claim under the SME intensive scheme should look to maintain historical evidence of their qualifying expenditure against the relevant intensity thresholds. Those businesses that enter into arrangements with third parties will also need to review these contracts in detail to understand how the contracted-out rules may affect them.
With little time until the merged scheme is implemented, it's essential that the Government provides sufficient guidance to support businesses in their preparations – as, above all else, businesses need clarity and certainty to enable effective planning on cashflows.
For more insight and guidance on preparing for these changes, please get in touch with Lindsey Copland or Ian Rowland.
