The changes to the legislation reflect the government’s ongoing commitment to supporting R&D in the UK and to ensuring the UK’s R&D tax relief regimes are globally competitive and fit for purpose. There's also a focus on compliance and the elimination of fraudulent claims, particularly within the SME space, with costs to the exchequer estimated to be £469 million for 2021-22.
HMRC’s recently published Annual Report highlights that the average time to conclude enquiries has increased, as has the average claim turnaround time, which further emphasises the increase in claim scrutiny and points to a toughening of HMRC’s approach.
“The Government wants to increase the proportion of UK gross domestic product spent on research and development (R&D) to 2.4% by 2027 from the current 1.74%, as part of its aim to make the UK a “science and tech superpower” by 2030.”
Science and Technology Committee (Lords)
Overall, the modernisation of the schemes through the inclusion of data license and cloud computing costs will be well received, as will the introduction of additional compliance requirements to tackle abuse. There are, however, still some question marks around what these compliance requirements will look like in practice and the potential administrative burden of the e-filing and advanced notification requirements.
Further, the restrictions on overseas workers are likely to affect many claimants, particularly where development teams are sat outside of the UK.
The key changes to the legislation are outlined below, and stakeholder input for the new measures is currently open:
Extending qualifying expenditure
As previously announced, in an attempt to incentivise R&D using modern computational approaches, the scope of qualifying expenditure is to be expanded to include data licenses and cloud computing services. A data license for the purpose of R&D tax is defined as “a license to access and use a collection of digital data”. Cloud computing services include ‘the provision of, or access to, and maintenance of, remote data storage, operating systems, software platforms and hardware facilities”.
Secondary legislation will also be introduced that extends the scope of R&D tax to cover ‘pure mathematics’ costs, which have previously been excluded from the definition of R&D. The definition of ‘pure mathematics’ has yet to be announced.
These changes will broaden the scope for claimants and will allow for activities previously overlooked by the existing R&D definition to now be included. We anticipate that certain industries, particularly those involved in cutting-edge technologies such as artificial intelligence, quantum computing and robotics, should see a positive difference to their R&D claims going forward.
Refocusing the reliefs towards innovation in the UK
Under the new legislation, relief for expenditure on subcontracted work and externally-provided workers will be limited to "UK or qualifying overseas expenditure." The government hopes this will focus relief more effectively on UK expenditure so that more of the spill-over benefits produced by research and development activity, such as employee skills and industrial know-how, will arise in and benefit the UK.
There are some narrow exemptions to the restrictions, with the legislation defining ‘qualifying overseas expenditure’ as that attributable to activity undertaken overseas which is necessary due to geographical, environmental or social conditions not present or replicable in the UK (for example, deep ocean research), or legal or regulatory requirements which prevent the R&D being undertaken in the UK (for example, clinical trials). Commercial reasons, such as cost of the work, and availability of workers, are specifically excluded.
Overseas externally provided worker costs will only qualify to the extent that those workers’ earnings are taxed through UK PAYE, or their R&D activities are undertaken overseas as a result of geographical, environmental, social conditions, legal or regulatory requirements.
Although there are some exemptions noted, we anticipate these restrictions will negatively impact many claimants, particularly where development teams are sat outside of the UK. Further, this may be a high-risk area moving forwards, and additional filing notes may be required to substantiate your claim position and stay compliant. This may prove to be a real challenge for organisations that do not have robust time/project data capture implemented to identify overseas workers readily and where granular data gathering exercises (eg, invoices and contracts) will be required to substantiate the location of the third party worker.
Tackling abuse and improving compliance
A number of new compliance measures have been introduced to tackle abuse of the R&D regimes.
Mandating digital claims
In future, all corporation tax returns that contain an R&D claim, including amended returns, must be submitted digitally through HMRC’s tax return portal
Provision of additional information
This measure provides HMRC with the power to make regulations setting out additional information to be provided in relation to a claim. This information will include a description of the R&D undertaken, breakdown of qualifying costs, details of any agent who has advised on the R&D claim and space for sign off from a senior officer of the company, as each claim will need to be endorsed by a named senior officer of the company
Pre-notification of claims
Companies will need to inform HMRC in advance that they plan to make a claim and will need to do this using a digital service within six months of the end of the accounting period to which the claim relates, otherwise the claim is nullified. Companies that have claimed in one of the preceding three accounting periods will not need to pre-notify
Although the governments’ commitment to tackling abuse should be seen as a positive measure, the increase in scrutiny of claims and level of documentation required may in practice lead to an increase in the administrative burden of filing a claim. Furthermore, the requirement of a company to pre-notify HMRC of its intention to make a claim may have a significant impact on new claimants by reducing the window in which they have to make a claim.
Previously announced measures to address anomalies and unforeseen consequences
The government will be implementing a series of changes to correct anomalies and unintended consequences arising from the existing legislation. These changes include:
- allowing companies to claim RDEC instead where they had previously erroneously claimed SME relief and the time limit for amending claims has expired
- amending the time limit for making a claim to two years from the end of the period of account to which they relate, rather than 12 months from the statutory filing date
- new legislation to clarify how an enterprise should be treated in a situation whereby a linked enterprise becomes large in the period, or in a situation where an enterprise is acquired by an SME in the period
- amending the definition of ‘going concern’ so that where a company ceases to be a ‘going concern’ solely because of the transfer of a trade and is otherwise viable, it may still make a claim.
Further consequential measures
To ensure the reliefs operate as intended, the following further changes will be made:
- Patent Box legislation will be amended to include the revised definition of R&D qualifying expenditure (which includes the new definitions for datasets and cloud costs)
- Health and Social Care Levy costs can be included as qualifying staffing costs
What should you take away from this?
The upcoming changes are only nine months’ away and likely to create some new opportunities as well as unexpected challenges. We therefore advise preparing now to maximise the incentives currently available and ensure your future R&D claims are optimised:
- Read the latest draft legislation along with the guidance – we're working with our clients to gather their responses and comments to feedback to HM Treasury on any suggestions in helping to improve the draft wording before April 2023
- Review your data and identify costs that will be eligible or potentially excluded – start to model the impact to see how much spend is at risk
You should also ask these questions
- What's the size of your DevOps teams and how many are based overseas?
- What sort of documentation is kept on file to substantiate the claims?
- Have you considered moving to real-time reporting and does your current data capture process enable you to achieve this?
We have a strong working relationship with HMRC and can help advise and plan for the changes accordingly (ie, we can model the impact and interaction of the changes highlighted above). We have also created a short workshop with a calculation tool to assist your forward planning for these changes.
To find out more on how you can be ready for the changes ahead, get in touch with Lindsey Copland.
