The UK government has announced significant reforms to its Research and Development (R&D) tax credit system. This transformation seeks to combine the Research and Development Expenditure Credit (RDEC) and the SME relief into a singular scheme, effective from accounting periods beginning on or after 1 April 2024. LimestoneGrey delve into the details of the merged scheme.
A Unified R&D Tax Credit Scheme
The Autumn Budget’s confirmation of a new unified R&D tax relief scheme, set to come into effect for accounting periods starting on or after April 2024, marks a significant shift from the current separate R&D schemes. This merged approach aims to streamline the system by introducing a single set of qualifying rules, a departure from the more complex structure of the existing RDEC and SME schemes. However, this consolidation may raise concerns about the scheme's overall effectiveness compared to the older, higher-rate SME scheme. The new unified scheme's impact on fostering R&D investment and innovation, especially for smaller enterprises, remains to be fully understood.
The key changes in the UK's new unified R&D tax relief scheme include:
- The introduction of a single set of qualifying rules, rather than separate rules for SME and RDEC claims.
- The scheme allows companies making R&D decisions and bearing risks to claim relief for subcontracted R&D. This looks to be more in keeping with the way HMRC administered recently , when HMRC then changed to their current draconian interpretation of the existing subcontractor legislation, denying relief to many companies that used to be able to claim SME relief. This is a welcome change and will force HMRC to administer the relief in a more logical way.
- Subsidised expenditure rules from the SME scheme are removed, meaning external funding won't reduce the available support. Grant funded projects remain claimable, which again is a very welcome announcement.
The rate under the new scheme is set at the current RDEC rate 20% (figure before tax). For loss-making companies, a notional tax rate of 19% will apply. This means loss making SMEs and loss making R&D intensive SMEs will receive a benefit of 16.2%, after tax. Profit making SMEs and large companies will receive a benefit of up to 16.2%, with the figure depending on the level of profit they make.
Changes to the R&D intensive relief
Announced in the Spring budget, a separate R&D scheme was established to provide more support to ‘R&D intensive’ SME’s. This effectively is the current SME scheme (with the lower uplift rate of 86%), but retained the older loss surrender rate of 14.5% (instead of the reduced 10% rate for non-R&D intensive SME’s). This was only accessible to R&D intensive SME’s (broadly defined as those where over 40% of the company’s expenditure was on R&D) which were also loss making (and wanting to surrender that loss for a payable tax credit).
In a strategic move to support more SMEs, the intensity threshold for R&D-intensive, loss-making SMEs is to be reduced from 40% to 30%. This adjustment is expected to benefit around 5,000 additional companies, widening the scope of support for smaller businesses engaged in intensive R&D activities, particularly start-ups. This reduction is accompanied by the introduction of a ‘year of grace’ giving R&D intensive companies who fall below the 30% qualifying R&D expenditure threshold the ability to receive the higher payable credit for one additional year, providing a crucial buffer during uncertain times. This grace period applies to expenditures incurred from 1 April 2023.
Matthew Jones, Managing Director at LimestoneGrey, commented:
The merger of the RDEC and SME schemes into a single R&D tax credit scheme represents a significant change in the UK's approach to fostering innovation. Hopefully, by simplifying the system and making it more inclusive, the government is sending a strong message of support to businesses engaged in R&D activities. The Government state that this reform is set to boost innovation, reduce administrative complexities, and make R&D incentives more accessible to a broader range of businesses in the UK. Although some of the announcements are very welcome, it will still mean many SME’s undertaking qualifying R&D activities will receive a much lower benefit than would have been the case pre-April 2023, due to the substantial reduction in the benefit rate for SME’s.
Confirmation that the new merged scheme will be introduced for accounting periods beginning on or after 1 April 2024 is welcomed. This is a change from the draft legislation published in July 2023, which would have applied changes to expenditure incurred on or after 1 April 2024, giving companies and businesses alike more time to digest the changes and put plans in place. This will also simplify claims by avoiding the need to claim under different regimes for an accounting period that straddles this date.
The clarification of subcontracted R&D is also very welcome. The seismic shift in HMRC interpretation of subcontracted R&D for the current SME and RDEC schemes has completely disrupted the industry. It will be interesting to see if HMRC’s current interpretation will now be more heavily challenged, with the hope that the tribunals will push back and revert HMRC to incorporate their original thinking. We do all need to be mindful that HMRCs current interpretation is not a law change, just a change in their interpretation of the existing R&D tax credit legislation.
Recent R&D tax credit reform has reduced the rate SMEs can claim on expenditure incurred from 1 April 2023. Depending on your business tax status, the relief could be as low as 9%. Even though the relief rate for the new scheme is below the (up to) 33% figure that everyone has come to recognise, I believe that the more inclusive R&D intensive relief and the introduction of additional cost categories will prove beneficial for many companies.