Merging R&D tax relief schemes – how it will work
Merging R&D tax relief schemes – how it will work
At the 2023 Autumn Statement the Chancellor announced further changes intended to simplify and improve the R&D tax incentive schemes in the UK. On 29 January 2024, amendments to the Finance Bill 23-24 were released which provided further details about the changes.
The Government’s intention is to merge the current SME and RDEC R&D schemes into one above the line credit scheme which broadly follows the current RDEC scheme, with a headline rate of relief of 20%. The merged scheme will take effect for accounting periods beginning on or after 1 April 2024 and run alongside the SME R&D intensive scheme which started on 1 April 2023 but will also see some changes from that date.
There is no suggestion that the core definition of what constitutes R&D (DSIT guidelines) for tax purposes is going to change: claimants will still need to prove that their project sought to achieve an advance in science or technology in line with the new Guidelines for Compliance published on 31 October 2023.
The merged scheme will follow this approach and this is designed to raise the prominence of the R&D function within a business. It will make it easier for larger businesses to make the transition to the merged scheme, but SMEs will need to start planning for the impact of this change now.
Thus the net effect of the calculation will give R&D relief to loss-making companies of 16.2p for every £1 of qualifying spend, profitable ones will get effective relief at 15p in the £ (16.2p for companies paying the small companies rate). The overall impact for SMEs is that will they receive less relief than under the current rules unless they qualify for the separate SME R&D intensive scheme (see below).
A comparison of the current and merged scheme R&D relief benefits is set out below.
* The post-tax RDEC/Merged scheme rates from 1 April 2023 will vary depending on the level of taxable profits a company has and, therefore, the corporation tax rate applied to those profits. The Net RDEC at the main rate of corporation tax (25%) is 15%, for the small companies’ rate (19%) it is 16.2%.
**Loss-making R&D intensive companies are those whose qualifying R&D expenditure constitutes at least 40% (from 1 April 2023) or 30% (from accounting periods starting on or after 1 April 2024) of total expenditure (splitting accounting periods as required). Total expenditure for this purpose will be calculated from the total expenses figure in the profit and loss (P&L) account, adjusted by adding any amount of expenditure used under s1308 Corporation Tax Act (CTA) 2009 and by subtracting any amount not deductible for CT purposes.
At present, companies claiming under RDEC can only claim for the costs of outsourcing their R&D when the work is sub-contracted to a limited number of ‘qualifying bodies’ (e.g. universities and other not for profit organisations), to individuals or partnerships. SMEs, however, can claim 65% of the costs of most subcontractor payments.
Under the merged R&D regime, all companies will be able to claim for qualifying subcontractor payments where the principal ‘intended or contemplated’ at the time the contract was entered into, that the subcontractor would be required to undertake R&D to satisfy the contract.
Subcontractors can make a claim for R&D relief in the following limited circumstances:
Rules changes also mean that a company can claim relief for subcontracting costs, where it subcontracts its R&D to a company, which in turn subcontracts the R&D to another. This was previously disallowed.
As the new rules take effect for accounting periods starting on or after 1 April 2024, this could, in theory, have created a transition problem where a principal could claim for its contracted out R&D cost and the subcontractor could also claim because their accounting periods were different. An amendment published on 29 January 2024 confirms that in such transitional cases the old rules take precedence – favouring SME subcontractors in most cases.
However, the R&D Intensive rules have been softened slightly such that:
There are now multiple tax and tax credit rates depending on if you are a profit or loss-making company. There is the inclusion and exclusion of certain cost categories depending on a company’s period end; further complicated by periods straddling either 1 April 2023 or 2024. The concept of an SME still exists and needs to be considered, following the introduction of an R&D intensive company rules.
Whilst changes in the subcontractor rules attempt to provide some clarity on whom should be claiming R&D relief, they could easily create additional confusion, uncertainty and are unpractical in many real-life situations.
Therefore, it is critical that claimant companies and their clients discuss, agree and document (ideally within contracts) R&D activities that are expected and/or anticipated.
We can help you assess the potential impact of the proposals on your business and identify what possible organisational and operation changes may be appropriate to protect you UK R&D function. For help and advice, please contact Carrie Rutland or your local BDO R&D contact.
The Government’s intention is to merge the current SME and RDEC R&D schemes into one above the line credit scheme which broadly follows the current RDEC scheme, with a headline rate of relief of 20%. The merged scheme will take effect for accounting periods beginning on or after 1 April 2024 and run alongside the SME R&D intensive scheme which started on 1 April 2023 but will also see some changes from that date.
There is no suggestion that the core definition of what constitutes R&D (DSIT guidelines) for tax purposes is going to change: claimants will still need to prove that their project sought to achieve an advance in science or technology in line with the new Guidelines for Compliance published on 31 October 2023.
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The combined scheme will principally be based mainly on the current RDEC rules, but with a few beneficial elements imported from the SME regime – with the aim of making the new merged scheme more generous than the existing RDEC regime as follows:1. Recognised Above the Line
The R&D Expenditure Credit (RDEC) is the current scheme under which large companies (and small companies that do not qualify for the current SME schemes) can claim tax relief for their qualifying R&D. The RDEC relief is given via a taxable credit which is a proportion (currently 20%) of the qualifying expenditure – this is recognised in claimant company’s pre-tax income.The merged scheme will follow this approach and this is designed to raise the prominence of the R&D function within a business. It will make it easier for larger businesses to make the transition to the merged scheme, but SMEs will need to start planning for the impact of this change now.
2. The taxable credit calculated following RDEC seven steps
Like the RDEC, under the merged scheme the credit itself is taxable so will appear as taxable income in your accounts. There is a seven-step process for calculating the relief and, as part of this, the notional tax rate applied to the RDEC for loss-making companies will be set at the small profits rate of 19%. For profit making companies it will continue to be at the main rate of corporation tax of 25% or the small companies’ rate of 19% where this applies.Thus the net effect of the calculation will give R&D relief to loss-making companies of 16.2p for every £1 of qualifying spend, profitable ones will get effective relief at 15p in the £ (16.2p for companies paying the small companies rate). The overall impact for SMEs is that will they receive less relief than under the current rules unless they qualify for the separate SME R&D intensive scheme (see below).
A comparison of the current and merged scheme R&D relief benefits is set out below.
| SME SCHEME | RDEC SCHEME | MERGED SCHEME | |||
| Up to 31/03/2023 | From 01/04/2023 | Up to 31/03/2023 | From 01/04/2023 | APs starting after 01/04/2024 | |
| Profitable company | 130% uplift on costs = 24.7% net benefit | 86% uplift on costs = 21.5% net benefit | Headline rate 13% = 10.5% post tax | Headline rate 20% = post tax rate between 15% - 16.2%* | Headline rate 20% = post tax rate between 15% or 16.2%* |
| Loss making company | Costs plus 130% uplift = 230 x 14.5% repayable credit = 33.4% subsidy | Costs plus 86% uplift = 186 x 10% repayable credit = 18.6% subsidy | 10.5% subsidy | 15% subsidy | 16.2% subsidy |
| Loss making R&D intensive company** | NA | Costs plus 86% uplift = 186 x 14.5% repayable credit = 26.97% subsidy | NA | NA | NA |
* The post-tax RDEC/Merged scheme rates from 1 April 2023 will vary depending on the level of taxable profits a company has and, therefore, the corporation tax rate applied to those profits. The Net RDEC at the main rate of corporation tax (25%) is 15%, for the small companies’ rate (19%) it is 16.2%.
**Loss-making R&D intensive companies are those whose qualifying R&D expenditure constitutes at least 40% (from 1 April 2023) or 30% (from accounting periods starting on or after 1 April 2024) of total expenditure (splitting accounting periods as required). Total expenditure for this purpose will be calculated from the total expenses figure in the profit and loss (P&L) account, adjusted by adding any amount of expenditure used under s1308 Corporation Tax Act (CTA) 2009 and by subtracting any amount not deductible for CT purposes.
3. Contracted-out R&D
This is one area where the current SME regime rules will be brought into the merged regime – albeit with some important modifications.At present, companies claiming under RDEC can only claim for the costs of outsourcing their R&D when the work is sub-contracted to a limited number of ‘qualifying bodies’ (e.g. universities and other not for profit organisations), to individuals or partnerships. SMEs, however, can claim 65% of the costs of most subcontractor payments.
Under the merged R&D regime, all companies will be able to claim for qualifying subcontractor payments where the principal ‘intended or contemplated’ at the time the contract was entered into, that the subcontractor would be required to undertake R&D to satisfy the contract.
Subcontractors can make a claim for R&D relief in the following limited circumstances:
- Their own in-house R&D that is unrelated to a customer contract; or
- Where the customer did not “intend or contemplate” contracting out R&D at the time of the contract (ie because it did not have the technical knowledge to do so) but nonetheless R&D work is needed to fulfil the contract, or
- Where the customer is an "ineligible company" (still to be fully defined but does currently replace entities previously considered “qualifying bodies”), or
- A party that is not carrying on a taxable trade in the UK, e.g. Government body or overseas customer.
Rules changes also mean that a company can claim relief for subcontracting costs, where it subcontracts its R&D to a company, which in turn subcontracts the R&D to another. This was previously disallowed.
As the new rules take effect for accounting periods starting on or after 1 April 2024, this could, in theory, have created a transition problem where a principal could claim for its contracted out R&D cost and the subcontractor could also claim because their accounting periods were different. An amendment published on 29 January 2024 confirms that in such transitional cases the old rules take precedence – favouring SME subcontractors in most cases.
4. Subsidised expenditure
As a result of the changes to the contracted-out R&D rules, the current provisions relating to subsidised expenditure are no longer relevant and will be removed from the legislation. This means that in some cases relief will be available to companies that have R&D projects which are either subsidised or grant funded.5. Capping relief for loss making companies
All the UK’s R&D relief schemes apply a cap on the relief available to loss making companies. The PAYE/NIC cap rules from the existing SME scheme are the most generous and it is now confirmed that these will be adopted for the merged scheme (and the R&D intensive scheme – see below).Externally provided workers
The merged scheme will also reflect HMRC’s recent concern over the costs claimed for externally provided workers: such costs will only be claimable if they related to UK workers and where the worker is part of (and paid through) a PAYE scheme. This means that costs of engaging those working through a personal service company are potentially limited to the salary drawn.Overseas R&D costs
The government has already proposed a ban claiming for overseas outsourcing costs (apart from a few limited exceptions) and, after a one-year delay, this is also now due to take effect for accounting periods starting on or after 1 April 2024 as a feature of the new merged scheme, although the exceptions would also apply.Standalone SME R&D intensive scheme
It had previously been announced that loss-making SMEs whose R&D expenditure constitutes at least 40% of their total expenditure, incurred on or after 1 April 2023, would continue to receive relief in the form of an SME tax credit. This will continue and give an effective rate of relief of 26.97% of allowable R&D expenditure.However, the R&D Intensive rules have been softened slightly such that:
- The R&D ‘intensity’ threshold will be reduced from 40% to 30% for accounting periods beginning on or after 1 April 2024; and
- A one-year grace period will be applied where a company’s R&D intensity falls below 30%. This will aid companies in situations where expenditure fluctuates year on year (and they may otherwise end up switching between the intensive scheme and the main merged scheme). This will result in greater consistency on where the R&D tax relief is reported in the company’s accounts.
Summary
Although we have updated draft legislation, there is much still to be clarified when HMRC's guidance on the new rules is published. We had hoped the government would delay the introduction of the merged scheme for a least a couple of years. Our main concern is that in merging the main schemes whilst maintaining a separate scheme for loss making R&D intensive SME companies, the government has in fact added complications and uncertainty in the coming periods.There are now multiple tax and tax credit rates depending on if you are a profit or loss-making company. There is the inclusion and exclusion of certain cost categories depending on a company’s period end; further complicated by periods straddling either 1 April 2023 or 2024. The concept of an SME still exists and needs to be considered, following the introduction of an R&D intensive company rules.
Whilst changes in the subcontractor rules attempt to provide some clarity on whom should be claiming R&D relief, they could easily create additional confusion, uncertainty and are unpractical in many real-life situations.
Therefore, it is critical that claimant companies and their clients discuss, agree and document (ideally within contracts) R&D activities that are expected and/or anticipated.
We can help you assess the potential impact of the proposals on your business and identify what possible organisational and operation changes may be appropriate to protect you UK R&D function. For help and advice, please contact Carrie Rutland or your local BDO R&D contact.