Research & Development (R&D) tax relief changes – how they work in practice

HMRC has broadened the scope of who can apply for Advanced Assurance of their R&D claims. All SMEs are eligible to apply for Advance Assurance for R&D they are planning to do (or have already done) as long as the company is not part of a group and none of the companies linked to the claimant entity have previously made a claim.

From a process standpoint, application remains relatively straightforward with the submission of an online form. However, before the company can proceed to claim for R&D tax relief for accounting periods beginning on or after 1 April 2023, a claim notification form to notify HMRC must be completed. HMRC will also contact companies seeking Advance Assurance to arrange a telephone call discussing the R&D in more detail. This is normally a short telephone call, but it may involve a longer discussion or a visit to the company in complex cases. We would recommend professional advice is sought prior to making an Advance Assurance application in order to streamline the process and minimise the time required by the business seeking it.

The Guidelines on the meaning of research and development for tax purposes (issued by the Secretary of State for the purposes of Section 1006 Income Tax Act 2007) were updated on 7 March 2023.  Paragraph 1 now states that ‘For the purposes of research and development allowances (Part 6 Capital Allowances Act 2001) this definition is extended to include oil and gas exploration and appraisal as defined in Section 1003 of Income Tax Act 2007.  The new Guidelines also clarify the position on qualifying indirect activities (QIAs). The original footnotes 2 and 3 to the 2004 Guidelines have been removed because they stated that the QIAs listed in para 31 are R&D, but do not attract R&D tax credits. In fact, whether or not expenditure on the QIAs qualifies for R&D tax relief depends on a number of factors, and there never has bene a blanket exclusion of them.

R&D expenditure categories have been extended to include the costs of datasets and cloud computing. However, there are exceptions such as when these relate to a “qualifying indirect activity” where you are including a small proportion of non-technical personnel time attributable to qualifying R&D projects.

R&D in pure mathematics will also qualify for relief and can form part of the qualifying R&D activities of the claimant from accounting periods beginning on or after 1 April 2023. The Guidelines on the definition of R&D now state:

‘Mathematical techniques are frequently used in science. From April 2023 mathematical advances in themselves are treated as science for the purposes of these Guidelines, whether or not they are advances in representing the nature and behaviour of the physical and material universe’.

This definition is, perhaps, rather wider than previously expected. For example, the development of new mathematical models, the study of mathematical structures and symmetries may qualify alongside the exploration of new mathematical concepts and the foundations of mathematics itself.

Changes originally announced for accounting periods beginning on or after 1 April 2023 are now to take effect for costs incurred in accounting periods starting on or after 1 April 2024. R&D activity will have to be physically located in the UK for the costs to be included in R&D tax relief claims. UK companies who currently claim R&D costs paid to overseas group companies or third parties may no longer be able to include these costs in their claims. The costs of externally provided workers (EPWs) will be limited to work undertaken in the UK where workers are paid a salary under the PAYE/NIC scheme.

There are specific exemptions where work outside the UK is permitted for geographical, environmental, social or regulatory/legal requirements. HMRC’s statement published with the draft legislation gives examples such as deep ocean research and clinical trials, and therefore, by inference, this would include medical-tech trials in specific patient groups, international telecoms testing, or technology designed for extreme environments.

Companies will not be able to claim that overseas costs fall within the exemptions where the main reason that the work is being carried out overseas is due to cost constraints or that the business does not have suitable workers in the UK.

There are also many issues to consider when it comes to the international structures of businesses carrying out R&D. For example, a UK group may have a branch in another company where work on UK R&D projects is undertaken. If all the IP from the project is retained in the UK and profits from the overseas branch are taxed in the UK, the staffing costs of the ‘overseas’ work will continue to be allowed for UK R&D relief purposes.

Conversely, if an overseas company seconds a worker to a group company in the UK to carry out a UK R&D project, but the worker is paid by the overseas company (recharged to the UK company at a mark-up), those salary costs will not qualify for UK R&D relief. The worker must be liable to UK PAYE and NIC for the costs to qualify.

The new restriction on overseas costs does not apply to the R&D ‘nexus fraction’ required to calculate patent box relief – so overseas R&D costs will still increase the proportion of tax relief that can be claimed under the patent box scheme.

All claims are required to be made digitally, except for companies exempt from the requirement to deliver a Company Tax Return online, and include an Additional Information form to be submitted through a new online portal (ie separately from the main Corporate Tax Return). An Additional Information form will be required for every R&D claim made on a tax return and all details must be entered (even if you are making a second or later year claim on the same project) – it has even confirmed that HMRC Customer Compliance Managers do not have the authority to dispense with the form for specific clients where they already have details of the claim.  Each Additional Information form must be signed by a named senior officer of the claimant company and must contain detailed information on the R&D project - including the name of the agent who has advised the company on compiling the claim. The form must also include a breakdown of costs across categories. However, the from does not, in many instances, completely replace the R&D report that is currently submitted by good R&D advisors. Indeed, HMRC recommend that large businesses in particular submit an R&D report along with their R&D claim to explain the methodology and cost sampling techniques used to prepare the claim. If the ‘Additional Information Form’ has not been completed, that this renders the R&D claim invalid and HMRC will have the power to remove the R&D claim from the company’s tax return where it believes a claim was made “in error".

Companies are required to inform HMRC of their intention to file a claim at any time from the start of the accounting period to six months after the end of the accounting period to which the claim relates. The aim of this rule is to prevent last minute ‘speculative’ claims made after the relevant accounting year: it took effect for accounting periods starting on or after 1 April 2023. HMRC have confirmed that if the 'Advance Notification Form' is needed but not completed that this renders the R&D claim invalid and, if shown in the corporate tax return, it will be removed by HMRC as an "error".  There are exceptions to the Advance Notification requirement – for example, you do not need to make advance notification for every single project in an accounting period. In addition, where claims are made within six months of the end of the accounting period, provided you have claimed in the three years preceding the end of the claim notification period there is no need to notify.  When making an Advance Notification, a company must submit "a summary of the high-level planned activities, for example if you’ve developed software what it will be used for to show that the project meets the standard definition of R&D". However, it is not necessary to submit proof or documentation at that stage. The Advance Notification form is available here.

Where a company breaches the SME size tests, it is allowed to continue to claim as an SME for one additional year, but other members of its group lose SME status. This one-year extension to SME claims was made available to all group companies for accounting periods starting on or after 1 April 2023.

In future, if a company ceases to be regarded as ‘going concern’ solely because of the transfer of a trade out of the business, but it is otherwise financially viable, the company will still be able to claim R&D relief. This has been applicable for accounting periods starting on or after 1 April 2023.

There are simple steps you can take to minimise the risks of a having an R&D tax relief claim reviewed or challenge with all the associated costs and delays.

When submitting a claim, make sure you clearly define your case and how you arrived at that decision, to prevent any potential challenges on HMRC’s part, completing all entries on the R&D section of the corporation tax return (CT600 form).

Ensure you submit a well-structured, technical report to support your R&D claim, with HMRC stating that 'submitting additional information to support any claim, such as an R&D report, will also help HMRC to process claims quicker'. This will also leave HMRC in no doubt about the reasons behind the submission.

HMRC has set out 13 expectations for steps that should be taken before an R&D claim is submitted in it's "Guidelines for compliance". Working with an experienced R&D tax specialist, who will guide and support you through the process, can be invaluable in meeting these expectations. HMRC has warned that if a claim is incorrect, inflated, or fraudulent then a penalty could be issued. An R&D tax specialist or consultant will ensure that your claims are accurate and submitted correctly.

To ease any pressure on cashflow, submit your R&D claim as soon as possible to mitigate any delays in payment.

It is clear that there will be much greater scrutiny of R&D tax relief claims. If R&D claims prepared for you, or that you have submitted, do not go into a forensic level of detail, it is quite possible that HMRC may challenge your claim, leading to a tax enquiry.

Businesses currently outsourcing their R&D project work overseas in order to reduce costs will need to review their financial projections and arrangements for future years. The changes to the claims regime may make it more cost effective to undertake R&D in the UK.

Our specialist R&D and Tax Dispute Resolution teams can work hand in hand with your technical teams to test and validate your claim and come to a resolution with HMRC before the dispute escalates into other areas of your tax compliance. For help and advice please contact Carrie Rutland or Dawn Register and read more about our R&D HMRC Enquiry Resolution services.