Merging R&D tax relief schemes – how it will work

Merging R&D tax relief schemes – how it will work

Original content by BDO United Kingdom.
 

At the 2023 Autumn Statement the Chancellor announced further changes intended to simplify and improve the R&D tax incentive schemes in the UK. 

Draft legislation relating to the merged R&D scheme was announced earlier this year and will establish an above the line credit scheme which broadly follows the current RDEC scheme, with a headline rate of 20%. The merged scheme will run alongside the SME intensive scheme.  

There is no suggestion that core definition of what constitutes R&D (DSIT guidelines) for tax purposes: claimants will still need to prove that their project sought to achieve an advance in science or technology. 

The government confirmed that the merged scheme would take effect for accounting periods beginning on or after 1 April 2024 as well as introducing several changes to the proposals. 

A pick and mix approach

The combined scheme will principally be based on the current RDEC rules. This should help to raise the prominence of the R&D function within a business by recognising the R&D incentive in a company’s pre-tax income – the so called “above the line credit”. It will also make it easier for larger businesses to make the transition, but SMEs will need to start planning for the change soon. However, it will adopt some elements from the existing SME scheme, which are highlighted below. 

Rates of relief

The notional tax rate applied to the RDEC for loss-making companies will be set at the small profits rate of 19% rather than the main rate of 25%. The R&D relief available to loss-making companies will therefore become 16.2p for every £1 of qualifying spend. 

R&D relief for profitable companies continues to be 15p for every £1 of qualifying spend where the main rate of corporation tax applies.

  SME SCHEME RDEC SCHEME MERGED SCHEME
Up to 31/03/2023 From 01/04/2023 Up to 31/03/2023 From 01/04/2023 From 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 14.7% - 16.2%* Headline rate 20% = post tax rate between 14.7% - 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 corporation tax rate applied to those profits. The Net RDEC at the main rate of CT (25%) is 15%, for the small companies rate (19%) is 16.2% and for companies paying tax in the marginal rate band (26.5%) is 14.7%.                    

**Loss-making R&D intensive companies are those whose qualifying R&D expenditure constitutes at least 40% (from 1 April 2023) or 30% (from 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. While this higher rate is intended to apply for the 2023/24 tax year, it will be legislated for in Finance Bill 2023-24 which is expected to become law in spring 2024, therefore, these relief rates cannot yet be used for accounting purposes.     

Contracted-out R&D 

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. This would expand significantly under the merged scheme, which it is suggested would adopt the current SME rules allowing costs for most outsourced R&D to be claimed (apart from overseas costs – see below). 

Interestingly, the current 65% restriction on outsourced costs that can be claimed by SMEs would continue. 

Broadly, the new rules are intended to align the R&D claim with the company making the R&D decisions and taking the risk. Although, as already noted in the draft legislation, the new rules will not prevent a UK entity making a claim where the work has been subcontracted to it from an overseas or governmental entity. The changes apply to both the merged and R&D intensive schemes for relief. 

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.  

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. 

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 costs incurred for accounting periods starting on or after 1 April 2024 as a feature of the new merged scheme, although the exceptions would also apply. 

Other changes 

The proposal for the more generous PAYE/NIC cap rules from the existing SME scheme to be adopted has been confirmed.  

Enhanced support for R&D intensive SMEs 

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 was confirmed in the Autumn Statement, along with a reduction in the threshold as follows: 

  • The R&D ‘intensity’ threshold to be reduced from 40% to 30% from 1 April 2024 

  • SME tax credit remain 14.5% 

  • This remains a stand-alone scheme of relief and reported in the tax line of claimant companies’ accounts (in contrast with the above the line treatment of the merged scheme) 

  • 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

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. 

For help and advice, please contact our team: Lorraine Nelson.