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

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

Original content produced by BDO United Kingdom
 

Following a consultation launched in January 2023, the government published updated proposals for merging the SME and RDEC tax relief schemes on 17 July 2023: although this is described as a “potential merger” it does seem likely to go ahead. The merged scheme could take effect as early as for costs incurred on or after 1 April 2024 - although no final date has yet been set yet. 

Below we explain the current proposals and consider the impact they may have on the wide range of businesses that would be affected by the merged rules. 

A pick and mix approach

The combined scheme would 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, some elements of the current rules from the SME scheme would be adopted (detailed below) and, in some instances, this will give a more favourable result to businesses undertaking or commissioning R&D projects. 

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

Rates of relief

Although the rates of relief under the current R&D schemes have been more closely aligned since 1 April 2023, there are still significant differences. 

Under the merged scheme, all companies would get a headline rate of relief at 20% and their net benefit 15% as the main rate of corporation tax must be used to calculated this (apart from ‘ringfenced’ trades).

However, the proposals suggest that the special rate of relief for R&D intensive companies will continue – with this relief “running alongside” the merged scheme, so it seems that there will be a special scheme for start-up companies doing high levels of R&D. 

Overall, the proposals as currently drafted mean that smaller companies see a further reduction in the benefit they get from R&D relief claims. This is disappointing and does not appear to give scope for the government to target additional relief to specific sectors of the economy. Worse still, the new rules on subsidised R&D (explained below) mean that where a company has received grant funding for its R&D project it will not be able to claim R&D tax relief at all. 

Loss cap rules

Both the current RDEC and SME schemes include rules that limit the amount of relief that can be claimed when a company is loss-making, but the SME scheme rules are the more generous of the two. Broadly, it caps the refund that a loss making company can claim to £20,000 plus 3 times its PAYE and NIC liability for the period of the claim and there are specific exemptions from it for companies investing heavily in developing their own Intellectual Property – read more here. 

Happily, it is proposed that the merged scheme will adopt the SME scheme loss cap rules.

Qualifying costs

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 (eg universities and other not for profit organisations) or to individuals. 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. 

It is important to note here that relief could only be claimed by the principal company - not organisation doing the R&D work. If this approach is adopted, it will be a big change for contract research organisations with UK clients, although they will still be able to claim where overseas organisations outsource research to them. 

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 for outsourcing work to self-employed individuals or those working through a personal service company could not be claimed. 

In recent years, HMRC has pursued a number of tax cases where it claimed that the cost of the R&D work was effectively subsidised so cannot be claimed under the SME scheme – for example, Hadee Engineering where HMRC successfully claimed that R&D work carried out to develop a product for a customer was effectively subsidised by that customer. This trend would continue within the merged scheme as the proposed rules would not allow an R&D claim to be made where any form of subsidy or grant is received in respect of the R&D project. 

There has always been a friction between receiving a grant and claiming R&D relief on a project - an outright ban on claiming relief after grant funding will make decisions about applying for grants even more tricky for companies in future.

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 on or after 1 April 2024 as a feature of the new merged scheme, although the exceptions would also apply. 

Preparing for the merged scheme

There are some positive suggestions in the proposals for the merged scheme – especially for large businesses already claiming RDEC. However, with so many changes to the R&D rules already taking effect in 2023, it is hoped that implementation of a merged scheme can be delayed until at least 2026 to give SMEs and other businesses that will lose out time to plan ahead for the new rules. 

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 us.