It’s all change for the R&D tax relief regime: what does this mean for SMEs?

By Michael Williams, Knill James Tax Manager

Major changes ahead

This is a year of significant change for the Research and Development (R&D) tax relief scheme. Unfortunately, the changes are mostly negative for small and medium-sized enterprises (SMEs) and will make claiming relief harder as well as reducing its value.

The good news – more expenditure now qualifies for relief

The scope of expenditure that qualifies for R&D relief has been expanded from 1 April 2023 to include expenditure on data, cloud computing and the costs of pure mathematics. This will capture more costs for many R&D projects and is a positive change to help modernise the scheme.

The bad news – rate of additional relief reduced…

Since 2015, eligible R&D expenditure has obtained an additional Corporation Tax (CT) deduction of 130%. This has meant that every £100 of eligible R&D expenditure resulted in a deduction of £230, and could save CT (at a 19% CT rate) of up to £43.70 – giving an effective tax saving at 43.7% on taxable profits.

From 1 April 2023, the rate of additional relief was reduced to 86%. This reduces the total deduction to £186 per £100 spend. The tax saving will then depend on the rate of CT payable following the change to the regime also taking effect from that date. More information can be found in our blog here.

These changes will give effective tax savings on profits from between 35.3% to 49.2%, depending on the company's profit levels. Profitable larger SMEs may therefore obtain a better effective rate on their R&D spend, whereas smaller companies may be worse off.

… and rate of repayable credit reduced…

For loss making SMEs, there is the option to surrender the losses generated by R&D activity for a repayable tax credit. This often provides vital cash flow for companies early in their lifecycles and helps to fund the ongoing R&D.

All SMEs have been able to receive this repayable tax credit at a rate of 14.5% since 2014. However, from 1 April 2023 this rate is reduced to 10% unless the SME qualifies as 'research intensive'. This requires the company to spend 40% of its total expenditure on amounts qualifying for R&D. For the more mature companies who may be continuing to innovate but have already established a market for products derived from their previously completed R&D projects, this may well reduce their cash flow benefits from the scheme and restrict future innovation.

… and significant new HMRC obligations

There have been a number of bad actors advising in the R&D market which has resulted in some exaggerated and occasionally outright fraudulent R&D claims being submitted.

HMRC have acted in order to clamp down on this, which unfortunately is going to impact on all claims being made and so will affect all the legitimate and appropriate claims that the vast majority of companies make.

Details of additional requirements for all claims

1. Claim notifications: act early to avoid missing out on relief

For accounting periods commencing on or after 1 April 2023, a claim notification may be needed to claim R&D relief. Broadly, this will apply if a company is claiming for the first time, or has not made a claim in the last three years.

This notification must be made to HMRC within six months following the end of the period of account. If it's not made by this date, any claim for R&D relief for that period will not be valid.

Companies and advisers will therefore need to give R&D relief early attention, particularly with start-up companies. It may be too late to notify by the time accounting records are sent in to prepare the first set of accounts and valuable R&D relief may go to waste.

Along with some fairly standard information, any claim notification must include:

• The senior contact in the company who is responsible for the R&D claim
• The contact details of any agent involved in the R&D claim
• A summary of the R&D activities

This will require the company and agent to address the R&D activities thoroughly ahead of making a notification, as they will be noted as being responsible for the making of an appropriate claim. Prompt assessment of the eligibility of the R&D activity will also be required to ensure the claim is valid and an appropriate summary drawn up for the notification.

2. Submission of additional information: significant extra admin needed

Where the claim submission is on or after 1 August 2023 – irrespective of the period of account date – additional information about the claim must be submitted to HMRC.

This additional information has to be included in a specific form, separate from the company's tax return. All companies making R&D claims will therefore be saddled with this additional administrative burden, even where detailed reports and information are already included within their company tax return submission.

A company representative or an agent for the company can submit the additional information form. If the form is not submitted before the claim is included in the company tax return, HMRC will automatically remove the claim from the return.

Some of the information required is similar to that of the claim notification. However, there are some significant details required in relation to:

• The qualifying R&D expenditure
• Any qualifying indirect activities
• The R&D projects

The number of projects that need to be detailed in the form depends on the total number of projects undertaken in the period. A minimum of three projects require description, unless the total number is less than that. Where there are more than three projects, the projects described must cover at least 50% of the qualifying expenditure.

Good record keeping is vital

It is therefore imperative that good record keeping and accounting is in force so that the costs of each project can be identified and the requirements of the form met.

The description of each project must cover:

• What is the main field of science or technology
• What was the baseline level of science or technology that the company planned to advance
• What advance in the science or technological knowledge did the company aim to achieve
• The scientific or technological uncertainties that the company faced
• How the project sought to overcome those uncertainties
• Which tax relief you're claiming and the amount of qualifying expenditure

Whilst companies that have prepared detailed R&D reports to support their claims in previous years may well have all this information, the need to reformat this into HMRC's form will add to the company's compliance obligations. Other companies that may not have been capturing this level of detail in their claims will now need to do so, which will be a significant impact on their claim process.

Companies with minor claims for R&D will now have to assess if the time and/or professional fees incurred in meeting these obligations is worthwhile when compared to the benefit received.

There is now therefore need for all companies to be reviewing their R&D projects and claim processes in detail to ensure the additional information form can be, and is actually, completed ahead of making the claim in the company tax return. Assessments will need to be made of the financial and time resources required to comply with the new form.

Exclusion of non-UK based subcontractors

From 1 April 2024, any R&D activity subcontracted by an SME to a third party that undertakes the work outside of the UK will not be eligible for the relief. Whilst there is a carve-out for work carried on outside the UK for geographical or regulatory reasons, this is still a potentially large reduction in eligible costs.

The aim is obvious in trying to boost and amplify the UK's own R&D work, but for SMEs sourcing this inside the UK is not always commercially viable. Detailed calculations may be required to assess the financial impact of using UK based subcontractors and obtaining the R&D relief, compared with any existing arrangements with overseas subcontractors.

Conclusion: making R&D claims will be more onerous for all companies

Despite a welcome modernising of the relief in terms of qualifying expenditure, it is undoubtedly far more onerous to make a claim to R&D from 2023 onwards for all companies.

The reduction in the rate of the enhanced deduction will hurt smaller SMEs, and when combined with the potential reduction in the repayable credit for non-research intensive companies, loss-making SMEs will be far worse off.

The new claim notifications and additional information obligations could add significant administrative burdens for all companies and this should be thought about sooner rather than later.

Companies with overseas subcontracted R&D will also need to assess the impact of the new exclusion on the value of their claims.

We're here to help

At Knill James we have significant experience in the R&D field. For assistance with what these changes will mean for your company, please get in touch with Michael Williams (michaelw@knilljames.co.uk) or Zelie Byrne (zelieb@knilljames.co.uk).