Navigating the New Landscape: Understanding the Merged R&D Tax Credit Scheme

Introduction

There are some significant changes to the R&D Tax Credits scheme that are going to be implemented soon. We wanted to keep you up to date on these changes and what it might mean for you.

In a shift that is aimed at streamlining the process of claiming R&D Tax Credits, the UK government has announced the merger of the current Small or Medium Enterprise (SME) and Research and Development Expenditure Credit (RDEC) schemes into a single, unified scheme. The existing SME R&D scheme will still continue for what are being called R&D intensive companies (‘The Intensive Scheme’).

This change will take effect for accounting periods beginning on or after 1 April 2024, and is meant to make the scheme more accessible to qualifying companies. However, it may also pose a number of challenges for companies that are unprepared, particularly for those who have subcontracted their R&D out.

HMRC also introduced some new interpretations of the rules relating to SMEs that are performing R&D in the existing SME R&D scheme under a contract from a client. More on this later.

Overview of the Intensive Scheme

Loss-making SMEs that are heavily invested in R&D, will be allowed to claim up to a 26.97% cash rebate on their R&D spending. Initially, the benchmark for being considered as an R&D-intensive company was set at a threshold of 40% spending of total allowable expenses on R&D. However, during the last Autumn Statement, this was reduced to 30% for accounting periods commencing from 1 April 2024.

The government also introduced a grace period of one year for businesses that do not meet the 30% expenditure threshold in the year after the initial year of meeting the threshold. This was done to consider fluctuations in R&D spending without penalising the claimants. However, companies attempting to shorten their financial year to reach the 30% mark will not be eligible to claim.

Overview of the Merged Scheme

The newly merged scheme follows the RDEC mechanism of an “above-the-line credit” which can either reduce your company’s tax liability or, after certain calculations, result in a direct cash payment to your organisation.

Companies will still be allowed to claim for their qualifying R&D costs, including expenses for where they subcontract R&D. This scheme is more aligned with some of the more generous aspects of the previous SME scheme, particularly regarding the PAYE and National Insurance contributions cap. However, it also introduces restrictions on claims for overseas expenditures and R&D performed under a commercial contract. More on this later.

Under the merged scheme, the relief rate is set at the current RDEC rate of 20% and is taxable. This translates to a benefit rate of 16.2% of qualifying expenditure across the board. An exception to this is the rate of 27% for “R&D intensive SMEs” that have an R&D expenditure of 40% or more of their total expenditure.

The below table illustrates the benefit rate changes under the merged scheme in comparison to the current schemes:

Claim Type SME Scheme RDEC Scheme Merged scheme
Before 1 April 2023 After 1 April 2023 Before 1 April 2023 From 1 April 2023 From 1 April 2023
Loss-making SME Costs plus 130% uplift = 230x 14.4% repayable credit = 33.35% subsidy Costs plus 86% uplift = 186 x 10% repayable credit = 18.6% subsidy 10.5% subsidy 15% subsidy 16.2% subsidy
Profit-making SME 130% uplift on costs = 24.7% net benefit 86% uplift on costs = 21.5% net benefit Headline rate 13% = 10.5% post taxHeadline rate 20% = post tax rate between 14.7% – 16.2%* Headline rate 20% = post tax rate between 14.7% – 16.2%* Headline rate 20% = post tax rate between 14.7% – 16.2%*
R&D intensive SME NA Costs plus 86% uplift = 186 x 14.5% repayable credit = 26.97% subsidy NA NA NA

Restrictions on Overseas R&D

Companies that have subcontracted their R&D to overseas suppliers or use overseas contract workers (EPWs) will no longer be able to include this as qualifying expenditure.

The good news is that, instead of a blanket rule affecting all overseas R&D, there are 3 exemptions. They must all apply for the expenditure to qualify:

  • the first circumstance is that “conditions necessary for the R&D are not present in the UK”. 1
  • the second is that the “conditions are present in the location where the R&D is undertaken”. 2
  • the third is that “it would be wholly unreasonable for the company to replicate the conditions in the UK”. 3
1 Source: paragraph  CTA09/1138A(2)(a) of the legislation.
2 Source: paragraph CTA09/1138A(2)(b) of the legislation.
3 Source: paragraph CTA09/1138A(2)(c) of the legislation.

The legislation does not include an exhaustive list of the sorts of condition necessary for the R&D that may be considered. The term “conditions” is fairly wide, and includes:

  • geographical, environmental and social conditions
  • legal or regulatory requirements

Note: Cost and availability are specifically excluded as conditions for exemption.

Besides payments to contractors and EPWs, there are other types of overseas spending can still be included in a claim. Costs like materials, software, and travel for UK employees working on R&D projects abroad can also qualify as R&D expenses. The location of the spending on these costs matters in determining if the work being outsourced is happening in the UK.

Restrictions on Contracted R&D

Under HMRC’s current interpretation of the rules, SMEs with an accounting period beginning before 1 April 2024, cannot claim SME R&D tax relief for R&D activities that they have performed to fulfil the terms of a commercial contract.

This is still an area of ongoing legal challenge and the final decision on this will likely depend on the outcome of a number of cases that are currently being heard by the Tax Tribunal.
As of 12 March 2024, the HMRC interpretation of the law is that if there is a contract between a client and supplier, and the supplier performed R&D in the course of delivering that contract, then it is the client who will be able to claim, not the supplier.

However, there is a good chance that suppliers will once again be able to claim if their year-end falls on or after 1 April 2024, providing there was no specific intent by the client to perform R&D.

If you believe this particular change will affect you as an Innovation Plus client, please contact us unless we have contacted you already, so we can advise you on the best way to navigate this change.

Tips for Minimising Negative Implications of the Merged Scheme

  • Review R&D Activities: Assess current and planned R&D projects to understand how they align with the new qualifying rules, especially concerning overseas expenditures.
  • Update Internal Systems: Ensure that accounting and claim preparation systems are updated to accommodate the new scheme’s requirements, reducing the risk of errors or delays in claims. As a client of Innovation Plus, we will update you on any required changes on an individual basis if needed.
  • Seek Professional Advice: If you are not an Innovation Plus client, consider consulting with tax professionals or advisors who specialize in R&D tax credits to navigate the changes effectively and optimise your claims.
  • Monitor Regulatory Guidance: If you are not an Innovation Plus client, stay informed about further guidance from HMRC, especially regarding compliance and detailed rules for contracted R&D work, to ensure full compliance and maximisation of benefits.
  • Review HMRC GFC3 – although aspirational in that it expects a level of documentation that is not practical for small companies, it has a lot of best practice information: https://www.gov.uk/government/publications/help-to-see-if-your-work-qualifies-as-research-and-development-for-tax-purposes-gfc3

Conclusion

The merger of the SME and RDEC schemes into a unified R&D tax credit scheme marks a significant change in the UK’s approach to incentivising innovation and supporting research and development within the business sector. While the transition may require businesses to adapt, the long-term benefits of a simplified, more accessible scheme could outweigh the initial challenges. By taking proactive steps to align with the new rules and seeking appropriate advice, businesses can continue to harness the power of R&D tax credits to drive innovation and growth.

If you are still unsure about how these changes will impact your business or you need further guidance on your company’s specific position, we are here to help. Contact one of our team.