HMRC published draft tax legislation this week to amend the enhanced research and development (R&D) tax reliefs, following a consultation process that started all the way back in 2020. There were few surprises in the detail released, but the changes are due to come into effect for accounting periods beginning on or after 1 April 2023, so businesses now have little time to prepare. The main areas of change are:
Data sets and cloud computing
In positive news, the categories of qualifying expenditure will be extended to include certain expenditure on data sets and cloud computing. This has been a long time coming and will be welcomed by many companies, particularly by those in the technology sector and other heavy users of cloud computing and hosting services. The government has also confirmed that the guidelines setting out the definition of R&D for tax purposes will be amended to remove the exclusion of pure mathematics.
Focus on UK innovation
In a significant restriction to previously qualifying expenditure, externally provided workers (EPWs) will have to be paid via a UK payroll if the expenditure is to benefit from the relief. As regards the scheme applicable to small and medium-sized enterprises (SMEs), activities subcontracted to third parties will also need to be carried out in the UK for the associated costs to qualify.
Interestingly, under the R&D expenditure credit (RDEC) regime generally applicable to larger companies, a similar change will be made in respect of contributions to independent research. This will impact RDEC claimants making payments to overseas universities (or other qualifying bodies).
Certain exemptions may apply where R&D activities that are subcontracted or carried out independently must be undertaken outside the UK due to necessary geographical, environmental or social conditions not present in the UK. This means, for example, that expenditure on sub-contracted deep ocean research may still qualify.
These exemptions may also apply where regulatory or other legal requirements mean the activities must be undertaken overseas, which could be the case for certain clinical trials operated by drug development companies.
Cost or the availability of workers will not be acceptable reasons for R&D activities to be carried out overseas, and the associated expenditure will therefore be excluded from the claim. We understand from discussions with HMRC’s technical specialists that these exemptions are based on the premise of allowing expenditure carried out overseas to qualify based on ‘necessity, rather than convenience or preference’.
This will clearly have a huge impact on many businesses and immediate action should be taken to assess the impact of these proposals. For many, there will not be time to amend supply chains: Indeed, based on our research, most will prefer to maintain existing relationships for commercial reasons, despite the loss of relief for such costs.
Tackling abuse
Several changes to the R&D claims submission process will be introduced, including requirements that:
1. claims must be made digitally;
2. the categories of qualifying expenditure incurred should be disclosed and brief detail of the R&D activities provided;
3. claims must be endorsed by a named senior company officer;
4. the company must inform HMRC in advance of its intention to make a claim within six months of the end of the period to which the claim relates; and
5. the details of any agent who has advised the company in making the claim must be provided.
We emphasise point 4, as it is this that stands to exclude a significant number of new entrants to the regime, where they fail to notify by the deadline because of a lack of awareness of either the R&D relief regime or that their activities may qualify.
While it is clear more needs to be done to prevent substandard R&D claims being submitted to HMRC, and we have long been supporters of any targeted efforts to crack down on abuse of the system, this could be a bitter pill to swallow for start-up and fledgling companies. Companies inadvertently impacted by the new rules could find that a valuable tap for cash flow is turned off, stunting their ability to grow, develop intellectual property, and create jobs.
Addressing anomalies and unforeseen consequences
The draft legislation also includes various measures to address anomalies and unforeseen consequences, thereby ensuring that the R&D tax reliefs operate as intended. Perhaps most notably, these reforms include ensuring that employer’s health and social care levy costs may qualify for relief, and ensuring that companies that have transferred their trade intra-group are not prevented from making certain claims simply because of the transfer.
Summary
It seems a long time from the beginning of the consultation process to the publication of draft legislation this week. It remains to be seen whether the changes will have the desired effect in each of the areas above, or whether an opportunity has been missed for more wide-reaching reforms to help ensure the regimes remain fit for purpose in a rapidly changing scientific and technological environment.
With the current political turmoil to factor in too, we question whether there may be further reforms to R&D tax reliefs in the not too distant future?
For more information contact sheetal.sanghvi@rsmuk.com
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