From April 2023, significant changes to R&D tax relief will take effect
From April 2023, significant changes to R&D tax reliefs will take effect
Following a consultation process that began in 2020, HMRC has published draft tax legislation for amending enhanced research and development (R&D) tax reliefs. Businesses have little time to prepare for the changes since they are due to take effect for accounting periods starting on or after 1 April 2023.
Four main areas are affected by the changes.
Data sets, cloud computing and pure mathematics
A positive development is the expansion of the categories of qualifying expenditures to include expenditures on cloud computing and data sets. In particular, companies in the technology sector and other heavy users of cloud computing and hosting services are looking forward to this long-awaited change. The Government has also confirmed that the guidelines setting out the definition of R&D for tax purposes will be amended. This will remove the current exclusion for projects seeking advances in pure mathematics.
A focus on innovation in the UK
Relief will be restricted to R&D undertaken in the UK and to qualifying overseas expenditure. Small and medium-sized enterprises (SMEs) will generally need to pay externally provided workers (EPWs) through a UK payroll in order to qualify for enhanced R&D tax relief. Therefore, eligible activities subcontracted to third parties will generally need to be carried out in the UK. Under the published draft legislation, however, employees of UK companies who conduct eligible activities overseas would still qualify for enhanced relief.
A similar change will be made in respect of contributions to independent research under the R&D expenditure credit (RDEC) regime applicable to larger companies and certain SME costs. RDEC claimants making payments to overseas universities (or other qualifying bodies) will be affected by this.
In order to qualify as overseas expenditure, overseas R&D activities, whether subcontracted or carried out independently, must be conducted outside the UK because the necessary geographical, environmental, or social conditions, or legal or regulatory requirements, are not present in the UK to be tested. Subcontracted deep ocean research, as well as clinical trials conducted by drug development companies, may still qualify, for example.
Expenditures associated with R&D activities carried out overseas are specifically excluded from eligibility for enhanced R&D tax reliefs due to cost or availability of workers. Based on discussions with HMRC's technical specialists, we understand that the approach is based on allowing expenditure to qualify based on necessity rather than convenience.
There is no doubt that these changes will have a significant impact on many businesses, and immediate action should therefore be taken to assess their impact. Many will not have time to amend supply chains; indeed, many may prefer to maintain existing relationships for commercial reasons, despite the loss of enhanced relief.
Tackling abuse
Several changes to the R&D claims submission process will be introduced, including requirements that:
Claims must be made digitally
The categories of qualifying expenditure incurred should be disclosed and brief details of the R&D activities provided
Claims must be endorsed by a named senior company officer
Companies must inform HMRC in advance of their intention to make a claim within six months of the end of the accounting period to which the claim relates
Details of any agent that has advised the company in making the claim must be provided.
It is crucial to pay attention to point 4. By failing to notify HMRC of their intention to claim by the deadline, a significant number of new entrants to the R&D relief regime may be excluded. This could be caused by a lack of awareness of the R&D relief regime.
It is evident that more needs to be done to prevent substandard R&D claims from being submitted to HMRC, and we support targeted efforts to curb abuse, but the potential consequences of this particular proposed rule could be a bitter pill to swallow for start-ups and fledgling companies. It is possible for companies inadvertently adversely affected to be deprived of a valuable source of cash flow, limiting their ability to grow, develop intellectual property, and create jobs.
Addressing anomalies and unforeseen consequences
The draft legislation also contains various measures to address anomalies and unforeseen consequences, so that the R&D tax reliefs operate as intended. Specifically, it ensures that employer health and social care levy costs will qualify for relief. In addition, it ensures that companies that have transferred their trade within a group will not be prevented from making certain claims.
Summary
R&D tax regimes will need to be adapted to a rapidly changing scientific and technological environment in order to remain relevant to the needs of businesses. The effect of these changes will remain to be seen, or whether a greater opportunity was missed for more comprehensive reforms.
If you would like support with your R&D claim, contact Zyla Accountants today. You can view more about our R&D Tax relief services here.