R&D tax relief: changes in the pipeline

In November last year, HM Treasury published an R&D Tax Reliefs Report setting out proposed reforms to the research and development (R&D) tax relief regime. Whilst this report has received relatively little fanfare, some of its proposals could have a major impact on how and when companies can claim R&D tax relief from April 2023.

The report covers changes to small and medium enterprises (SMEs) and R&D Expenditure Credit (‘RDEC’) schemes, and focuses on three main areas:

• Data and cloud computing costs
• Refocusing R&D relief towards the UK
• Abuse and compliance

As set out in more detail below, while the first two will only affect certain claimants, the proposals around abuse and compliance are much wider-ranging.

Data and cloud computing

In a move that will be welcomed by many, the report confirms that the definition of qualifying expenditure for both the SME and RDEC schemes will be extended to include:

• licence payments for datasets (other than those which can be resold or have a lasting value beyond the duration of the R&D project);
• staff costs associated with collecting data that directly contributes to an R&D project; and
• cloud computing costs used directly for R&D (e.g. computation, data processing analytics and software).

Refocusing on the UK

Alongside this expansion of qualifying costs, the report also proposes a narrowing of the territorial extent of R&D relief.

Currently, under both the SME and RDEC schemes, relief can be claimed in respect of qualifying R&D activity undertaken anywhere in the world. This explains, at least in part, how UK companies could claim tax relief on £47.5bn of R&D expenditure in 2019 when the ONS estimates that only £25.9bn of R&D was actually undertaken in the UK that year.

To refocus relief on UK innovation, the report proposes that:

• costs associated with subcontracting work to a third party will only qualify for R&D relief if the subcontracted work is performed in the UK; and
• expenditure on externally provided workers (EPWs) will only qualify for R&D relief if the EPWs are paid through a UK payroll.

Effectively this means that costs associated with overseas subcontracting or EPWs won’t qualify for R&D relief, though they can still be deducted from taxable profits in the usual way. Companies who subcontract R&D work or use EPWs will also have to put processes in place to check whether the associated activities are UK based or not.

Abuse and compliance

The scale of abuse and boundary-pushing in R&D relief claims remains a concern. HMRC’s accounts for 2019-20 estimate error and fraud to cost £311m, with the number and cost of R&D relief claims continuing to grow year on year.

Therefore, it’s not surprising that the most wide-ranging changes proposed in the report fall under the heading of ‘abuse and compliance’.  However, whilst these are directed at stopping abuse, they will affect all R&D tax relief claimants, including those who are fully compliant and making genuine claims.

HMRC are allocating additional resources to R&D relief compliance and working with stakeholders to explore ways to address to this issue. In addition, HMRC plan to introduce the following changes to the R&D claims process:

• Requiring all claims to be made digitally (except where the company is exempt from online filing)
• Requiring more details as to what expenditure a claim covers (e.g. the nature of the advance sought, the uncertainties overcome)
• Endorsement of claims by a named senior officer of the company
• Identifying any agents advising the company on a claim
• Requiring companies to notify HMRC in advance that they plan to make a claim

Whilst some of these changes appear sensible, the ATT and other stakeholders have expressed concern that the proposed requirement for advance notification could exclude many genuine claimants from accessing R&D relief.

As an extreme example, if a detailed notification of a specific project were required before the start of the accounting period in question this would completely exclude newly formed companies from relief in their first period.

Others who may be adversely affected by any advanced notification requirement include smaller companies (who often do not plan their activities far in advance) and those choosing to commence projects partway through an accounting period.

It seems unfair that companies could be excluded from claiming relief that they are otherwise entitled to merely because they are unable to make an advanced notification by the required date.

What next?

All the changes proposed are scheduled to come into effect in April 2023, with draft legislation published this summer for consultation and the final version legislated in Finance Bill 2022-23.

Whilst not strictly a consultation, the report did invite comments from interested parties by February 8, 2022.

Given the potential impact of some of these changes, companies claiming R&D relief and their advisers should keep an eye out for further developments so they can take them into account when planning for future years