HMRC v R&D – increasing the pressure on SME R&D endeavours

Last year’s Autumn Statement revealed changes to R&D Tax Relief, dealing a significant blow to industries spearheading innovation in the UK. Loss-making firms, accustomed to claiming up to £33 cash credit for every £100 spent, now face a reduced credit of £19 for the same expenditure. The government partially reversed this decision in the Spring budget, allowing loss-making companies with at least 40% of overall spending on R&D activities to claim £27 credit for every £100 spent. However, its applicability is expected to be limited, leaving the remaining SME industry receiving diminished rewards for their risky and costly R&D endeavours. Jason Mitchell, Partner, MHA Macintyre Hudson, explains.

The Autumn Statement saw the SME Tax Relief Enhancement Rate drop from 130% to 86% and the cash credit rate of surrendered losses decrease from 14.5% to 10%, from 1st April 2023. High loss-making start-ups engaged in risky and innovative technological development experienced a reduction in cash credit on R&D expenditure, from 33p to 19p per £1 of R&D Spend. The Autumn Statement also indicated the exclusion of International Subcontracted costs, scheduled to take effect from 1st April 2023. While the Spring Budget postponed this measure to 1st April 2024, the ultimate exclusion of these costs severely dampens the incentive for R&D start-ups in the UK, conflicting with the government’s ‘Global Britain’ agenda.

Claiming R&D relief is increasingly complex, as the Spring 2023 Budget unveiled a new category of ‘R&D intensive’ SME, where 40% of their total expenditure is R&D-related. The enhanced deduction for these companies remains at the reduced rate of 86%, but the enhanced loss can be surrendered at the 14.5% rate, yielding a cash credit of 27p/£1. However, the ‘R&D Intensive’ SME qualification won’t be available until the government implements the requisite tax legislation. Meanwhile, the Autumn 2022 changes came into effect from 1st April 2023, with claimants receiving only 19p/£1 of R&D spend rather than 27p/£1. These SMEs can delay submission until the new legislation is in place or submit under the current legislation, amending the claims once the new legislation is introduced. This ‘interim’ period adds complexity and uncertainty, potentially causing economic hardship and postponing any re-investment reliant on R&D cash credits.

New HMRC treatment on R&D Project involving direct commercial deliverables: Subcontracted R&D: Precedent vs New Position

Where businesses use contractors, it can be difficult to determine who the R&D belongs to and ensure the same work isn’t being claimed for by both the contractor and the contractee. The previous precedent on subcontracted R&D, used a test to check if a project or a technical package of works belongs to a company for inclusion in its RDTR claim:

• The Claimant Company (Subcontractee) owns the IP.
• The above also has the Lead Technical Professionals.
• R&D work is done at cost, i.e. no direct relationship between the project funding and R&D work. (If the company can bill for additional hours/materials for the R&D work, it would fail to meet this criterion, and the project must be claimed under RDEC).
• A Project may be contracted to an SME Company by a Large Company, where the IP specifically belongs to this Large Company. and the R&D work is accounted for in the contractual agreement; the Large Company cannot claim for the subcontracted work (as per RDEC rules), but the SME can claim this work under RDEC.

For SME RDTR claims, this precedent was a sensible way for the industry to self-regulate. However, recent experience with HMRC has shown a more aggressive stance being adopted, where ANY work that fulfils a contractual deliverable is considered Subcontracted R&D. This new position has emerged, unofficially (or not announced in HMRC policy), since Summer 2021. The industry believes such a stance is unjustified and idealistic, as few companies have the resources, or means to develop a fully-fledged prototype at cost with no commercial contract with a client in place, and then proceed to build the actual deliverable separately.

Where the contractor is a Large Company or Individual, claims can still be made under the less generous RDEC Scheme, even though the company and project may meet the other RDTR Requirements. This contradicts the previous position ignoring IP ownership and the presence of competent professionals within the claimant company. It also suggests SME’s could claim for R&D work encountered by their subcontractor regardless of involvement in the project, which goes against the principles of the scheme.

The MHA R&D Team have successfully resolved numerous complex enquiries by HMRC on claims originally prepared by the client themselves, or boutiques, and expects HMRC to continue enforcing this new position on Subcontracted R&D aggressively, unless they are ruled against in a First Tribunal hearing and then an Appeal (the latter confirming the position into case law).

Subsidised R&D: Precedent vs New Position

Any R&D projects carried out by a company that would otherwise claim under SME RDTR, would have to claim in RDEC where there’s a direct relationship between the payment made and the R&D work done. Specifically:

• The previous precedent involved consideration of the levels of funding the project received, whereby claims must be made within RDEC to the extent they are subsidised. An argument was made that contracts are often fixed price, with additional payments only relating to changes in the scope of works. Therefore, no direct relationship between the R&D work and the payments from the client.
• HMRC’s new position asserts that since the company realises a commercial gain from the work done, it is considered subsidised. This was challenged in a First Tribunal Hearing, (Quinn International vs HMRC), where the judge admonished HMRC’s position, stating the legislation as written was never meant to be applied this way. However, HMRC haven’t appealed the decision, to avoid the position becoming legal precedent.

Conclusion

Despite the expectation that the UK’s R&D Tax Relief Schemes will continue supporting innovative companies, the multitude of changes in structure, process, and incentives necessitates thorough planning and adaptation. Companies already claiming R&D relief must completely refresh their claim processes in light of these modifications.

The MHA R&D Team is actively engaged with HMRC consultations regarding the future of the R&D schemes and welcomes any feedback or concerns.

SUMMARY OF CHANGES TO THE 2 MAIN R&D SCHEMES IN THE UK

PRE-31 MARCH 2023:

SME R&D TAX RELIEF: is more generous, previously providing Tax Benefit up to £25p/£1 for Profitable period, £33p/£1 for highly Loss-making periods, and £18.85p/£1 at breakeven; however, care has to be applied, as it has additional conditions for Subcontracted R&D & Subsidised Expenditure, and where projects have any form of government subsidy/grant.

R&D EXPENDITURE CREDIT (RDEC): Primarily claimed by large companies, with a 13% Tax Credit rate applied on Qualifying Expenditure. The credit is added ‘above the line’ in accounting terms, i.e. it adds to the Taxable Profits made by the Company. This Tax Credit is therefore Tax Liable, and under the 19% Corporation Tax Rate, the effective RDEC Tax Benefit is 10.5% of the Qualifying Expenditure.

Changes to UK R&D Tax Relief Schemes:

The government have confirmed their intention to eventually merge the SME & RDEC Schemes by April 2024. While details have not yet been confirmed, it’s expected to be more heavily modelled around the RDEC Scheme.

FROM 1ST OF APRIL 2021 ONWARDS:

• SME R&D TAX RELIEF: the Cash Credit Cap came into force, which is £20,000 + 3*(total PAYE + NIC Liabilities) – (if claim is made in the SME Scheme), and that most, if not all of the R&D Enhanced Deduction will be exhausted to reduce the Tax Liability (the cash credit cap is only significant if the claim is larger, and losses are even larger).

• R&D EXPENDITURE CREDIT (RDEC): Any repayable cash credit (i.e. where relief against Taxable Profits is exhausted in the claimant company and group) is still capped by the total Employer PAYE + NIC Liabilities of R&D Staff.

• SME & RDEC: Introduction of CT600L Supplementary form to the normal Corporation Tax Return (CT600), which records the PAYE Reference and PAYE + NIC Liabilities.

FROM 1ST APRIL 2023 ONWARDS:

• SME R&D TAX RELIEF – COST CATEGORIES: An explicit inclusion of costs relating to Cloud Infrastructure and Acquisition of Datasets, and expansion of the Definition of R&D to include Pure Mathematics.

• SME R&D TAX RELIEF – BENEFIT RATES: Enhancement rate reduced from 130%to 86%, and a reduction in Cash Credit rate of R&D Enhanced Losses from 14.5% to 10%. In addition, the ability for ‘R&D Intensive’ companies to be recognised as those spending at least 40% of overall expenditure on R&D activities, who will be able claim a payable credit rate of 14.5% instead of 10%. However, legislation for this is not in place yet, and the government recommends claiming at the lower rate initially (10%) or delay the claim and submit later (or re-submitted the same claim to realise the higher credit rate of 14.5%).

• R&D EXPENDITURE CREDIT (RDEC):  An increase in the Tax Credit rate for the R&D Expenditure Credit Scheme (RDEC) from 13% to 20%. This is in line with the increase in Corporation Tax Rates from 19% to 25% coming into force at the same time. This would mean that the minimum effective Tax Benefit rate to be 15%.

• SME RDTR & RDEC: Pre-Notification on the intention to claim for accounting periods starting on or after 1st April 2023, with companies required to provide additional digital information (applicable to claims made on or after 1st August 2023).

FROM 1ST APRIL 2024 ONWARDS:

• SME TAX RELIEF: An exclusion of any International/offshore subcontracted activities.

• SME RDTR & RDEC: Potential merger between the SME & RDEC Schemes.

For more information about MHA visit www.macintyrehudson.co.uk and to find out more about how the firm supports clients with R&D Tax Relief claims or with  HMRC investigations, email Jason Mitchell at [email protected]

MHA have national R&D specialists who help UK businesses to identify qualifying expenditure and help to maximise their R&D Tax relief claims. Their team is made up of qualified and experienced financial advisors, accountants and tax specialists with scientific and engineering qualifications who can provide expert advice in all areas of the claim and support any defence of existing claims taken into enquiry by HMRC.