What does the future hold for R&D tax relief?

Plans for an overhaul of research and development tax reliefs need to be finetuned to ensure a merged system is effective, warns Nigel Holmes, director, research and development, Ryan

Nigel Holmes, Director, research and development, Ryan

While most tax advisors would secretly admit that complex tax rules are good (it keeps us busy), there was much outcry when the Chancellor announced in his Autumn Statement the abolition of the Office of Tax Simplification.

However, one development that was announced and is expected to simplify matters is the consolidation of the current two-tier research and development (R&D) tax relief system, commonly known as small and medium-size enterprise (SME) and R&D Expenditure Credit (RDEC), into one yet to be named RDEC-like scheme.

On 18 July 2023, the draft legislation for such a proposed merged scheme was published, even though it is yet to be confirmed that this will actually happen. While it clarified some matters, it also raised areas of concern.

What will the merged R&D scheme look like?

Despite the hype, there will still be two schemes. So much for simplification!

The merged scheme will be accompanied by an SME-like scheme for R&D-intensive companies, as described in the March budget. It is unclear why such companies could not merely benefit from a better rate of relief under one common set of rules.

The whole idea was to allow companies to know where they stood on R&D tax relief regardless of size and profit/loss. Now, this will no longer be the case. Some companies will need to wait until accounts are prepared to see if they meet the R&D-intensive criteria, and those on the cusp may put themselves at greater risk of scrutiny.

The draft legislation indicates that a new merged scheme could apply for expenditure incurred on or after 1 April 2024; therefore, some companies will already be within an accounting period that straddles this date.

A better solution would be to commence from accounting periods beginning on or after 1 April 2024 or, better still, wait a year or so. After all, R&D tax relief advisors have had enough changes recently to last a while!

The merged scheme will create an RDEC-style credit but will take some of the rules from the SME scheme, creating a new hybrid set of rules.

For example, the merged scheme will adopt the more generous PAYE cap from the SME scheme. However, the plans to exclude overseas activities undertaken by subcontractors and externally provided workers will take effect, resulting in a double anti-avoidance provision that appears to be over the top. The geographical and legal exemptions to the exclusion will also apply.

Two interesting areas that are already contentious under the existing schemes relate to ‘subcontracted’ and ‘subsidised’. These two areas of R&D tax legislation are causing confusion and disruption to claims at present.

While the HMRC denies that their stance and change of guidance represents a change in view, the profession thinks otherwise. The Quinn (London) case did provide further clarity to the profession on ‘subsidised’, yet HMRC does not accept its findings. Further lead cases to be heard soon should clarify matters. So, how have these matters been dealt with in the proposed new scheme?

Subcontracted

HMRC has taken the decision in the draft legislation to ensure the contractor receives the R&D tax relief benefit. This allows the claimant to claim for subcontractor costs and ensures the company that benefits or exploits the R&D will make the claim, while also ensuring no double claiming.

With this in mind, the definition of ‘subcontracted’ should be made clear for R&D-related activities, as most of the R&D tax relief advisory profession believes the intention of the current legislation was meant to mean anyhow.

Therefore, the claimant should be the company highest up the chain that is doing R&D, even if a subsequent company has subcontracted non-R&D activities further up the chain. Otherwise, no company would be able to claim, which should not be the outcome of the new scheme, planned or otherwise.

Thought should be given to revising the guidance to how it used to be and considering the ownership of any intellectual property to be a good guide as to where the R&D sits.

Great examples are in construction where, quite often, the end ‘customer’ merely wants a job doing and a contract fulfilling and does not care or realise there are R&D activities to be undertaken by their subcontractor. It must be ensured that, in these cases, there is no risk of the situation that no company can actually claim.

Subsidised

As with ‘subcontracted’, we are concerned that too wide an interpretation could result in many claims no longer being valid. It appears from the draft legislation that no tax relief can be claimed on subsidised R&D whereas, at present, an RDEC claim can be made. HMRC does confirm that this is one particular area that they require input from advisers on.

Should HMRC continue to deny relief for subsidised costs, then, at the very least, as with ‘subcontracted’ above, care must be taken to ensure ‘subsidy’ is carefully defined. The findings of the Quinn case need to be taken seriously and only genuine contributions towards R&D (grants and receipts akin to grants, not success-based income such as sales/turnover) are classed as subsidies.

Once again, referring to the old guidance, financial risk needs to be a factor here. If a company cannot guarantee proceeds unless the R&D is successful and an output is delivered, it is not a subsidy.

In conclusion, there are still lots of ambiguous areas, and we would recommend all advisors to share their concerns, in particular regarding the commencement date at the very least.

One thing is for certain—it’s never dull in the world of R&D tax relief.