New rules for R&D tax relief amid HMRC clamp down

This spring heralded major changes to the research and development (R&D) regime, following the British government’s concern about the effectiveness of the tax reliefs. From 1 April 2023, the rates changed for R&D expenditure incurred on or after that date.

For the Research and Development Expenditure Credit (RDEC) scheme, which is mainly used by large companies, the rate increased to 20% from 13%; while for SMEs, the additional deduction decreased to 86% from 130%, and the SME tax credit rate shrank to 10% from 14.5%.

But these aren’t the only changes — and there are more to come. Following the review of R&D reliefs launched in the 2021 Spring Budget, the government has already “taken many steps to reduce the costs of the UK’s R&D scheme to get better value for money,” observes BDO innovation incentives partner Carrie Rutland.

However, the release of HMRC’s 2022/23 accounts in July showed an estimated £1.1bn lost to error and fraud in R&D tax credits claimed under the SME scheme in 2020/21. This figure is equivalent to 16.7% of claims across both the SME and RDEC scheme, and significantly higher than HMRC’s previous estimate of 3.6%. Rutland says “it’s no great surprise HMRC is keen to clamp down on non-compliance”, adding 300 new officers to its R&D team.

Justin Arnesen, R&D tax partner at Evelyn Partners, says HMRC’s report “highlights the size of the problem [it] is tackling” in its attempts to combat fraud and error within the system. “Concern over abuse and boundary-pushing has grown in recent years,” he says.

As well as doubling the number of people working on R&D compliance, Arnesen notes that HMRC set up a dedicated R&D Anti-Abuse Unit to target unscrupulous advisers and fraudulent and erroneous R&D claims.

Pre-notification and additional information

Along with the rate changes in the two schemes, HMRC brought other changes in earlier this year to combat fraud and error, increase tax yield and modernise the relief. New claimants with accounting periods beginning on or after 1 April 2023 need to pre-notify HMRC of their intention to claim R&D.

Nigel Holmes, tax director of Catax, notes that from 1 April new items of expenditure now qualify as R&D: “Data sets, cloud computing costs, and pure mathematics are now claimable,” he says, “and there is a new concept of ‘loss-making R&D-intensive SME companies’ who will be impacted less by the rate changes.” Loss-making R&D-intensive companies are those whose qualifying R&D expenditure constitutes at least 40% of total expenditure.

From 8 August, a new requirement for R&D-claiming companies to submit an Additional Information Form to HMRC was introduced. The form is submitted through a new online portal, separate from the corporation tax return, and should be completed before or at the same time as the corporation tax return.

As Lucy Lloyd, R&D specialist at Kilsby Williams, explains: “The Additional Information Form requires businesses to collect claims and cost data at a much more granular level, with different data headings and on a project-by-project basis. Failing to submit the form… [will result in] claims automatically being invalidated with no method of reinstatement.”

Nigel Holmes says record-keeping is more important than ever: “Businesses should keep records of both costs and projects – R&D should involve systematic planning, so do document it and retain it,” he advises. “With the requirement to complete the Additional Information Form from August onwards, the need for every claim to include details of projects and costs broken down by project is a massive step-change for those advisers who never used to provide project narrative.”

Draft legislation

HMRC says the April 2023 reforms ensure that taxpayer support is as effective as possible and improve the competitiveness of the RDEC scheme, adding that the reforms are “a step towards a simplified, single RDEC-like scheme for all” — and released draft legislation in July containing this and other proposals, with a consultation deadline of 12 September.

It is unclear at the time of writing if HMRC intend for the changes to take place on 1 April 2024 as HMRC previously suggested, but Rutland says such change would be “too far, too fast” if implemented at that time, and calls for them to be delayed until at least 2026 “so they don’t damage the R&D investment the relief is supposed to support”.

“Given all the changes, creating more uncertainty by changing the R&D regime could risk turning innovative businesses away from investing in the UK,” Rutland says.

The draft legislation does include design proposals that many will welcome, she adds: “The original proposals on who claims relief where R&D work is subcontracted could have caused problems for many businesses — the draft legislation allows outsourcing costs to be claimed where the work is outsourced to a UK company. But the most significant downside is the new rule that any R&D project which is subsidised (including grants) cannot be included in a claim.”

Mark Smith, partner of innovation incentives at innovation consultancy Ayming, believes the draft legislation’s proposals would be “a major setback”, even though on the surface, merging the two R&D schemes “represents a welcome simplification of the system”.

“The government plans to merge the two R&D schemes, expanding the cost rules of the SME scheme to apply to businesses of all sizes, will prevent claims for subcontracted R&D. This means the companies that are doing the R&D won’t be eligible to receive the funding for it,” Smith says. In particular, it would raise problems for subcontractors in the construction industry, where (for example) a subcontractor carrying out R&D would not be able to access funding from tax credits, while the company engaging them can.

However, Richard Turner, senior managing director in FTI Consulting’s UK tax practice, is more positive. “The proposed changes represent a move towards a more coherent framework to provide incentive for companies to develop new science and technology here in the UK, and for the UK to be a key player in the knowledge economy,” he says.

Justin Arnesen wants improved guidance to be released alongside any new legislation: “Considerable changes are required to guidance on both qualifying and non-qualifying activities: for example, the R&D guidelines have an example [regarding] a DVD player — an obsolete technology,” he points out.

While HMRC will share a further update in winter 2023, he adds, “given the two-year time lag on estimates, we may not know for some time whether these measures have had a meaningful impact. Additional measures, such as requiring additional information directly from advisers, or an annual adviser audit, may need to be considered.”

The new Additional Information Form

From 8 August it is mandatory to include the following on an Additional Information Form before submitting a corporation tax return to HMRC:

• Project details – the scientific or technological advances, uncertainties, baseline and activities undertaken.
• Project costs – including details of qualifying indirect activities.

Holmes advises businesses should:

• Maintain robust recordkeeping – businesses should be able to discuss all expenditure on a project-by-project basis. By having project information captured and readily available, firms can complete the form more easily.
• Start the process early – the new claims process is more demanding and time-consuming. Avoiding a last-minute rush can prevent firms making silly and costly mistakes. If using an adviser to complete a claim, consider the time needed to provide more information.
• Consider speaking to an R&D specialist – some advisers may have made only a handful of claims before without an accompanying report or comprehensive narrative that’s now expected from HMRC.