Research and Development Tax Relief: the state of play after the Autumn 2022 Statement

The key topics covered in this piece are:

1. We will examine the main changes that were outlined in the Autumn Statement (November 2022), for the SME R&D scheme and the RDEC larger-company scheme, with examples of how the changes may impact different UK companies which claim R&D tax relief.
   
2. We also review other changes to the R&D schemes, previously announced in Spring 2022, which are likely to come into force from April 2023 with new eligible categories of spend and a refocus on UK-based expenditure for outsourced costs.
   
3. Finally, we will discuss the future of the R&D SME scheme considering the recent announcements made in the Autumn Statement, underlining that the scheme and the UK Government’s commitment to supporting R&D in the private sector remains intact.
   

The Chancellor spent six minutes talking about tax changes during his hour-long Autumn Statement on 17th November 2022. Even though the R&D scheme was only mentioned briefly, the changes will have a significant impact for claims relating to R&D taking place after 1 April 2023. However, please remember that any changes to the R&D tax relief scheme will need to be seen in context. In parallel to the R&D scheme changes, there will be increases in Corporation Tax rates for businesses making over £50,000 from April 2023, that will offset some but not all the changes in the R&D tax scheme relief rates.

First, we want to highlight a major change for the SME R&D Tax Relief scheme. Chancellor, Jeremy Hunt, announced the ‘enhanced deduction’ would be reduced from 130% to 86%. The actual cash-flow effect of this change depends on whether the company is profit- or loss-making and the rate of Corporation Tax that they will pay.

• Larger more profitable SME companies will see their benefit from an R&D claim decrease from a net 24.7% to net 21.5%. This assumes the company pays the 25% corporation tax rate which will apply to companies with profits over £250,000, from 1 April 2023.
  
• Where a SME company has annual profits between £50,000 - £250,000, their Corporation Tax rate on the ‘slice’ between £50-250k will essentially be taxed at 26.5%, and therefore their benefit from an R&D claim will be 22.8%.
  
• Therefore, for accounting periods starting from 1st April 2023, profitable companies with profits over £50,000 will still receive a substantive claim benefit, but at a lower net percentage than previously.
  
• For companies making profits below £50,000, or that rely on repayable R&D credits from HMRC to support cashflow, it will be a different story.
  
• Businesses with annual pre-tax profits lower than £50,000 will see a material change in their R&D Tax Relief as their Corporation Tax will remain at 19%, but their claimable expenses will reduce from 130% to 86% of eligible expenditure.
  
• For loss-making businesses, the repayable tax credit will reduce from 14.5% to 10%, from 1st April 2023. The net effect will be that a company surrendering a loss equal to all of their R&D spend, under the SME scheme, will see the benefit change from a 33.4% rate to 18.6%. A significant reduction.
  

The good news R&D story in the Autumn Statement, was for companies which make claims under the Research & Development Expenditure Credit (RDEC) scheme. This usually applies to larger businesses.

Currently, RDEC relief is set at 13%, equating to a net benefit to the claimant of 10.5%, as the benefit is accounted for as income and therefore is taxable. This RDEC rate will increase to 20% from April 2023, meaning a net benefit of 15% for companies paying 25% Corporation Tax. Whilst this might seem generous, it is still less than the SME scheme, so most companies will still be likely to prefer the SME scheme, if they are eligible.i

A company has profits of £765,000. It spends £165,500 on qualifying R&D and makes an R&D claim under the SME scheme.

Here, pre-April 2023 the company receives an enhanced deduction of 130% instead of the 86% post April 2023. However, because the pre-April 2023 corporation tax rate is 19%, the company gets a benefit of £40,879 (£215,150 x 19%), whereas the corporation tax rate will be 25% post April 2023 and therefore the company gets £35,475 of corporation tax relief, even though the enhanced R&D deduction is c£74,000 less.

A company has profits of £240,000. It spends £87,000 on qualifying R&D and makes an R&D claim under the SME scheme.

Like the example above, the enhanced R&D deduction post April 2023 is significantly lower. However, because of the way Corporation Tax will be calculated for companies with profits between £50,000 - £250,000, this company gets almost as much R&D relief as they would have done under the pre-April 23 regime.

In this example, the company has profits of £65,000 before their R&D claim, but they are an R&D intensive company and have spent £140,000 on R&D. They wish to receive the maximum cash-flow benefit immediately, and so have surrendered their qualifying R&D losses for a payable credit.

Here, the company saves more on their Corporation Tax bill by virtue of the remaining £15,000 (£65,000 profit minus the first £50,000 which will be taxed at 19%) of their profits being taxed at 26.5%, post-April 2023. However, after deducting their profits from their enhanced R&D deduction, they have a lower level of losses to surrender post- April 2023 and these will be surrendered at a lower rate of 10% rather than the current 14.5%. The result is that the total R&D claim the company will receive is more than £10,000 lower under the new criteria.

In this example, the company is investing significantly into their R&D processes and have losses. The company has a £135,000 loss before their R&D claim and they have spent £79,000 on qualifying R&D.

Here, you can see the company receives substantially less for its surrendered loss in the way of a cash repayment from HMRC. The company can only surrender the total of its R&D losses, which are the qualifying R&D spend and enhanced deduction added together. In this example, pre-April 2023 the company will have £181,700 to surrender at a rate of 14.5%. Whereas post April-2023, the company will only have £146,940 to surrender at the lower rate of 10%.

Other changes coming in April 2023, for R&D tax schemes

In addition to the Autumn Statement, earlier in Spring 2022, there were other announcements related to R&D tax schemes by Rishi Sunak, then our Chancellor. These planned changes, will also come into effect from 1st April 2023, attempting to minimise error and fraud, while also modernising the R&D scheme.

Jeremy Hunt has clearly indicated that the Government support and want to continue to incentivise the British private sector to drive greater innovation and economic productivity. He suggested that the total Government investment in R&D schemes should remain at a similar cash level to today and their publicly stated position is that they are not trying to reduce the overall cost of the programme.

However, there are still clear signs that there is an unacceptable level of criminal fraud and error in the current scheme – these represents a small minority of claims but a substantial amount of claim value. Sunak and Hunt have both supported measures that are designed to reduce incorrect or illegal claims. HMRC have put in place an increasingly robust, albeit rather untargeted, set of new compliance and review processes for R&D claims. Recently, the Chartered Institute of Taxation criticised the government’s “over-zealous” approach to what assessing qualifies as R&D tax relief, and we have evidence of a number of investigations that are opened by HMRC targeting entirely legitimate claimants.

In our view, it is likely that the planned cut in the rate of payable credit, will have a greater impact on early-stage companies who often are investing more heavily in their innovation and may be running at low or negative profit rates. These R&D-heavy companies will be less incentivised to take a risk and drive British innovation. The new steps for extra signatories on R&D tax claims and the current scattergun approach to compliance checks also seem to be further barriers to making a claim. We believe that the current heavy-handed HMRC compliance regime may be a step too far. It may not necessarily stop those committing fraud, nor will it deter inadvertent errors. So overall the changes being made are not a net benefit to industry and may trigger unintended consequences with entirely valid investment and R&D not being put through for a claim.

As a leading national tax advisory service, specialising in R&D tax relief, we welcome and support well-designed efforts to make the scheme more effective, with lower abuse or error rates. We look forward to the HMRC compliance checks becoming more sophisticated and data driven as they enhance their focus on real criminal intent and reducing significant errors in claims.

Looking further ahead, Jeremy Hunt’s Autumn Statement also suggested that a consultation will be established to determine the additional support SMEs may need to accelerate innovate and support UK economic growth. All the signs point towards a unified R&D scheme, collating the large and small company schemes. In this scenario, it could be possible to offer an increased rate of relief to SME companies while simplifying the system. We are carefully monitoring the Government’s next steps and their statements of intent; we will keep all our customers fully appraised of plans and the their possible impacts.

What action should our business take related to our R&D claims?

Firstly, please be aware that the planned changes to the R&D tax relief schemes (SME & RDEC), new eligibility criteria and the restructured Corporation Tax regime will become valid only after 1st April 2023. For most businesses this means that the claims related to the relevant annual accounts will not be finalised or submitted until 2024 at the earliest and 2025 at the latest.

Any R&D claims submitted to HMRC should continue to be supported by sufficient contemporaneous records. Better record keeping optimises the claim, reduces the time involved in collating a claim and minimises the chance of an HMRC investigation. You can read our recent article on best-practice for record keeping here.

Regarding the planned changes to the SME and RDEC schemes it is important to speak to your professional tax adviser. They can help you to better understand how these changes could impact your business. They will offer you options to optimise your claim, and will ensure that your business is fully compliant with the upcoming legislation.

Should you have any queries on these planned changes to R&D tax relief or any aspects of the current R&D schemes and your claims, please do get in touch with our Easy R&D expert team.