Upcoming R&D Tax Relief reforms


Andrew McMillan

Andrew McMillan

Tax Director


Significant changes are on the horizon for the UK R&D Tax Relief regimes. These changes represent some of the most fundamental alterations made to the UK R&D Tax Reliefs since their inception in 2000. 

In announcing the reforms, the Government has stated that the changes are designed to:

  • Target abuse and improve compliance;
  • Refocus support towards innovation undertaken in the UK; and
  • Support modern research methods by expanding qualifying expenditure to include data and cloud computing costs.

The legislation setting out the mechanics of the changes announced has now been released in draft form. Although the secondary legislation, which will contain further details, is yet to be published, as the changes will impact accounting periods commencing on or after 1 April 2023, we felt it important to communicate what we know, such that you are aware of any potential impact and in order that any actions necessary can be taken in advance of the legislation coming into effect.  

Pre-notification requirement

Currently a company has two years from the end of an accounting period to make a claim in respect of eligible activities undertaken in that accounting period. So, for example, if a company had undertaken eligible work in an accounting period ended 31 December 2020, it would have until 31 December 2022 to make a claim.

For accounting periods starting on or after 1 April 2023, this will change, with a pre-notification requirement coming into place. Instead of having a two year window, prospective claimants will now have to pre-notify HMRC of their intention to claim. This notification will need to be submitted no more than six months after the end of the accounting period to which the R&D claim relates, or the claim will be invalid. Using the 31 December 2020 accounting period example again, pre notification for this period would have to be made no later than 30 June 2021. 

It should be noted that the requirement to pre-notify will only apply to new claimants or companies that have claimed before, but not made a claim in any of the previous three accounting periods.

Tackling abuse and improving compliance

It is no surprise that the Government has been considering what can be done to improve compliance associated with the UK R&D Tax Reliefs. The UK has one of the most generous R&D Tax Relief systems in the world, spending, as a percentage of GDP, more than any other country in the OECD. However, expenditure on self-financed business R&D in the UK is less than half the OECD average. These disparities will, in part, result from the well documented abuse of the UK R&D tax relief system.

HMRC has already allocated additional resources to R&D Tax Relief compliance and is undertaking work to better understand the nature and scale of the error and fraud associated with the reliefs. As part of the next stage of this strategy, HMRC will further increase the resources for R&D tax credit compliance, with the creation of a new cross-cutting team focused on abuse.

However, it is acknowledged that additional resources alone cannot completely solve the problem. Therefore, with a view to better targeting their resources, and to better correlate incorrect claims with the relevant agents, the following changes are to be implemented:

  • All claims will have to be made digitally except for those made by companies exempt from the requirement to deliver a Company Tax Return online.
  • Further information will be required alongside the claim submission (details of the scientific or technological advance sought, qualifying expenditure etc.).
  • Claims will need to include details of any agent who has advised the company in preparing the relevant claim.
  • Each claim will need to be signed off by a named senior officer of the claimant company.

Refocusing the reliefs towards innovation in the UK

Whilst a number of jurisdictions (including the US), restrict relief associated with R&D to activities performed within the jurisdiction, this has not been a feature of the UK regimes to date. This is partly down to the UK’s past membership of the EU, as the EU framework does not allow for individual member states to restrict freedoms around the provision of services and the movement of goods. As the UK is no longer a member of the EU, it is no longer bound by this framework.

For accounting periods beginning on or after 1 April 2023, two territorial restrictions will come into force, both pertaining to third party costs.

  • Subcontractor costs – from April 2023, where a company incurs expenditure in making payments to a third party in respect of subcontracted R&D, it will only be able to claim R&D Tax Relief in respect of the expenditure where the third party performs the relevant work within the UK. This will be felt most acutely by companies making claims under the SME scheme as the remit of eligible subcontractor costs is already much narrower under the RDEC regime. However, the same principle will apply under the RDEC regime, including situations where a large company seeks to claim for contributions it makes towards independent R&D.
  • Externally Provided Worker (EPW) costs – from April 2023 where a company incurs expenditure in making payments to a third party in respect of the provision of EPW’s, it will only be able to claim relief in respect of the expenditure to the extent that the relevant EPWs are paid through a UK payroll.

There will be some narrow exemptions where factors such as geography, environment, population or other conditions that are not present in the UK are required for research (for example, deep ocean research) or where there are regulatory or other legal requirements for certain activities to take place in specific territories (for example, clinical trials). The exemptions will not include cost, or workforce availability.

Data and cloud computing costs

The extension of qualifying expenditure to include data and cloud computing costs has been trialled for some time and is very welcome. 

R&D Tax Relief is currently available for traditional “licenced” software. However, relief is not available for other forms of software costs, such as expenditure on software leased and accessed via the cloud. There has been a general shift away from traditional software stored on in-house physical servers, towards software leased and accessed via the cloud, which can allow companies greater flexibility to flex storage and computing capacity according to need.

Similarly, there has been a growing importance of the use of data within modern R&D in many areas, such as functional genomics and machine learning. Datasets, such as genomics information from medical samples can be extremely expensive.

The draft legislation extends the boundaries of eligible expenditure to include the costs of data licences and cloud computing services. Data licence costs are defined in the draft legislation as a licence to access and use a collection of digital data, while cloud computing services include the provision of access to, and maintenance of, remote data storage, operating systems, software platforms and hardware facilities.

As is always the case though, there is nuance to the legislation. For example, expenditure on data licences and cloud computing services will not be treated as qualifying if there is the right to sell data in respect of which the licence is granted or the service provided, or if there is a right to publish, share or otherwise communicate data in respect of which the licence is granted or the service provided to a third party, other than for the purposes of communications reasonable necessary for, or incidental to, the purposes of the relevant R&D. Expenditure on data licences or cloud computing services will also not be eligible if it is attributable to anything other than direct R&D activities. So, for example, the costs will not qualify to the extent that they relate to any HR or finance function support of the relevant R&D project.

A final change worth noting is that, with a view to further supporting cutting edge R&D, the definition of R&D for tax purposes will be changed to remove the current exclusion of pure mathematics.

Summary

The changes we have detailed above represent some of the most fundamental alterations made to the UK R&D Tax Reliefs since their inception in 2000.  

To the extent that the changes are designed to improve compliance with the R&D Tax Reliefs, we are in full support. Abuse of the UK’s R&D tax reliefs has been well publicised and represents a threat to the long-term viability of this important relief and we are glad to see the Government taking steps to address this.

The extension of qualifying expenditure to include data and cloud computing costs is welcome, as is extending the definition of R&D for tax purposes to include pure mathematics. These changes will ensure that the reliefs better reflect the course of modern innovation, rewarding companies for undertaking pioneering work which will benefit the UK as a whole. 

In announcing the territorial restriction, the Chancellor stated that he was looking to refocus the reliefs toward innovation undertaken in the UK, and to promote the development of a modern cross-sector R&D talent pipeline across the country. Despite the positive intentions, the changes in their current form will negatively impact many companies, including multinationals that have headquartered their R&D in the UK, but access services from other group companies around the globe. However, it is not just large multinationals that will be impacted, many claimant companies, whether for cost or other reasons, engage third parties situated outside the UK to assist with their R&D activities. Sourcing similar expertise in the UK might not be practical or even possible, and with the exemptions likely to be narrow and no grandfathering period to be implemented, the changes may have a detrimental impact to the progress of R&D investment and output in the short to medium term.

If you have any questions with regards to how the proposed changes might impact you company, or any other R&D Tax Relief queries, please contact: David Ward or Andrew McMillan