Background to R&D
R&D Tax Credits have been available since 2000, providing attractive tax relief to support potentially expensive research and development activities in the private sector.
In simple terms, the rules allowed you to identify allowable expenses that met the criteria for an R&D project, apply a percentage uplift (130% prior to 01/04/23), and then receive Corporation Tax relief on this enhanced expenditure.
If you were a loss-making company, you could apply a repayable credit percentage (14.5% prior to 01/04/23) and have this amount physically paid into your bank account by HMRC, rather than offsetting it against a future Corporation Tax liability.
To successfully claim R&D tax relief, you need to demonstrate:
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Your project sought to achieve an advance in a field of science or technology
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During the project, you worked to overcome scientific or technological ‘uncertainty’. An uncertainty is something that might have been proven as scientifically or technologically achievable in theory, but how to achieve it in practice wasn’t straightforward to work out to a competent professional working in the same field.
HMRC tightening the tax gap
The attractiveness of the incentive naturally led to an increasing number of wrong or just outright fraudulent cases in the SME world.
This would have been partly caused by greed or, most likely, un-informed business owners, but worse than this was the ballooning R&D tax credit claim industry.
Now, to be clear, there are plenty of very reputable companies out there specialising in helping SMEs process claims. However, there were far more companies that were just out to make a quick buck and played very fast and loose with the rules - or just ignored them altogether.
I liken this industry to the ambulance chasers or the PPI reclaim lawyers.
Ask any accountant, and they would be able to recall cases they have heard of where the justification for meeting the R&D rules was obscene - a chef creating a new dish on a menu, for example!?
Claims were paid out with very little or no scrutiny from HMRC. This fuelled the belief that what was happening must be OK - never mind the fact that HMRC could always look closer at the claim further down the line and not only claw it back but impose fines, too.
This is exactly what we are seeing happening now.
HMRC are going all out to investigate claims, and the Government have brought out a whole raft of changes announced over the last two budgets to tighten up on legitimate claims.
Changes to Rates
From 01/04/2023, the uplift % dropped from 130% to 86%. This meant the net benefit for a profit-making company dropped from 25% to 16.34% - 21.5% (depending on what rate of Corporation Tax you are paying).
If you are a loss-making company, the repayable credit dropped from 14.5% down to 10%. This means that the net benefit dropped from 33% to 18.6%
However, for loss-making R&D-intensive SMEs, the cash R&D tax credit rate remained at 14.5%. These SMEs are defined as having qualifying R&D expenditure that constitutes at least 40% of the company's total expenditure (30% from 01/04/24).
The scheme then totally changes from 01/04/24.
Currently, these latest changes are sat as draft legislation, so let me tell you what we know so far, but keep in mind that they could change before they are passed as law.
Prior to this, there were two schemes. The SME scheme and the RDEC scheme. As the RDEC scheme was for much bigger businesses, I have only spoken about the SME scheme. From April, these two will merge to form one single R&D scheme. With that come some major changes for SME’s
Previously, you applied an uplift and were allocated a credit on enhanced expenditure levels. Now, there will be a flat 20% credit applied to your allowable expenses.
This credit is now an “above the line” credit. This means it sits in your profit and is subject to Corporation Tax. So, when looking at the net benefit to you, we now apply the credit and then deduct the additional Corporation Tax you will pay.
To complicate things further, we now have two rates of Corporation tax for small companies. The small business rate at 19% and the main rate at 25% (as well as the marginal rate between the two). The rate of Corporation Tax you pay will impact your net benefit from the credit.
Other Important Changes
It’s not just the rates that have changed. We have also seen many changes in the way that you make a claim and the expenses you are allowed to include on the claim.
Digital and Information Submission Requirements
All submissions now need to be made digitally, including extensive additional information such as a detailed breakdown of R&D expenditure and details of any advising agents. HMRC will be looking at any agents supporting incorrect claims and then using this to investigate their other clients further.
Companies are also required to submit claims supported by a named officer from within the company.
This rule came into play for any claims submitted after August 2023.
Advanced Notification
For accounting periods starting on or after 01/04/2023, if you are new claimants or haven't claimed in the last three accounting periods, then you will need to inform HMRC of your intention to file a claim within six months of the end of the accounting period.
This is just an intention to claim, not the actual claim itself, but still, this will catch a lot of small businesses out.
Overseas R&D Expenditure
For accounting periods starting on or after 01/04/2023, restrictions on qualifying expenditures for overseas R&D activities will be tightened.
The general rule will exclude overseas R&D expenses from qualifying unless it's deemed wholly unreasonable to replicate the necessary conditions for R&D in the UK.
This could have huge implications for a lot of tech companies who sub-contract dev work abroad. Previously, they would have been able to claim up to 65% of their costs in a claim and now potentially 0!
R&D Intensive SME Adjustments
The threshold for SMEs to be considered 'R&D intensive' (thereby qualifying for more favourable treatment) will be lowered from 40% to 30% of their total expenditure from April 24.
Proceed carefully
This is a major headache for entrepreneurs. A reduction in the net benefit, tightening of the rules, fighting with different rates of Corporation Tax, and not being able to claim for non-UK expenses is a major blow.
That being said, the scheme does still provide some great benefits and is certainly still worth wrapping your head around the rules.
You just need to be more proactive in planning for these claims, and you must not be tempted to bend the rules! We have already heard plenty of cases of stiff retrospective fines from HMRC for past claims.
As R&D claims are made historically, once your company accounts are completed, then you could be battling with 3 different sets of rules in a very short space of time, so be very careful to understand what period your claim relates to.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.