Research and Development Tax Reliefs

Research and Development Tax Reliefs

UK R&D tax reliefs are among the most effective and generous tax allowances in the world. Yet many companies, entitled to the incentive, do not claim reliefs that are due, either through a lack of awareness or because the reliefs seem complex or inappropriate to their business. But the significant increases in the value of the incentive, and the widened variety of sectors claiming, make the UK’s R&D tax relief code even more important. At the same time, the growth in HMRC powers and penalty-based tax regime highlight the importance of accurately documented claims. This comprehensive commentary brings together the many aspects of the R&D tax relief framework and its alternatives into a readable and manageable reference point. It includes the latest extensive Finance Act 2024 changes to the incentive rates, and the legislative and administrative changes introduced by the HM Treasury Report of 2021; as well as technical case law analysis and updates and linked examples and calculations. Topics covered include:

• The new ‘Merged’ scheme for RD reliefs and incentives effective for accounting periods beginning on or after 01 April 2024.
• The transitional schemes and reliefs up to 31 March 2024.
• The new ‘Intensive SME’ scheme which is available for accounting periods beginning on or after 01 April 2023.
• The detailed administrative changes and procedures under which HMRC operate all the schemes for relief and incentives.

UK R&D tax relief has traditionally been dominated by large IT and Pharma companies, but this picture is changing as UK technology hubs and space satellite projects compete on a global scale. The UK definition of ‘Research and Development’ for tax purposes, helpfully, is a universal one and can apply in almost any industry. It is relevant to any type of technology or science and any area of technical uncertainty. For the relief to be effective, the identification of project objectives and boundary is paramount.

The rise in popularity of the R&D relief schemes began to emerge in 2008. Then, the SME rate of relief was increased for the first time since its introduction in 2000; and the rate of tax credit refund similarly enhanced, reversed its downward trend. The most recent consultation on the future of the reliefs (June 2021) was formalised in the Autumn 2021 Budget and was legislated in Finance Act 2023, with further Statutory Instruments to follow. This addressed the key areas on the future of the relief:

• The introduction of a new, simplified scheme. This is focussed on sustained rises in RDEC rates aimed at larger RD operations. It also removes the anomalous situation where the UK was the only territory to have multiple RD relief schemes at differing rates and in different commercial circumstances.
• Greater compliance powers and effectiveness for HMRC to administer the transitional schemes to 31/3/2023 and the new merged scheme from 01 April 2024.
• Whether the current tax definition of R&D continues to be fit for purpose and the design of a single RDTR incentive scheme. (see Chapter 3).
• How the two principal relief schemes operated and their effectiveness (Chapters 4 and 5).
• If the schemes’ rates of relief are effective and appropriate.
• Whether the R&D incentive schemes are internationally competitive (see Chapter 8 for context).
• Overseas expenditure: Adaptation of the schemes to fit with government policy, particularly ‘Inward innovation and investment.

The UK’s R&D tax reliefs and incentives have been around in their current form since 2000. A significant increase in the SME rates of relief in the Finance Act 2008 began to improve their uptake, and enhanced SME tax credit rates similarly improved the level of first-time claimants. Both incentives continued to be uplifted by a government keen to promote ‘UK PLC’ as a centre for international R&D operations. Coupled with the ‘above the line’ large company tax credit, Patent Box reforms, and wider grant support agencies, the UK R&D framework has become very far-reaching. Not surprisingly, tax relief support administered by HMRC now reaches an average of 90,000 companies from all types of technological and scientific environments. This uptrend brought aggregate tax relief to £38bn, with over 195,000 companies receiving R&D tax support since the reliefs were first introduced in 2000. The government is keen to make the reliefs effective and internationally competitive. As set out at Autumn Budget 2021, UK companies claimed tax relief on £47.5bn of R&D expenditure in 2019, but the ONS estimates that businesses only carried out £25.9bn of privately financed R&D in the UK. While this gap is partly explained by companies being able to claim for activity taking place overseas, this does not account for the full difference.

The latest evaluations published by HMRC show that while the RDEC scheme generates £2.40-£2.70 of additional R&D expenditure for each £1 of tax relief claimed, the SME scheme generates £0.60-£1.28. At the same time, the SME scheme costs more than RDEC and has grown at a faster rate than RDEC, and the R&D reliefs are forecast to continue growing. The OBR predicts the reliefs will increase from £7.7bn in 2021/22 to £11.9bn in 2026/27. Given the sums involved, the 2023 reforms were timely and the introduction of the new merged scheme is well focussed.

ONS statistical studies show encouraging trends for UK foreign direct investment (FDI) in R&D sectors. Recent counter-weighted indices show that 64% of UK economic growth is sustained ‘pure’ rather than exchange rate induced investment [2019]. Similarly UK inward FDI is dominated by R&D intensive industries such as IT, the Financial Sector and Manufacturing. Chapter Eight explores some of these global R&D trends as the UK steps into ‘Post Brexit’ markets. The Government’s policy commitment to R&D and innovation support is encouraging: its latest ‘Industrial Strategy’ White Paper foresees, by 2030, ‘the world’s most innovative economy’. The new ‘Tech Cities’ and ‘Science Parks’, are a vital part of this picture putting into practice Knowledge-transfer and the commercialisation of innovative ideas; strongly underpinned by the R&D tax credit scheme.

It is clear then that the R&D relief scheme offers something of huge value to almost any innovative company seeking a technical ‘first of class’. This commentary draws together the many strands of legislation and requirements making up a competent claim into a single reference point. UK R&D rules have been amended in almost every Finance Act from 2000 to 2021 and this consolidated manual scopes these changes and provides a handbook to use and compare the reliefs with confidence. The transition out of the current schemes into the new merged scheme is explained in three chapters, (Chapter 4, SME rules to 31/3/2024; Chapter 5, Large company ‘RDEC’ rules to 31/3/2024 and Chapter 6, New Merged Scheme rules from 01 April 2024). HMRC procedures and guidance are explained at Chapter 7.

SUMMARY OF CONTENTS

Chapter 1 outlines a brief history of the reliefs and the schemes on offer to SME and Large Companies and their context. There have been many, many developments for companies within the R&D arena, since 2000. These include the large increase in the cash value of these reliefs announced over the last four Finance Acts, and the changes introduced by the Finance Act 2023 and their history. Over the past six years, the wider corporate environment for innovative companies has also changed dramatically. The changes include the introduction of the new R&D Expenditure Credit for large companies, the advent of the new Creative Sector reliefs and the introduction and modification of the UK’s Patent Box. As the Dyson Review, ‘Ingenious Britain’ foresaw, a catalogue of reliefs and non-fiscal incentives provides a springboard for the Tech Economy if the UK is to compete with emerging Tiger Economy technologies and have an EEA equivalent fiscal incentive for innovation.

Chapter 2 looks at the detail of the R&D tax relief framework. Any claim to tax relief must have a legislative basis and the underlining regulations are explored in depth. The UK has many disparate strands of legislation and interpretations that make up the relief matrix. Each aspect is taken sequentially and explained on a step by step basis. Frustratingly, a claim to R&D tax relief can fail or be significantly reduced at any stage of this process, perhaps because the company’s accounts do not identify costs that are eligible for relief or perhaps because of the influence of a range of commercial circumstances in which the company performs R&D activity. A number of worked examples and Case Studies draw out the importance of each stage making up the claim. Some of the HMRC interpretations complex these rules and the latest perspectives are outlined here and in Chapter six.

In Chapter 3, the BIS Guidelines, which have provided the core definition of ‘Research and Development’ for tax purposes since 2000, are considered in depth. The definition of project work eligible for tax relief is in reality, extremely broad. It is characterised by a ‘Gateway test’ which requires research and/or development work to target an advance in science or technology through the resolution of an area of specific technical uncertainty. The practical application of what is, at first sight, an opaque terminology will in practice draw in a wide range of commercial development work far beyond traditional IT and Pharma based technologies. A number of Case Studies and practical examples highlight the opportunities and restrictions found within the current tax definition, and answer the important question, ‘What is R&D’? The Guidelines contain a number of examples to develop what is meant by an ‘advance’ and these move through a number of further key terms which are discussed through worked examples.

In Chapter 4, the transitional reliefs available to SME companies to 31/3/2023 are detailed together with the rules defining which project costs are eligible for enhanced tax reliefs. The cash value of the relief is shown in a number of worked examples. For most advisors and innovative companies, familiar with the rules of the Chapter 2 SME Scheme, the detailed requirements of Chapters 3 and 4 may also be encountered at some point within a company’s project work. These are explained clearly showing the impact on the relief calculation where R&D activity is subsidised or subcontracted. Commercial considerations underline the R&D tax relief framework and these are brought together to enable a full reference point for the reader. But what is an SME for the purposes of R&D tax relief? The impact of EC Legislation in defining the SME Enterprise is clearly explained to provide the reader with a quick reference point for linked and partner enterprises which are relevant to the SME claimant. HMRC’s viewpoint upon identifying the SME goes beyond the EC Regulation and this is detailed in the outline of the Pyreos Case.

The proposed 2024 ‘qualifying overseas expenditure’ and current Finance Act 2023 changes to the definition of costs eligible for R&D reliefs are outlined at 4.34.

Chapter 5 looks at the latest reliefs on offer to Large Company Scheme claimants to 31/3/2023 and consider the success of the move toward the ‘Above the Line’ R&D Expenditure Credit from 1 April 2016. The special rules of the Large Company Scheme are outlined through a number of worked examples, including the detailed rules for large companies engaged within subcontractor relationships. The impact of the Patent Box enables the Large Company to claim both R&D tax relief incentives and reduced corporation tax charges upon UK/EEA Patented relevant income streams.

In Chapter 6, the rules and procedures affecting the new merged scheme effective for accounting periods beginning on or after 1 April 2024 are discussed with useful examples and case studies. The new ‘SME Intensive scheme’ effective from 01 April 2023 is also reviewed. Subcontractor and EPW costs: - the concept of ‘overseas expenditure’ and detailed exceptions is explained. The new administrative framework for both schemes is discussed together with special situations for group relief allocation and the detailed ‘Steps’ required in the new merged scheme calculation methods.

In Chapter 7, the administration of the relief schemes is outlined, together with the forthcoming ‘Digitalisation’ of R&D claims and linked requirements. The ‘advance notification’ rules effective from 1 August 2023 are summarised. The work of HMRC has become both more difficult and more significant as claims grow in volume and value. As the HMRC R&D Units struggle with claims that are incorrect or incomplete, the chapter provides clear and concise guidance upon common errors and misconceptions and the significance of key HMRC interpretations. R&D records form a vital part of the company’s record keeping requirements for CTSA and practical guidance is given on the minimum standards of documentation and support. The parallels drawn from recent first tier tax tribunal and important 2015 tax cases and the older key cases such as Gripple Ltd and BE Studios Ltd are a vital part of the HMRC interpretation of R&D tax relief administration and the key practical points are explained in detail. The onset of the pandemic brought emergency business relief measures such as the CBIL loan programmes [April 2020], and the CJRS, Job Retention Scheme framework [February 2020]. These have significant impacts for R&D relief claimants which are explained in depth.

HMRC continue to establish their interpretations of the relief frameworks through the courts and several key tax cases were published in 2021 affecting key areas of the incentives. These are summarised at 6.32 to 6.41.

In Chapter 8 the grants and sponsor programmes on offer for UK R&D projects are reviewed. Grants are a commonplace strategy funding the ‘Innovation Gap’ for micro and large companies alike. Non fiscal support for R&D activity has grown very significantly over the past seven years and a number of programmes, including the new Horizon programmes will provide vital ‘post Brexit’ pathways for innovative businesses. The application processes and their benefits are summarised. Lead by ‘Innovate UK’ the UK now has a joined – up grant process. Practical tips on alternatives to tax relief are brought together in this chapter, including the interaction with tax based R&D support.

Chapter 9 looks at the worldwide trends in R&D and the UK context. R&D Expenditure has sustained itself through global recession and continued to produce innovative change in a variety of micro circumstances. This leads to the key question – what is the impact of tax relief upon innovation? A number of studies are brought together in this chapter to provide some interesting answers and commentary. Current OECD ‘BERD’ (Business expenditure on R&D) puts the UK at the top of OECD nations stimulating R&D expenditure. The performance of the UK R&D Economy compares favourably with its European counterparts, and it is very exciting to see the growth in key engineering and technology based R&D activities mirroring the traditional Pharma and biotechnology growth which has traditionally dominated the UK innovation base.

In Chapter 10, a number of Industry Case Studies bring the R&D rules alive across a selection of innovative industries. These include development work in the engineering and construction sectors, manufacturing and ‘traditional’ development sectors, and software and ICT based business. It is only through sustained R&D infrastructure investment that we have seen some of the most exciting UK innovations over recent times, including:

• The advance of AI ‘Artificial Intelligence’ across industries globally.
• The rapid COVID-19 vaccination developments and scale-ups.
• Quantum computing (Harwell NQCC investment £30m June 2023).
• Space and Satellite science centres (Harwell – ESA 5G/6G Hub).
• Genome centre of research and Next Gen sequencing (Cambridge Genome).

As the UK innovation growth cascades across a variety of SME companies, the importance of emerging technologies is summarised. Against this industry background, a number of common scenario’s such as how to identify R&D project work, the impact of the R&D budget funding, the impact of employee and consultancy hire, the effect of group dynamics and subcontracting relationships are explained.

In Chapter 11, specialist reliefs for the Creative Sector have now been phased in. Their history from 2018 is explained together with their application for companies engaged in gaming technologies and television/animation production companies as well as the other creative sectors. The Creative Sector is estimated to employ over 1.5 million talented people in the UK and have an economic significance of around £36 billion. The reliefs play a vital part in the overall R&D scene.

The Appendices provide an at-a-glance summary of the key reference points for the relief and up to date tables of rates and allowances.

I hope that the book will provide an interesting acknowledgement to the work of an army of skilled and talented innovators, as well as a pathway through the complexity of the tax relief framework currently making up the R&D incentive.

This commentary has been inspired by the new generation of ‘Techpreneurs’, many of whom I have been able to help with practical tax advice. The UK has some truly breath-taking technologies emerging into the innovation race and I am delighted that the R&D Tax Relief Scheme can now play such a significant part in moving towards an ‘Ingenious Britain’.

This book would not have been written without the kind encouragement of my publisher Dave Wright and his team at Bloomsbury Professional. I must also acknowledge the work of the UKSPA community, many of whom have helped with this manuscript in so many ways.

As ever, suggestions for how the publication can be further developed are always welcome and I can be contacted through maria@tax-insight.co.uk.

Maria Kitt

Surrey Technology Centre,

Surrey Research Park, Guildford.

Partner, Tax Insight UK

April 2024