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Overview of the New R&D Tax Credit Regime

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The UK Government has decided to implement a single, unified ‘research and development expenditure credit (RDEC)-like’ scheme applicable to all companies. This scheme will replace the existing separate schemes for small and medium-sized enterprises (SMEs) and larger companies, offering an above-the-line credit for all, with some exceptions for R&D-intensive SMEs. This transition is scheduled for accounting periods starting on or after April 1, 2024.

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Key Features of the Merged Scheme

  • Uniform Credit Rate: All companies will receive a 20% credit rate, aligning with the current RDEC regime.
  • Notional Tax Rate Adjustments: For loss-making companies, the notional tax rate on the R&D credit will be set at 19%, a reduction from the previous 25%. This adjustment means profit-making companies will see a net benefit of 15%, while loss-makers will benefit from a 16.2% net benefit.
  • Relaxed Subsidized R&D Restrictions: The new scheme will not incorporate the subsidized R&D limitations from the current SME regime. Thus, if a company’s R&D costs are subsidized, either via grants or external funding, the relief available to the company will not be reduced.
  • Adoption of the PAYE/NIC Cap: The new scheme will incorporate the PAYE/NIC cap (calculated as £20,000 + 3 times your total PAYE/NIC) that was part of the SME regime.
  • Revised Rules for Large Entities and Subcontracting: The new scheme modifies the rules for claiming subcontracted R&D expenditure, removing the existing stipulations for qualifying bodies.

Merged R&D Tax Credit Scheme

The existing R&D tax credit schemes for SMEs and large companies (RDEC scheme) will be merged into a single scheme. This merged scheme offers a 20% credit rate, aligned with the current RDEC regime providing a net R&D credit rate of 16.2%. Notably, the merged scheme will not include the subsidised R&D restrictions from the current SME regime. This means that companies whose R&D costs are subsidised, for example through grant funding, won't have to reduce the relief available to them. Additionally, the PAYE/NIC cap from the SME regime will be adopted in this merged scheme​​. This means a total R&D will be capped to £20,000 + 3 times your total PAYE/NIC on UK payroll.

Changes for Subcontracted R&D

A key difference in the new regime concerns subcontracted R&D. Under the merged scheme, if a company subcontracts R&D to a third party, it's the company subcontracting the work that can make the claim on this expenditure. The subcontractor can only claim this expenditure if the subcontracting company is not subject to UK corporation tax, such as an overseas company​​. Examples:

  • Claims by Contracting Companies: If a company (Company A) subcontracts R&D to another entity (Company B), Company A will be eligible to claim the R&D expenditure. Company B can claim this expenditure only if Company A is not under UK corporation tax, such as an overseas company.
  • Initiated R&D by Subcontractors: If Company B, the subcontractor, initiates R&D as part of its own project in a service or goods contract with Company A, then Company B is entitled to the claim, and Company A cannot claim it.
  • Overseas Workers: Please note, that in July 2023 it was outlined that no overseas contracting would be allowed unless under exceptional circumstances. This means that costs of overseas workers will not qualify for UK R&D relief where incurred after 1 April 2024, unless 3 factors are demonstrated.
    • The first factor is that conditions necessary for the R&D are not present in the UK.
    • The second is that the conditions are present in the location where the R&D is undertaken.
    • The third factor is that it would be wholly unreasonable to replicate the conditions in the UK.
  • Therefore simply hiring developers outside of the UK because it is less expensive will not qualify, but running clinical trials in a lab outside of the UK because it is impossible to do the trial in the UK due to lack of facilities, will probably qualify.

Special Consideration for Loss-Making and R&D-Intensive SMEs

Loss-making R&D intensive SMEs will see a reduction in the R&D intensity threshold from 40% to 30% of total expenditure, effective for accounting periods beginning on or after April 1, 2024. This allows more SMEs to qualify as R&D-intensive and benefit from a higher claim rate. Eligible companies will receive an 86% enhanced deduction on qualifying R&D expenditure and a repayable tax credit of 14.5%​​​​. This would mean the effective rate for loss-making companies will be 26.97%.

Implications for SMEs

Financial Impact

For SMEs, the additional tax relief available will reduce from 130% to 86%, with the cash R&D tax credit rate for loss-making companies dropping from 14.5% to 10%. However, for loss-making R&D intensive SMEs, the cash R&D tax credit rate will remain at 14.5%​​. Either scheme will result in less generous R&D tax credit claims pre-2023 for SMEs and therefore they must budget for the reduced R&D claim.

Administrative Changes

From April 1, 2023, companies that haven't claimed R&D tax credits in the past three years must notify HMRC of their intention to file a claim within six months from the end of the period in which the claim relates. Additionally, from August 1, 2023, all claims will need to be made digitally, with additional information required to be submitted via a new online portal​​. There are also more stringent guidelines regarding what qualifies as R&D and doesn't, and companies will have to make sure they are following these guidelines.

Support for R&D Intensive Companies

From April 1, 2024, the threshold for a company to be considered R&D intensive will be lowered to 30% of overall expenditure. Companies meeting this threshold can still avail of the old SME scheme benefits, which could be critical for those heavily invested in R&D​​. In 2023, this was 40%, so the reduction is welcome because it means more SMEs are able to access the R&D tax credit at the effective rate of 26.97% (if loss-making).

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Conclusion

While these changes introduce some complexities, they also provide new opportunities for SMEs engaged in R&D activities. The move towards a more unified scheme aims to streamline the process, though the impact on individual businesses will vary based on their specific circumstances. Understanding these changes is vital for SMEs to optimise their benefits under the new regime.

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