Are you prepared for changes to the UK R&D regime?
David Byrne, from Moore Kingston Smith’s Research & Development team, discusses the impact of recent changes to the UK R&D regime, particularly the ‘winners and losers’ arising from the merged R&D scheme and how companies can respond.
In the Autumn Statement, the Chancellor confirmed the merger of the R&D Expenditure Credit (RDEC) scheme for large companies with the enhanced R&D tax relief for small and medium-sized enterprises (SMEs). This will apply to all companies and accounting periods beginning on or after 1 April 2024. It provides a gross 20% ‘above the line’ credit, net 16.2% for those seeking a payable tax credit.
The merger is an opportunity to address one of the most contentious aspects of the R&D regime and resolve one of the key differences between the RDEC and SME regimes, namely, who benefits when third parties are involved in R&D projects. Companies currently negotiating contracts should consider the impact of the proposed legislation on their R&D benefits.
Previously, the SME scheme favoured the ‘decision maker’ who commissions R&D projects and bears the economic risk, even if the R&D itself is performed by a third-party supplier, whereas the RDEC regime favours those performing the R&D, even if funded by a third party/customer. In effect, SMEs could claim relief on expenditure for R&D activities it subcontracts out to a third party but cannot claim for work subcontracted in or subsidised by a third party. Conversely, RDEC claimants can claim for work subcontracted to it but not for work subcontracted out to third parties. In some circumstances, SMEs can claim subsidised/subcontracted R&D under the RDEC scheme.
Controversy
As the SME relief is much more generous than RDEC, much rested on what is regarded as subsidised/subcontracted (sub/sub) R&D. This may arise if projects are otherwise funded, for example, in receipt of a grant or subsidy or where R&D activities occur as part of a project to deliver goods or services paid for by a client.
HMRC has adopted a strict interpretation of what it regards as subcontracted or subsidised R&D. This is despite repeated adverse judgments in First Tier Tribunal judgements. In one instance, Judge Morgan’s verdict stated, “If HMRC’s approach were to be adopted, the circumstances in which an SME could claim enhanced R&D relief would seem to be confined to those where it has no prospect of exploiting the R&D for commercial gain.” and that “…it would be wholly out of kilter with the overall SME scheme if an SME were to be denied enhanced R&D relief solely because… it seeks to recover some or all of the relevant costs of the R&D under it its commercial contracts with its clients”.
Notwithstanding these judgements and the stated policy goals, HMRC has continued to reject SME claims for R&D, which it regards as being subsidised or subcontracted R&D claims from companies operating under contractual patterns or working practices standard across many sectors, from construction to manufacturing. The advent of the merged scheme, applicable to all companies, is an opportunity to resolve the impasse.
Changes
In addressing this, the changes published in the recent Finance Bill introduce a distinction between
- ‘in house’ R&D, for which there is no change compared to the SME/RDEC regime, the decision maker/risk taker, who is also the performer, can claim;
- ‘contracted out R&D’, for which, if the decision maker/risk taker intends or contemplates R&D may occur, they can claim; and
- ‘contracts for service’, during which, if R&D is initiated, the performer can claim.
Much will rest on how HMRC interprets the new legislation. Whether a contract would be regarded for services or for contracted out R&D remains subjective, with the legislation emphasising whether the decisionmaker/commissioner of the project intended, or contemplated, that R&D may occur in the performance of the subcontract. Again, the ambiguity presents opportunities and threats, and as the Technical Note accompanying the Autumn Statement indicates, “The exact details of who should claim the relief will depend on the specific contract”.
Companies should consider the impact of these changes, the extent to which any work with third parties may be deemed contracted out R&D or a contract for services, and the impact on the R&D benefits they receive. For those currently negotiating contractual terms, while remaining mindful of the commercial/risk context, elections or contractual terms may help resolve some of this ambiguity and provide greater certainty for beneficiaries on what remains a generous benefit.
What do companies need to do?
For many companies, the changes won’t impact immediately, perhaps even to the 2025 period. However, companies should now review their contractual arrangements with customers and/or suppliers, the extent to which any work with third parties may be deemed contracted out R&D or a contract for services, and model the impact of these changes on the projected R&D benefits. Where there is scope and commercial rationale to consider contractual changes, introducing statements to reflect whether the contract would be regarded as a ‘contracted out R&D’ (i.e. the decisionmaker foresees potential R&D and claims the R&D benefit) or a ‘contract for services’ (during which the subcontractor may initiate R&D and claim the R&D benefit) would remove ambiguity and provide increased confidence who receives what remains a generous R&D benefit.
As further details emerge, we’ll inform you about these and other changes in the R&D regime.
Need help?
If you want advice or support with these changes, contact Moore Kingston Smith’s R&D team. We’re here to help you understand and manage the transition effectively.