Overseas R&D tax relief changes and what they mean for your business

To refocus support for innovation within the UK and boost the use of UK-based suppliers and resources, the overseas research and development (R&D) tax relief scheme is changing. We explore what it could mean for your business and suggest how you can prepare adequately for when the reforms take effect.

The government has published draft legislation to implement its proposed changes to the R&D tax incentives. They apply to accounting periods beginning on or after 1 April 2023. To be read alongside this draft legislation are additional details of how these amendments will work in practice.

The legislation includes changes for both the SME R&D tax relief scheme (SME) and the R&D expenditure credit scheme (RDEC). The final legislation will be reflected in the Finance Bill 2023 and may differ from the published draft.

Changes to overseas R&D expenditure

For accounting periods beginning on or after 1 April 2023, expenditure on subcontracted R&D and the cost of externally provided workers (EPWs) employed on R&D projects outside the UK will no longer be eligible for UK R&D tax relief. It must either be attributable to relevant R&D undertaken in the UK or otherwise be qualifying overseas expenditure.

To be qualifying expenditure, expenditure on payments for EPWs must be subject to PAYE and national insurance contributions, unless it is qualifying overseas expenditure.

Qualifying overseas expenditure

For R&D expenditure outside the UK to be classed as qualifying overseas expenditure, it must meet all three of the following criteria:

• Conditions necessary for the R&D are not present in the UK
• Conditions are present in the location where R&D is undertaken
• It would be wholly unreasonable to replicate the conditions in the UK.

The conditions included within the legislation are geographical, environmental or social. Additionally, legal or regulatory requirements may apply.

For example, from April 2023, a UK company that has scientists carrying out clinical trials outside the UK, will not benefit from R&D tax relief (under either the RDEC or SME schemes). However, if regulatory or other legal constraints require such trials to take place outside the UK, this will qualify.

Software and technology

With the new legislation, costs for data licences and cloud computing services can be qualifying expenditure when employed in activities directly contributing to resolving scientific or technological uncertainty. Also, materials sourced overseas can still be qualifying expenditure if the R&D work is carried out in the UK.

Changing your company year end to claim for overseas expenditure longer

You might consider changing your year end to gain extra time under the old regulations. This would allow you to claim your overseas expenditure for longer. However, there are implications, so you should weigh up the positives and negatives of changing your year end.

Consequences of changing your reporting date

Changing your reporting date can have a multitude of implications for your organisation. You should be aware of the immediate and future ramifications so that you can make an informed decision before making the change.

The clear advantage in the current climate is an increased R&D claim due to the addition of the overseas expenditure. Additionally, if your company has another source of corporation tax repayments from loss utilisation or excess payments on account, shortening the reporting period can be a valuable method for bringing forward the repayment.

There is no restriction on the number of times a reporting period can be shortened, with the minimum period you can shorten it by being one day. Future reporting periods can be subsequently extended to return you to the original reporting date. However, the reporting period can only be a maximum of 18 months and extensions of the reporting period can only be done once every five years.

Points to consider when deciding to bring forward your reporting date:

• Changing your company reporting date often results in your corporate credit rating being downgraded. If your company is looking to obtain finance soon, you might face increased interest rates and find your affordability checks of debts are affected. There are credit improvement opportunities that can resolve this but it won’t be an instant solution.
• Cash outflows for audit/accounting and tax compliance fees will be brought forward, which may result in additional fees if firms feel that the change affects their service.
• If your company is part of a group, changing the reporting date may misalign your company from the rest of the group. This could result in more difficult consolidation processes and more planning for intragroup transactions, such as management charges and dividends.
• The change may result in non-coterminous VAT returns and other compliance returns which could result in additional labour requirements.
• Financial forecasts and budgets may need to be recalculated which will require senior management time and may affect employee incentives and reporting to investors and other stakeholders.

Help from the R&D regime experts

Contact us if you would like more guidance regarding the changing overseas R&D tax relief. Additionally, if you would like us to run a no-obligation calculation to see if your R&D activity qualifies and how much you might be eligible to claim, please contact Thomas Hayden.