Changes on the way for R&D tax relief

By Anthony Lalsing, tax partner at accountancy firm, Menzies LLP

The Research and Development (R&D) tax relief scheme has changed little since its introduction in 2000, but significant reforms are now in the pipeline. From April 2023, there could be an opportunity for businesses to increase the value of their claims, whilst encouraging more problem-solving enterprises to consider claiming tax relief for the first time. While these changes could benefit a huge number of companies, there are some important pitfalls to avoid, and some businesses could even run the risk of losing money if not properly informed.

R&D tax relief is intended to encourage and reward innovation in science and technology across the UK. To be eligible, the business must prove that it has made an advance in a scientific or technological field.

As there have been no major changes to the scheme for around 20 years, the rules urgently needed to be updated to bring them into line with the modern world and technology. Innovation no longer just means creating a physical product, it can also involve analysing ‘big data’ or developing AI systems to crunch business or market data. The eligibility criteria needed amendment to take account of these changes. Some long-awaited changes are now in the pipeline and tax relief spanning investment in cloud computing and data-based initiatives, will soon be introduced. Many businesses, large and small, have invested significant sums of money in adapting these computer-based technologies to meet their own operational needs and in theory many of them could benefit from the extended scope of the reliefs.

Another important change is that investment in mathematical based innovations may now be included in the scope of the R&D tax relief scheme. In the past, HMRC would only allow businesses to claim for tangible technological outputs, despite many companies arguing that software innovation and the development of more efficient algorithms were based on mathematical modelling.

The other motivation for the reforms is to ensure the R&D tax relief scheme is fit for purpose and genuinely encouraging innovation in the UK. The UK Government wants to incentivise business investment in innovation to help grow the economy and provide jobs in the UK, as well as advancing key fields of science and technology.

In an attempt to expand and develop the UK’s skills base, whilst optimising income tax and national insurance receipts – the proposed reforms will restrict overseas costs. Currently, companies can utilise subcontractors in overseas jurisdictions where the cost of labour is cheaper and in so doing, protect their business from domestic labour shortages and costs. The Government has stated that this will change going forward, although there may be exceptions if the company can prove that an equivalent of a particular skill or expertise cannot be found in the UK. However, these situations will be reviewed on a case-by-case basis. This particular change could have a disproportionate effect on start-ups, where every penny counts, but companies of all sizes are likely to be affected to some degree.

Although not a recent announcement, many businesses are unaware that the Government also introduced an employer PAYE/NIC cap for accounting periods starting on or after April 2021 to encourage businesses to use more UK-based staff. The cap limits the repayable tax credit to £20,000 plus three times PAYE/NIC. This will affect many start-up companies who often start with limited staff and make use of subcontractors. It may also affect larger corporates where the structure is such that it involves one company conducting a project, using staff from another. Again, there are some exceptions, however these will also be considered on an individual basis.

In preparation for the changes next year, businesses should review them in detail to evaluate whether projects that currently benefit from R&D tax reliefs will still meet the requirements. It is also possible that projects that didn’t previously qualify may do so in future. Consulting a tax professional when projects start means expenditure can be tracked throughout the year and this will make it easier to capture spending that might be eligible for R&D tax relief under the new guidelines.

Ahead of the changes, now may also be a good time to review the staffing of projects in detail. For example, a cost/benefit analysis could be used to indicate whether it would be more beneficial for the company to continue using cheaper overseas labour or switch to a UK-based staffing model, which would allow them to claim additional R&D tax relief. They could also review planned projects in light of the PAYE/NIC Cap.

While these ground-breaking reforms will create opportunities for more businesses to benefit from R&D tax relief, there could be drawbacks for some. All companies will have to examine the new legislation in order to make informed decisions about how to run R&D projects in the future and maximize their tax relief.