R&D tax credits – what your clients need to know

The H&M Treasury published its R&D Tax Relief report in late 2021, and although it didn’t cause a huge stir at the time, some of HMRC’s proposals in the new report could see the ways in which companies claim research and development (R&D) tax relief in April 2023 impacted massively. 

And so, to give you a full picture of what’s to be expected, let’s dive a little deeper into the world of R&D credits. 

What are R&D credits?  

Research and development (R&D) tax credits have the power to transform a business. 

R&D tax credits were specifically created by the government to reward UK companies for investing in innovation. The valuable government incentive is a source of cash for businesses to invest in accelerating the R&D, fuel the company’s growth, and hire the best talent to ensure a company’s innovative model reach new heights. 

R&D tax credits are one of the top incentives created by the UK government to encourage investment in research and development, allowing up to 33.35% of a company’s R&D spend to be recovered either as a cash repayment or a reduction in Corporation Tax.  

In 2020, 85,900 R&D tax credit claims were made – an increase of 16% from 2019 – which took the total R&D tax relief paid out in 2020 to £7.4 billion. 

The definition of R&D has been consistent since the incentive was brought to fruition. And although there have been some clarifications over the years, R&D encompasses two key points: 

• R&D for tax purposes are realised when a project or product aims to achieve an advance in science or technology 
• The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D. 

But who is eligible for R&D tax credit? 

The scope for identifying R&D is huge – and any company in any industry can be eligible for R&D tax credits. 

However, to benefit from the R&D tax incentive, a company must: 

1. Be a limited company in the UK that is subject to corporation tax 

1. Have undertaken qualifying research and development activities, including: 

• Creating new products, processes or services 
• Changing, enhancing, or modifying an existing product or service 

1. Have spent money on these projects 

It’s also worth noting if a business is making a claim for the first time, it can typically claim R&D tax relief for its last two completed accounting periods.  

Proposed changed to the system and the impact they could have 

HMRC’s R&D Tax Relief report details changes to small and medium enterprises (SMEs) and R&D Expenditure Credit (RDEC) schemes. 

In summary, the changes aim to: 

1. Modernise the regime by extending the relief to cloud and computing costs 

1. Refocus the incentives on UK-based R&D 

1. Improve compliance by deterring fraud and errors 

1. Resolve some flaws of the current rules 

Modernisation: Data and cloud computing costs 

HMRC’s report states that qualifying expenditure for SME and RDEC schemes extends to: 

• Licence payments for datasets (other than those that have a lasting value beyond the duration of the R&D project or those that can be resold) 

• Cloud computing costs – like data processing and analytics, software and computation – used for R&D 
• Staff costs for employees engaged in the collecting, cleansing and analysis of data for R&D purposes 

Refocusing R&D incentives on UK activities 

Under both the SME and RDEC schemes at present, R&D activity anywhere in the world qualifies for R&D relief. 

And so, the R&D report has proposed changes that will severely restrict UK R&D tax incentives for overseas R&D – meaning the relief will be claimed solely by UK companies. 

To ensure UK innovation benefits from the tax relief, the report proposes: 

• Subcontracted out R&D will only qualify for R&D incentives where the third party undertakes the R&D in the UK 

• Payment to externally provided workers (EPWs, workers provided by third-party staff providers) will only qualify where the workers’ salaries are paid through a UK payroll 

Although costs associated with EPWs or overseas subcontracting won’t qualify for R&D relief, these costs can still be deducted from taxable profits in the usual way.  

Tackling abuse and compliance 

While £47.5 billion worth of R&D tax relief was claimed by UK businesses in 2019, the Office for National Statistics (ONS) estimates businesses only carried out R&D of £25.9 billion that was privately financed in the UK by private businesses. 

And so, the scale of abuse and boundary-pushing in R&D relief claims has been a concern – with estimated error and fraud costing £311 million for 2019-20 according to HMRC’s accounts. 

The changes aiming to tackle this are: 

• All claims will have to be made digitally 
• Digital claims will require more details to substantiate the claims (unclear precisely what this will mean and in what format) 
• Each claim will be endorsed by a named senior officer of the company 
• Companies will need to inform HMRC in advance that they plan to make a claim (unclear if this is at a project or company level, or what the time frames will be); and 
• Claims will need to include details of any agent who has advised the company on compiling the claim. 

How can R&D credits benefit small-business growth? 

The credit scheme is a great incentive for small businesses as it allows them to leverage to compete and lead the market too. 

But what are the real benefits associated with R&D tax credits? 

• Cash injection: R&D tax credits provide an essential source of non-repayable funding for many small, medium and large enterprises. 
• Boost innovation: R&D tax credits help encourage businesses to invest in R&D and innovation. 
• Economic growth: Every £1 spent on public R&D delivers approximately £7 of net economic benefit to the UK and unlocks £1.40 of private R&D investment. 
• Global leaders: R&D tax credits help put the UK at the forefront of R&D and innovation across the globe. 

If your client’s company is ready to demonstrate its innovative idea for a new service or product, here are a few ways R&D can help a small business grow to discuss with them: 

• Unique selling point (USP): R&D can help businesses develop their unique services and products. But these services or products don’t need to be completely new – R&D can also drive product improvement or innovation within the existing business offering.  
• Income: unique products and services from successful R&D projects can bring financial benefits to a business, usually by generating new or enhanced income streams, but R&D can also attract potential new investors to a business too. 
• Funding: Small businesses can feel a financial sting when undertaking R&D projects. However, there are many opportunities for businesses to get global funding and support for innovation, as well as public-sector innovation, research and development grants through the R&D development initiative. 

• Tax relief: A company can claim R&D tax relief to reduce its tax bill or, choose to receive a tax credit (cash sum) paid by HMRC. However, only qualifying R&D expenditure will be considered. 
• Competitive edge: R&D will give a company a competitive edge from its contemporaries, enabling a business to establish itself as a market leader in the field.  Any by developing new services and products, a business can also generate new intellectual property which has the potential to benefit them financially too. 
• Collaboration: This can be achieved between not only a business and another enterprise, but also a college or university. Companies can enjoy the transfer of knowledge and skills, access to facilities, expertise and new ideas. 
• Reputation: A company’s brand and reputation can be strengthened through R&D, especially if a business collaborates with a trusted, reputable partner or a strong scientific institution. 

HMRC’s proposed changes to R&D tax relief could significantly impact businesses and their plans for innovation.

Clients will be relying on your advisory expertise to help them navigate these changes and prepare their business for the future.

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