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R&D: More barriers for tech start-up relief claims

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Is it getting too difficult for tech start-ups and other small companies to claim SME R&D tax relief?

16th Mar 2022
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Since its introduction in 2000, the core definitions within the research and development tax relief scheme have remained essentially the same. However, the use of the scheme has grown exponentially from an average of 5,000 claims a year in 2000/01 to almost 90,000 claims in 2019/20.

This massive growth in the number of claims has led inevitably to a massive increase in the cost of the scheme, which is expected to reach £7bn per annum per year. This increasing cost, alongside data suggesting that receiving tax relief does not increase spending on R&D for smaller companies, has led the government to introduce a raft of changes over the past few years aimed at refocusing the scheme and reducing suspected abuse. 

While these changes have, on the whole, been positive, many have disproportionately affected tech start-ups and other small companies with genuine claims. 

If nothing is done to mitigate these effects, over time it is likely to become uneconomic for these companies to claim R&D tax relief, counter to the Government’s stated aims of supporting start-ups in tech. 

PAYE/NIC cap

The PAYE/NIC cap for R&D tax relief was introduced in April 2021. The purpose of this change was to reduce abuse of the scheme by capping the amount of tax credit that could be claimed by loss-making companies with few employees, as this part of the scheme had become a target for abuse. These changes don’t affect many claims – a loss-making company with only 10 staff could claim tax credits of up to £170,000 before being affected, which equates to a massive R&D spend of £500,000–£700,000.

However, the negative consequence of this change is to reduce the tax relief that can be claimed by start-ups. Where a company has, for example, only two directors paid minimal wages (no PAYE/NIC costs) the maximum the company could claim would be £20,000, no matter how much it spent on genuine R&D. While this might represent a good return on R&D spending, those companies are still being unfairly penalised by these new rules.

Advanced notice of claims

In late 2021, the Government announced a raft of changes to the scheme that will come into force in April 2023. 

The first is a new requirement for companies to give HMRC advanced notice of their intention to claim R&D tax relief. 

The Association of Taxation Technicians (ATT) called for the Government to rethink the change. They have expressed concern that, if a company was required to inform HMRC before they embarked on their R&D projects, this would prevent many small companies being able to claim. The ATT’s argument is that smaller companies are more agile in how they carry out R&D and are far less likely than larger companies to have a planned and documented series of R&D projects upfront, potentially preventing these companies claiming the relief that they need. 

Overseas subcontractors

The second  proposed change from April 2023 is that companies will no longer be able to claim R&D tax relief on the costs of overseas subcontractors and externally provided workers (EPWs).

The aim of this change is to prevent abuse of the scheme, but as with the PAYE/NIC cap, it is likely to impact start-ups and small companies, especially in the software sector. Due to a lack of skilled workers, many of these companies have been forced to use overseas development houses to expand their capacity, and this change to the scheme would prevent them claiming for these genuine R&D costs. 

Mandated reports

Also, from April 2023, companies will be required to provide details about their claim, including what advances were made in science and technology and what uncertainties were overcome. 

While this is a huge step forward in ensuring that all claims comply with HMRC’s criteria, smaller companies may have difficulties in accessing appropriate advice and support to enable them to provide a robust narrative, because their claim will be too small to be of interest to most R&D advisors in the marketplace. These companies are also likely to be inexperienced in claiming R&D tax relief, so will not have the in-house expertise required to gather and present the data appropriately, increasing the likelihood of the claim being investigated and potentially denied. 

Minimum spend

Finally, a change that has been suggested by larger accountancy firms is the re-introduction of minimum spend requirements. Prior to April 2012, the minimum spend required to make a claim was £10,000. 

While only an idea at the moment, if this became law it would completely remove the ability for smaller companies with small R&D projects to claim relief. In 2018/19 some 11,480 R&D claims were for tax benefit of less than £5000, equating to eligible R&D spends of approximately £15,000–£25,000. Thus a minimum spend requirement would affect thousands of companies that are currently claiming, and would also impact small start-ups to the greatest extent. 

Unwanted side effect

Overall, while these changes are welcome and should go some way towards reducing abuse of the scheme, it can’t be denied that an unwanted side effect will be to make it more difficult for smaller SMEs to make claims. 

Given that the scheme can provide a vital source of funding for early stage technical companies in particular, it would be remiss of the Government to continue along this track without considering the effect this could have on the success of these companies. It has been suggested that additional grant monies could be made available to plug this gap, but this is yet to be confirmed.

Replies (3)

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By Hugo Fair
17th Mar 2022 00:18

It's hard to see most of the factors described in this article as either unfair or contrary to the original objectives of the scheme.
Indeed (with the exception of the exclusion of overseas workers which in itself feels reasonable) all the changes can be seen as merely tightening & clarifying the existent rules.
It was never intended to be a provider of grants, but to reduce the fiscal obstacles to investing in R&D for targeted projects planned to deliver real breakthroughs that translate into the commercial world.

Thanks (2)
Chris M
By mr. mischief
17th Mar 2022 08:57

The advance notification and minimal spend requirements are the 2 items which should be removed in my view.

I'd say a maximum of 0 accountants dealing with small claims have been consulted on this.

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Replying to mr. mischief:
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By Dib
17th Mar 2022 13:12

+1

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