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Single R&D tax relief scheme brings significant changes

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The government published draft legislation last week for the merger of the large and small company R&D schemes. Richard Edwards from The R&D Community explores the three significant changes as a result of the merged relief.

26th Jul 2023
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The government have just released their much-anticipated draft of the legislation for a new, combined scheme for R&D tax relief. These changes are highly likely to come into play on 1 April 2024, so R&D advisers and accountants are already trying to figure out what the combined scheme will mean for their business and their clients.

Here’s what you need to know.

Understanding the single R&D relief

The draft has been published for technical consultation, and if the legislation is to go ahead, this is likely to be announced in the Chancellor’s Autumn Statement. There are three significant changes included:

The rules around subcontracting aren’t getting any clearer

According to the draft legislation, companies won’t be able to claim R&D relief on activities that were contracted to them by another person or company. This is a concern, as historically there has been a lot of disagreement between HMRC and claimants about what activities were within the scope of a contract, and which were not. The challenge for HMRC is to make the rules fair and clear, whilst avoiding the risk of double-dipping; where two companies make a claim for the same work.

The new wording suggests that this wrangling and subjectivity could continue, with HMRC arguing that R&D activities were contracted to the claimant and advisers arguing that they weren’t.

Potential solutions to this issue are likely to involve yet more complexity and red tape, which is arguably the last thing we need in R&D tax relief. The flip side of this change, however, is that it will allow large companies to claim relief on a broader range of subcontractors than before.

Subsidised expenditure won’t qualify for relief

The second point is that expenditure may not qualify for relief if it’s been subsidised – either by a grant or by another entity. This will obviously be of major concern to contract research organisations and the high-tech life sciences companies that typically make heavy use of major grants.

However, this part of the draft legislation has been marked within square brackets, indicating that its presence in the text is more tentative.

Eligible costs and the value of the credit remain largely the same

Thirdly, the draft legislation confirms the costs on which relief will be given, which are very similar to the current set. Staffing costs, software, data licences, cloud computing services, consumables, externally provided workers (EPWs), clinical trial subjects and UK-based EPWs and subcontractors will attract relief.

Meanwhile, contributions to independent research no longer features (currently available only to large companies). It also reveals that the credit will be 20% of qualifying expenditure, which is in line with the recent increase in R&D expenditure credit (RDEC) from 13% to 20%.

So, while the new scheme feels familiar in many ways, it also (as drafted) shows signs of familiar problems – particularly around the issue of subcontractors and how HMRC will differentiate between contracted activities and those that the claimant elected to undertake at their own risk. Very clear guidance will be needed if the new scheme is to be less contentious than the current SME scheme.

The scale of fraud and error in the R&D scheme

These legislative changes have been in the works for some time, but it’s interesting to see them in the context of two reports published very recently by HMRC.

HMRC published its annual report on 17 July, which provided new figures on the level of error and fraud found across the two schemes. The report estimates that over £1bn of SME relief was attributable to non-compliant claims – a truly eye-catching statistic that confirms the unease of many who’ve worked in the sector for some time.

In the smallest claims (with expenditure less than £10,000) over 75% of the claim value was found to be non-compliant.

Even more damningly, HMRC found that small claims involving an adviser were even less compliant than average: “Claims under £10,000 have the highest rates of non-compliance, at 90% for those with an R&D agent and around 75% for those without,” said the report. 

There’s little doubt that the government will use this data as justification for a future decision to merge the schemes and take other steps to create barriers for SMEs who want to claim only small amounts of relief.

HMRC's view on its approach to compliance checks

The same day, HMRC also published details of its approach to compliance in R&D tax reliefs. In the report, HMRC describes its approach as educational and helpful. They say they’re trying to support the right companies to apply in the right way at the right time. Our experience has been quite different.

We have reviewed and assisted with 50-60 enquiries since the start of the year, giving us a startlingly different picture. HMRC’s standard approach seems to assume that none of the claim qualifies. The decision often seems to be made even before the enquiry is opened, with the anonymous caseworkers gathering evidence simply to support their initial gut feel that the claim isn’t valid.

Along with our own members, and other bodies like CIOT, we’re concerned that legitimate claims are being denied unfairly. There’s a particularly high risk of this happening with smaller claims, as these claimants have a lot less to gain from a vigorous defence and are more likely to simply accept the rejection of their claim and move on.

What will happen next in the world of R&D tax relief?

It is positive to see the government and HMRC make changes to improve compliance – including measures like the Additional Information forms (now delayed until 8 August 2023), prenotification rules, and potentially a simpler, combined scheme.

However, it will be some time before we see the impact of these changes, and if they have the intended effect. In the meantime, we’re concerned about how HMRC’s adversarial approach to compliance checks will play out. We’re expecting to see more discontent, political manoeuvring and first-tier tax tribunals as advisers and claimants push back on what they see as unreasonable and unfair tactics from HMRC.

Replies (4)

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By Hugo Fair
26th Jul 2023 20:02

I'm hardly a member of the HMRC fan-club, but what "unreasonable and unfair tactics from HMRC"?

The 'shake and bake' style of such a large %age of the R&D 'agent' community has been reported (and observed in action by myself and others) to be unprofessional/out of control/non-compliant.
“Claims under £10,000 have the highest rates of non-compliance, at 90% for those with an R&D agent and around 75% for those without” ... sums it up perfectly!

Roll on the imminent 'pre-notification rules' - although they seem to be rowing back already on how much wriggle room will be allowed, which indicates the heart of the problem.
Either police it better, or raise the entry barriers.

I can't for the life of me see why expenditure not actually incurred (because, say, it was subsidised via a grant) should qualify for relief - but that's within the remit of policy makers who may have their eye on a different prize.

The 'obvious' effective solution is to restrict advice of any sort to those who are accredited to give it ... surely not a problem for the professionals who say they want the market to be sanitised?

Thanks (1)
By ireallyshouldknowthisbut
27th Jul 2023 09:32

What HMRC have found is exactly what agents have found

The specialist R&D firms are almost all as bent as a nine bob note, but its never *their* firm, its always someone else's.

9 out of 10 HMRC have looked are are entirely fraudulent or huguely inflated through a dodgy agent and 75% without.

its good to see HMRC finally get stuck in on this, albeit very late in the day, and inevitably a little too softly. I would be tempted once a dodgy firm is identified to reject every claim they have ever made, explain to the tax payer the high % of erroneous claims, and ask the company to reapply if they have a valid claim. HMRC just don't play hard enough on these. The IRS would not pus$y foot about like this in the face of widespread systematic fraud.

This is not just free money to dish out, its supposed to be supporting genuine R&D which would not otherwise have arisen.

I still think this should be a pre-research application. So only genuine projects which are depending on the cash get it. Anyone who has already spent the money and didn't know about a claim, didn't need it. This would kill off almost all the dodgy claim firms overnight.

Thanks (2)
Replying to ireallyshouldknowthisbut:
By jon_griffey
27th Jul 2023 12:52

ireallyshouldknowthisbut wrote:

I still think this should be a pre-research application. So only genuine projects which are depending on the cash get it. Anyone who has already spent the money and didn't know about a claim, didn't need it. This would kill off almost all the dodgy claim firms overnight.

This suggestion has serious merit to it. If there is to a pre-research application required then why have a system of tax credits at all? Could this not be done as an Innovate UK type grant application? They might then get a higher degree of scrutiny at the outset.

Thanks (1)
Replying to ireallyshouldknowthisbut:
avatar
By Hugo Fair
27th Jul 2023 17:11

"it's supposed to be supporting genuine R&D which would not otherwise have arisen" ... is exactly the point I made here (on a different thread) a year or two ago - and was almost battered with animosity from respondents!

From my point of view, and from practical experience, I can't see how a project set-up without thought of obtaining a grant is either deserving of or requiring taxpayer support.

A proper R&D project will always have a project plan (with defined objectives, methodologies and measurements) - and it would be highly surprising if that wasn't accompanied by a project budget.
So the idea that you can trawl last year's activities and retrospectively identify some of that as R&D worthy of a TC claim is frankly laughable and verging on the overtly fraudulent.

Thanks (2)