Tax: R&D relief – welcome changes but outlook uncertain

Chancellor Jeremy Hunt’s new Spring Budget has brought with it the latest in a long string of reforms to the UK’s research and development (“R&D”) tax credits system – a new enhanced tax credit for R&D intensive small and medium sized enterprises (“SMEs”). The ongoing uncertainty has made planning ahead difficult for businesses, but the newest changes have been largely welcomed by the industries they are targeting. The upcoming changes that R&D intensive businesses should be aware of are highlighted below.

Enhanced tax credit

In the aftermath of the Chancellor’s Autumn Statement in 2022, in which he announced a cut to the R&D tax credit for loss-making SMEs from 14.5% to 10% and a cut to the SME additional deduction for R&D costs from 130% to 86%, many SMEs had been looking to the introduction of those cuts in April 2023 with considerable apprehension. In particular, loss-making SMEs – which are particularly reliant on the cash repayment as a source of financing – were expecting to see a significant reduction in their effective rate of subsidy by the R&D tax credit.

The Chancellor’s new announcement that a tax credit “worth £27 for every £100 they spend” will soon be available to loss-making R&D intensive SMEs has come as something of a relief to those it affects. Companies will only be able to qualify for the credit if they spend 40% of their total expenditure on R&D. For these “R&D intensive” companies, the payable credit rate will be 14.5%, reflecting the original rate of the R&D tax credit for all loss-making SMEs.

Unfortunately, R&D intensive SMEs which have begun to make a profit will not have access to the new tax credit. Loss-making SMEs that do not meet the 40% R&D expenditure threshold will also not qualify and will only have access to the 10% payable credit rate announced last autumn.

Overseas costs

The territoriality restriction, due to be introduced for accounting periods beginning on or after April this year for both the SME and RDEC (which provides R&D relief for larger companies) regimes, and aiming to prevent companies from claiming R&D relief in the UK for work undertaken overseas, has been pushed back until April 2024. This should be particularly well received by businesses in the life sciences sector, which must often undertake research abroad for regulatory reasons. However, as this postponement has come so late and will only last for one year, many businesses will have made their decisions on the basis that relief would not be available for overseas work and will not be able to take full advantage of it.

Increased scope of tax relief 

The new Finance Bill will allow tax relief under both the SME scheme and the RDEC scheme for two more types of expenditure: expenditure on data licences and cloud computing costs. This is particularly important, as for many companies the computation, processing and analysis of their data are an integral part of their R&D process.

Additionally, the definition of R&D in the Government’s guidance has been expanded to include pure mathematics. Depending on how this term is defined in the legislation, this change could be helpful for industries such as finance or insurance. These industries use complex risk modelling exercises which could substantially benefit from advances in mathematics and may therefore be inclined to invest more in mathematical research once a tax credit is available for it.

Future of the system

While some of the newly announced changes will be welcomed by businesses, the benefit of each change is arguably lessened by its presumed impermanence. The Government is currently considering proposals to scrap the current R&D tax relief system and replace it with a new single scheme based on the RDEC scheme from April 2024. It is proposed that – once the scheme has been introduced – relief will be simpler to apply for and there will be additional certainty as to whether it is available, which will encourage investment in R&D.

However, in the meantime, businesses are left with considerable uncertainty, particularly those falling within the SME R&D scheme. 

The Government consultation on the matter has now closed, and new draft legislation is not expected until the summer, which some fear will leave businesses without enough time to prepare for the introduction of the new scheme. A new, simpler system would be welcomed by most, but the details of that system, and the ease of the transition to it, will be crucial for R&D heavy sectors.