How changes to tax relief on overseas R&D could impact multinational companies

Following the publication of draft legislation last summer, we highlighted how proposed changes to R&D tax relief could result in significant reduction in benefit for businesses undertaking R&D activity overseas.

With less than three months before legislation comes into force in April, our research shows that many businesses have serious concerns about the potential impact on the UK’s attractiveness as a location for R&D investment.

We asked 101 C-suite decision-makers across the Information and Communications, Manufacturing, Financial Services, and Scientific and Technical sectors for their views on legislation which is intended to refocus R&D tax relief on UK based activity.

The results of our survey revealed fears that the changes could inadvertently hamper the UK’s ability to be part of global R&D programmes, discouraging foreign direct investment.

The changes to relief for overseas R&D exclude relief for subcontracted work and the cost of externally provided workers (EPWs) when R&D activity is undertaken outside the UK. This adaption of the relief assumes a commercial ability to pivot to UK-based suppliers or resources. In reality, companies carrying out research in fields such as AI and quantum computing need to access a global skills base to stay ahead of the competition.

What do changes to overseas R&D mean for multinational companies?

Currently, UK companies can make use of skills and resources overseas when pursuing scientific and technological innovation, while still benefiting from UK R&D tax relief. This ability helps to promote the UK as an attractive as a location from which to lead complex global R&D programmes.

From 1 April, such costs will only qualify under a narrow set of exemptions where it would be “wholly unreasonable” to undertake the R&D in the UK instead. But exemptions do not include the two most common reasons cited by the businesses we surveyed for carrying out some R&D activity overseas – a lack of available skilled workers in the UK (44%) and the higher costs involved (42%).

While at a superficial level, these changes appear to be an understandable way to ensure that UK taxpayer money is spent on UK activity, the devil, as usual, is in the detail as we saw in the HMRC draft guidance on R&D tax relief reform.

R&D in software development – a global endeavour

Increasingly R&D has become a global endeavour, particularly in developing software, where teams can collaborate without needing to be physically together. Most of the activity which will in future fall out of the incentive is there to support UK-led R&D projects and teams, allowing UK businesses access to the skills and expertise needed to accelerate R&D programmes and compete globally in cutting edge sectors.

When it comes to money spent overseas, the recognised spillover benefits of R&D activity are still very relevant as it is UK business which grows and prospers from the R&D.

This has the potential to reach a level of success that enables business to better draw global expertise into the UK and could give UK business an edge when establishing innovation hubs in key emerging technologies.

Restrict the funding and that R&D will slow down, presenting an additional hurdle for UK businesses in a global race for breakthroughs.

Further underlining the importance of innovation incentives, more than a third (34%) of companies surveyed said that the availability and attractiveness of tax reliefs were an important factor when considering where to locate R&D activity.

ForrestBrown’s view – building the UK’s innovation ecosystem

This legislation presents a real challenge for many of the UK’s most innovative companies who often have no alternative but to look overseas for the skills they need to carry out R&D.

We would also like to see connected-party EPWs excluded from these measures to ensure that global groups can continue to draw on employees of subsidiary companies to support R&D hubs in the UK.

One other possible solution would be to allow exemptions for skills on the shortage occupations list used to inform skilled worker visa applications.

Measures like this can help to maintain and build the UK’s innovation ecosystem which will be vital to our economic recovery in 2023 and beyond.

You can also read our article on the changes for R&D tax relief in 2023 for more information.