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R&D tax relief reforms - Proposed incentive changes & ForrestBrown’s response

Jenny Tragner
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In March 2021, the government launched a wide ranging review of the way that business R&D is incentivised in the UK through the tax system. This review marked a period of substantial change for R&D tax reliefs. While the wider review considers all aspects of the incentives – from the definition of R&D to the expenditure which attracts relief, to the mechanism for giving relief through to the administration of the reliefs by HMRC – some specific measures have already been proposed in the R&D Tax Reliefs Report.

These R&D tax reforms deal with data and cloud costs, overseas R&D and tackling abuse of the incentive, and were announced in the Chancellor’s Autumn Budget statement.

ForrestBrown has been actively involved in the R&D consultation since its launch. We’ve submitted a comprehensive response to these latest proposals, representing our clients’ views and our own. Our recommendations aim to ensure that this genuine government incentive is targeted to businesses that deserve it.

What R&D tax reforms are the UK government proposing?

The government is proposing to introduce a number of measures from April 2023, which will affect eligibility of certain costs for R&D tax relief. It will also impact the process by which companies can make a claim for relief.

Data & cloud costs and R&D tax relief

Software costs already attract R&D tax relief, however to date no relief has been given for the cost of datasets or cloud computing. This is regardless of whether such costs were essential to R&D. The government proposes to extend the definition of qualifying expenditure to include such costs and it has set out proposals for how this measure will work in practice, including various exclusions.

Overseas R&D and R&D tax relief

The government proposes to withdraw relief for certain R&D activities undertaken outside of the UK. Under this proposal, if a company subcontracts some R&D activities, it would need to confirm that those activities are undertaken within the UK in order to claim relief. If it engages the services of externally provided workers, it would need to confirm that the worker is paid via a UK payroll to include the expenditure in a claim for relief.

Tackling abuse of R&D tax incentives

A number of measures are proposed, aimed at tackling abusive behaviours, primarily stemming from unregulated malicious R&D agents:

  • All R&D tax relief claims will in future need to be made digitally.
  • Providing supporting information alongside an R&D tax relief claim will be mandatory.
  • R&D tax relief claims will need to 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.
  • Claims will need to include details of any agent who has advised the company on compiling the claim.

Our response & recommendations to proposed changes to R&D tax relief

Many of the new R&D measures proposed deal with abuse and boundary-pushing in the R&D tax advice market. Improving regulation in the wider tax advice market would better protect businesses and HMRC from this threat. Simplifying the rule base and reviewing the definition of R&D would improve accessibility and more clearly set expectations for those accessing relief, making it easier for businesses to be compliant.

We welcomed the broad review of R&D tax reliefs launched in 2021. It was an opportunity to seek positive reform without continuing the trend of piecemeal changes which add complexity to the incentive. However, some of the measures outlined in this R&D Tax Reliefs report appear at odds with the overall aims of the review.

We support changes which will improve targeting of the incentive, ensuring that genuine innovative businesses and activities attract relief. Modernising the software cost category to allow relief for data and cloud costs where these are necessary for R&D is a welcome change in line with this goal.

ForrestBrown do not support measures which simply aim to reduce the overall cost of the incentive because this is not the stated aim of these reforms. While these may reduce some abusive claims, they will also introduce unnecessary additional administrative burdens and in some cases deny relief to genuine R&D. This collateral damage is not acceptable. A blanket exclusion of relief for R&D carried out overseas is too broad and will erode UK based IP, undermining policy aims.

Abuse of the R&D incentive must be tackled and most of the measures proposed in the report are necessary to achieve this. Better regulation of the tax advice market is also essential to improve compliance, help HMRC and protect businesses.

Many of the operational proposals will introduce new administrative burdens on companies accessing R&D relief, so new measures should only be introduced when the case for them is clear. In implementing these changes, we would welcome a more open and transparent culture within HMRC, with better guidance available.

Summary of our key recommendations

Data and cloud costs 

The inclusion of costs related to licence payments for datasets is welcome. Having said that, some of the exclusions appear excessively restrictive and could limit the genuine application of the benefit.

We recommend that the actual use of a dataset within and after the R&D project should determine eligibility rather than the details of the licensing agreement.

Cloud computing costs should attract relief because they are, in our experience, essential for product testing. The proposed measures would benefit from greater clarity in their practical application to ensure that such costs are simple to calculate.

Servers and data storage are often the major proportion of costs in R&D projects using the cloud and should therefore also be included. Cloud-based services often use aggregated costs and so a pragmatic approach to apportionment should be adopted.

Overseas R&D

We are concerned that the proposal to exclude relief for overseas R&D carried out by subcontractors and EPWs is aimed at overall cost reduction rather than better targeting of relief. The case for its introduction remains unclear.

If it is introduced, some protections should be included to ensure that the proposed changes do not undermine the overall policy intent of the reliefs by eroding UK-based IP.

A de minimis threshold would ensure that where companies only carry out a minority of their R&D overseas, they are not burdened with new rules nor denied relief.

For those above the de minimis, a general necessity rule could introduce several acceptable reasons for activities taking place outside the UK. These include scarcity of specialist skills, regulatory requirements, geography and environmental considerations.

Further consultation should be carried out to determine appropriate evidence requirements in each case. Skills shortages in particular could be supported by using the published government list of skilled worker shortage occupations.

We recommend that connected-party EPWs are 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.

Tackling abuse

Although not covered within this consultation, our primary recommendation for tackling abuse of R&D tax reliefs is to improve regulation in the tax advice market. We support compulsory professional body membership for anyone offering paid-for tax advice.

Digital filing of R&D claims should become mandatory and most companies and agents already file in this way. Some small updates to the regulations governing late claims could ensure that missing a deadline due to technology failure would not prevent a company from making a valid claim for relief.

We agree with the requirement for supporting information to be submitted alongside an R&D claim. Further consultation on the content and process for this measure would be welcomed. HMRC should be clear and transparent regarding how they will use this information, particularly in respect of risk assessing claims and the timing of compliance checks.

Requiring a senior officer of the company to endorse the R&D claim specifically may have some positive impact. We are aware of cases where the directors of a company have not understood their R&D claim because they have relied too heavily on an agent. However, tax returns are already endorsed by a senior officer of the company, so this measure may have limited effect.

Introducing a new process which requires businesses to notify HMRC before making an R&D claim appears to be aimed at reducing the overall number of claims made. We sympathise with the type of claim HMRC is trying to target with this measure. However, we believe that targeted compliance efforts and the other measures included in this consultation would be a more effective method to target such abuse.

The introduction of a new process to allow companies to notify HMRC of the name of their R&D agent is also something we welcome. Much of the behaviour concerning HMRC relates to unregulated and malicious R&D agents. Directing some compliance resource to targeting such agents will be a more effective strategy, and one which helps to protect UK businesses.

ForrestBrown is the UK’s leading specialist R&D tax consultancy. We actively engage with these R&D consultations because we’re passionate about this incentive and its ability to transform your business’s growth journey.

Our aim is to help create an R&D tax relief incentive that delivers simplicity, certainty, and value for genuinely innovative UK businesses.

Since ForrestBrown was formed in 2013, we’ve been a member of the Chartered Institute of Taxation (CIOT) and have been putting professional standards at the heart of our culture.

We’re keen to hear from businesses and their advisers around this topic. Contact Jenny Tragner CA ATT today via email if you’d like to discuss any part of our consultation response: j.tragner@forrestbrown.co.uk