The history of R&D tax credits in the UK

In a Corporate Tax Roadmap published alongside the Autumn Budget, the government committed to maintaining the generosity of rates for the merged R&D Expenditure Credit scheme and the Enhanced Support for R&D Intensive SMEs (ERIS).

Mandatory requirement to submit an Additional Information Form to support all claims for R&D tax relief comes into force.

Following Chancellor Rishi Sunak’s announcements in the Autumn Budget 2021, draft legislation published in the Finance Bill 2022-23 on 20 July 2022 introduced changes to qualifying expenditure in R&D tax relief claims:

• A modernisation of the software expenditure category to include data licenses and cloud costs.

• A removal of the exclusion of pure mathematics.

• A restriction to exclude overseas R&D activities from the scope of relief.

Draft legislation published in the Finance Bill 2022-23 on 20 July 2022 introduced new measures to tackle abuse of the R&D tax reliefs:

• Businesses are required to notify HMRC of their intention to make an R&D claim, no later than 6 months following the last day of the accounting period to which the claim relates. This applies to businesses that have not previously claimed, or have not claimed for any of the three proceeding accounting periods immediately preceding the claim period.

• R&D claims are required to be endorsed by a named senior officer of the claiming company.

• Claims are required to include the details of any agent who has advised the company on compiling the claim.

• All claims are to be made digitally, including a breakdown of costs across the qualifying cost categories and a description of the R&D undertaken.

These changes will apply for expenditure incurred on or after 1 April 2023.

A reduction in the generosity of SME R&D tax relief:

The changes to the SME scheme include a significant reduction in the generosity of the relief for SMEs as part of a drive to improve compliance, reduce fraud and error, and to increase the efficacy of the relief as a whole.

The Chancellor has reduced the enhancement rate for SMEs from 130% to 86% and the credit rate from 14.5% to 10%. A typical loss-making SME currently receives up to 33%
payable credit on qualifying R&D expenditure. Following the Autumn Statement, from the 1 April 2023, the generosity.

HMRC publishes draft guidance for comment. The legislation is set to be included in the Finance Bill in 2023.
Final guidance may change from what is set out in the consultation document but the draft as published focuses on upcoming changes to:

• Overseas expenditure

• Data licenses and cloud computing services

• Claim Notification

• Mathematics

• Additional information requirements (including time limits)

The Chancellor, Jeremy Hunt, unveiled significant adjustments to rates of R&D tax relief, to be legislated for in the Autumn Finance Bill 2022.
The changes will apply for expenditure incurred on or after 1 April 2023.

A reduction in the generosity of SME R&D tax relief:

The changes to the SME scheme include a significant reduction in the generosity of the relief for SMEs as part of a drive to improve compliance, reduce fraud and error, and to increase the efficacy of the relief as a whole.

The Chancellor has reduced the enhancement rate for SMEs from 130% to 86% and the credit rate from 14.5% to 10%. A typical loss-making SME currently receives up to 33%
payable credit on qualifying R&D expenditure. Following the Autumn Statement, from the 1 April 2023, the generosity.

In his 2022 Spring Statement, Rishi Sunak responded to feedback on the proposed changes to R&D tax relief:

• The scope of R&D tax relief will be expanded to cover data and cloud computing costs. Data storage and work on pure mathematics will also attract relief.

• Restrictions on overseas R&D will go ahead, but with key exceptions where it is necessary for R&D activity to be carried out away from the UK.

The main rate of Corporation Tax is cut from 23% to 21%.

• The small profits rate remains at 20%, while the main rate moves another step closer to meeting it.

• The changing Corporation Tax rate affects the claim benefit both SMEs and large companies receive.

• For SME claims, a reducing Corporation Tax rate erodes the claim benefit profit-makers receive.

• Conversely, under RDEC, the Corporation Tax reduction increases the generosity of RDEC.

A significant boost is implemented, increasing the SME payable credit rate from 11% to 14.5%.

• This increase to the credit rate is enacted without amending the enhancement rate.

• Loss-making SMEs benefit from a boost to their claim benefit (24.75% up to 32.63%), whereas profit-makers miss out.

The main rate of Corporation Tax reduces from 24% to 23%.

• Small profits rate remains at 20%, while the main rate is decreased as the government moves towards one rate of Corporation Tax for all UK companies.

• Changing Corporation Tax rate affects the claim benefit both SMEs and large companies receive.

• For SME claims, a reducing Corporation Tax rate erodes the claim benefit profit-makers receive.

• Conversely, under RDEC, the Corporation Tax reduction increases the generosity of RDEC.

Research and Development Expenditure Credits (RDEC) are introduced to replace the previous large company scheme.

• After a period of consultation, RDEC is created to address feedback from industry on the existing large company super deduction scheme.

• RDEC seeks to provide greater visibility, certainty and value for loss-making companies, by allowing the benefit to be accounted for in ‘profit-before-tax’ in a company’s accounts (rather than as part of the tax charge)

• This decouples the benefit of RDEC from the company’s tax position and provides a cash credit for companies with no tax liability.

• On introduction, the RDEC rate is 10%. As the credit is taxable income, that meant the benefit RDEC claimants received was 7.6%.

PAYE and NIC liabilities cap (that has been part of the SME scheme since the start) is now removed.

• Liabilities cap removed that previously limited the amount of payable credit a company could claim to the total value of its PAYE and NIC liabilities.

• Removal of this cap part of a number of positive measures for R&D tax credit claims.

• The government re-introduced a PAYE and NIC cap in the 2018 Autumn Budget, to address potential abuse of R&D tax credits.

The £10,000 minimum level of expenditure a company must incur to make a claim is removed.

• With no lower limit on claim value, SMEs of any size can now access this valuable incentive.

Change removes the ‘tripartite arrangements test,’ which required a restrictive set of conditions to be met for externally provided workers expenditure to qualify.

• Prior to this change, EPW expenditure is excluded if an individual worker uses a personal service company, and then engages with a company via an agency.

• This follows years of discussion between advisers and HMRC via HMRC’s R&D Consultative Committee and provides welcome clarity for innovative businesses resourcing their projects with contract staff.

Corporation Tax is reduced in part.

• The small profits rate remains at 20%, while the main rate is decreased from 26% to 24% as the government moves towards one rate of Corporation Tax for all UK companies.

• The changing Corporation Tax rate affects the claim benefit both SMEs and large companies receive.

• A reducing Corporation Tax rate erodes the R&D credit claim benefit that profit-makers receive.

The SME relief rate is increased from 100% to 125% and the payable credit is decreased from 12.5% to 11%.

• New and favourable rates for the SME scheme are great news for small companies using R&D tax credits to grow their businesses.

• The corresponding increase in the enhancement rate and decrease in the credit rate means that loss-making companies receive the same benefit before and after the change (25%). Profit-making companies receive a small boost to their benefit rate.

New guidance on the production of goods and services is published in CIRD Manual.

• Guidance published following a consultation period with HMRC’s R&D Consultative Committee.

• It clarifies the eligibility of materials costs where companies produce prototypes or run manufacturing trials for R&D that also produce goods and services for customers.

• This new guidance exemplifies collaboration between HMRC and adviser to achieve clarity for R&D tax credit claimants.

• Although, this guidance is short-lived as new legislation changes the rules again in 2015.

By 2011, most companies were already using online software to file their Corporation Tax returns.

• R&D tax credit claims form part of a company’s tax return, therefore the most common way to file an R&D tax credit claim is online.

• This also speeds up the processing times as it minimizes the manual intervention at HMRC’s end of the process.

The main rate of Corporation Tax decreases from 28% to 26% and the small profits rate decreases from 21% to 20%.

• These changes are part of the government’s aim to ultimately achieve a single rate of Corporation Tax for all companies.

• Over the period from 2002 to 2015 the main rate of Corporation Tax reduces from 30% to 20%.

The SME R&D tax credit scheme rates are improved so that the relief offered to SMEs is increased from 75% to 100% and decreased in payable credit from 14% to 12.5%.

• New and favourable rates for the SME scheme are great news for small companies using R&D tax credits to grow their businesses.

• This marks the second increase in rates to the SME R&D tax credit scheme since its introduction.

• The corresponding increase in the enhancement rate and decrease in the credit rate means that loss-making companies receive approximately the same benefit before and after the change (25%). Profit-making companies receive a small boost to their benefit rate.

Prior to this change, under the SME R&D tax credit scheme, SMEs claiming R&D tax credits had to show that the IP generated vested with it.

• A positive move that simplified the eligibility criteria for SMEs, particularly around the complex area of IP.

HMRC announces a change of interpretation allowing Qualifying Indirect Activities (QIA) to qualify for R&D tax relief.

• QIAs are activities which do not directly contribute to the resolution of technological uncertainty, but indirectly support the project. They include admin, finance, personnel, security and maintenance activities.

New rules are introduced on how to claim for intangible assets.

• Revenue R&D expenditure capitalized as an intangible asset can now be claimed in the year it is incurred, rather than as amortised.

• This important change ensures that companies who had capitalised R&D costs could still maximise the benefit of their R&D tax credit claims.

The EU introduces a new recommended (2003/361/EC) definition of SME.

• The new definition isn’t intended to change the status of an SME, simply to provide a clearer definition for companies to apply.

Expenditure on consumable items and computer software is classified as qualifying expenditure for both SMEs and large companies.

• Expenditure on the materials consumed or transformed in the R&D process can now be included in your claim. Materials that are consumed or transformed in during the R&D process are defined as consumables: this category includes water, fuel, and power.

• This is great news for companies who invest in building prototypes as part of their R&D efforts. It is a major positive for manufacturers who invest in process development projects which involve running R&D.

• Expenditure on computer software involved in R&D activities can now also be included.

The staffing costs definition introduced on 6 April 2003 is updated to exclude benefits in kind.

• ‘Staff benefits in kind’ were not intended to form part of qualifying expenditure on staff costs.

• Changes to other sections of the legislation had inadvertently allowed their inclusion.

• Here the government repeals its legislative hiccup and finally exclude staff benefits in kind.

• During the period of uncertainty, claims that included these costs are honoured.

A new meaning of R&D is issued in the form of the 2004 DTI guidelines.

• These guidelines still used today to define what counts as R&D.

• They are purposefully broad to apply equally to businesses of different sizes and sectors.

Minimum spend on eligible R&D in an accounting period reduced from £25,000 to £10,000.

• Until now, the minimum spend condition prevented smaller companies from claiming R&D tax credits.

• It also prevented companies in the early stages of a project claiming and those where finance was limited were out too, regardless of the nature of the project.

• Now the minimum spend threshold is removed. This is great news for the smallest businesses.

• The minimum spend is later abolished completely.

The ’80:20’ split for expenditure on staffing costs is removed.

• Companies claiming R&D tax credits provide feedback to HMRC that the 80:20 rule, (which was designed to make claiming simpler) is creating an additional administrative burden.

• The government removes this rule, responding quickly to early feedback on the new incentive.

New expenditure category is introduced, to allow SMEs to claim for agency workers engaged on R&D projects.

• Following a period of controversy, EPW category (designed to allow companies to include agency workers in their claims) is changed to ensure the legislation continued to meet policy intent.

• Large company scheme minimum spend on eligible R&D in an accounting period set at £10,000.

• Under the large company scheme, expenditure on Externally Provided Workers (EPWs) is classified as eligible.

• Under the large company scheme, the ’80:20’ split for expenditure on staffing costs is removed.

SMEs gain ability to claim under the large company scheme if they do not meet the eligibility criteria for the SME R&D tax credit.

• SME R&D tax credits cannot be claimed, or are restricted, if a project has received grant funding, or if the company is acting as a subcontractor. In these circumstances, SMEs are eligible to claim under the large company scheme.

For both SME and large company schemes, the definition of staffing costs changes to include certain benefits in kind.

• Changes to other parts of tax legislation are used to define staff costs for R&D tax credit purposes.

• Erroneously, benefits in kind become eligible cost category for R&D tax credit purposes.

• Change is identified as accidental and repealed a year later, in April 2004.

The large company scheme is introduced.

• Following the successful introduction of the SME R&D tax credit scheme, an equivalent incentive for large companies is introduced.

The meaning of R&D issued in the 2000 DTI guidelines.

• The Department of Trade and Industry drafts the first iteration of the definition of R&D for tax purposes, which HM Treasury publishes. This makes the DTI guidelines the official definition of R&D for tax purposes.

Research and development tax relief first introduced.

• After a consultation period, the first R&D tax incentive regime is introduced for small and medium-sized companies by the incumbent Labour government, under Chancellor Gordon Brown.

• The system offers SMEs who undertake R&D a reduction in Corporation Tax and/or a payable credit.

• UK joins a number of other countries already offering similar tax incentives to drive innovation.

• The government aims to improve R&D spend as a percentage of GDP to 3% from a position of 1.7%.