Policy paper

Technical note on changes to research and development tax reliefs at Autumn Statement 2023

Published 22 November 2023

1. Introduction

This note provides detail on the reforms to the research and development (R&D) reliefs from April 2024 which were announced at Autumn Statement 2023. It provides businesses with additional information before the Autumn Finance Bill 2023 is published later this year. It sets out the main changes to the policy design of the proposed merged research and development expenditure credit (RDEC) and the small and medium-sized enterprise (SME) intensives scheme which was announced at Budget 2023 as a result of the technical consultation.

The government recognises the important role that R&D plays in driving innovation and economic growth as well as the benefits it can bring for society. The UK’s R&D tax reliefs have a key role to play in supporting R&D investment in a fiscally sustainable way. This is why at Autumn Statement the government announced reforms to the R&D tax reliefs to simplify and improve the system, as well as a package of spending measures to support our scientists and researchers.

Merging schemes will be a significant tax simplification. These include having a single set of qualifying rules and being able to remove the list of qualifying bodies, which companies in RDEC are currently allowed to claim for contracted R&D costs to.

The government has carefully considered both the evidence and stakeholder views in designing the merged scheme. By taking the best of both schemes, the merged RDEC scheme, along with the SME intensive scheme, will provide the best incentives and support to businesses innovating in the areas of science and technology.

At Spring Budget 2021, the government launched a review of R&D tax reliefs to ensure the UK remains a competitive location for cutting edge research, the reliefs continue to be fit for purpose and taxpayer money is effectively targeted. The government is now concluding that review with the announcement of the merged scheme. Further action may needed to reduce the unacceptably high levels of non-compliance in the R&D reliefs, and HMRC will be publishing a compliance action plan in due course. The government will also continue working with industry to develop the enhanced support for R&D intensive SMEs, and consider further simplifications.

2. The merged scheme

Contracted out R&D

The objective of the R&D reliefs is to increase the overall levels of R&D in the UK economy to generate productivity growth by reducing the cost of investing in R&D, counteracting the market failure from the risk that arises from investing in R&D. Therefore, it is important that the company making the decision to do the R&D and bearing the risk gets the relief. Allowing the decision maker to claim for R&D contracted out aligns the relief better with the company that holds the risk.

Academic evidence also suggests that relief for R&D subcontracting should result in increased collaboration and therefore knowledge sharing and spillovers, which are crucial for economic growth. This was also the preferred option among stakeholders in response to the consultation earlier this year.

For these reasons, in the draft legislation published in July, the government proposed adopting a position on subcontracting where the decision maker is allowed to claim for contracted out R&D.

The government also stated it wanted further discussions with industry to understand how a potential merged scheme could distinguish between ‘contracts for services’ and ‘contracted out R&D’ so that those undertaking qualifying R&D are able to claim relief, whilst avoiding double claims. Following engagement over the summer, the government will legislate for the approach outlined below in the Autumn Finance Bill 2023.

Where a company with a valid R&D project contracts a third party to undertake some of the (qualifying) work connected with their R&D project, the company may claim the relevant (qualifying) costs of that contract. The company contracted to do that work may not claim for R&D activities which delivers the project outcome for another company’s project.

If a company is contracted to do work for another company, but the work does not form part of R&D for the customer and was instead initiated by the contractor, then the contractor may be able to claim relief for their work, if they meet the requirements of having valid R&D which is otherwise eligible for tax relief. This is considered an essential element.

Moving the claim to the company making the decision to do the R&D will result in more R&D getting relief. In certain cases currently in RDEC there are companies conducting subcontracted work as part of another company’s R&D project whose work is ‘routine’ (not R&D) in isolation so that neither company can receive R&D relief. Allowing the decision maker to claim for R&D contracted out should resolve this issue. For example, where a company contracts out qualifying activities to a contract research organisation, such as a clinical trial, the company will be able to claim for the costs of that contract.

As set out in the draft legislation in July, contracted R&D carried out by subcontractors who are working for non-UK corporation taxpayers, such as overseas companies, will continue to qualify for relief.

However, if a company is contracted to provide a product or service which is not R&D, such as constructing a building or a software product, if they undertake R&D in delivering that product or service, they would be able to claim relief even though they are undertaking R&D on an activity contracted to them. The exact details of who should claim the relief will depend on the specific contract.

To ensure consistency across the regime, for accounting periods beginning on or after 1 April 2024 these rules will also apply to R&D intensive SMEs.

Subsidised expenditure

The intended operation of the contracted-out R&D rules set out above means that rules relating to subsidised expenditure in the existing SME scheme are no longer relevant, so these sections will be removed from the legislation for the merged scheme before it is published in the Autumn Finance Bill 2023.

For example, if a company receives a grant that covers part of the cost of its R&D, or if the cost of the R&D is otherwise met by another person, then (subject to the contracting out rules above) this will not reduce the amount of support available under the merged scheme.

Externally provided workers

The government recognises that the draft clauses published in July suggested that there would be a double restriction on externally provided workers (EPWs). This is not the intention and final legislation will ensure that the rule operates correctly to simply remove overseas expenditure.

Step 2 reduction

As with the existing RDEC, payments of the merged scheme will be reduced via a notional tax, for loss-makers so that the amount of benefit is similar for loss-makers as for profit-makers, with companies being able to off-set the amount withheld against tax in future years.

This will be done by calculating the net amount at Step 2 using the rate applicable to the taxpayer (either the small profits rate (SPR) – currently 19% – or the main rate (25%)), but applying the SPR to loss makers.

This change will ensure that loss-making companies receive more cash benefit upfront, compared to the position set out in July.

Commencement

All changes will come into effect in respect of accounting periods starting on or after 1 April 2024. For the majority of current RDEC claimants, who are most affected by this change, this is a delay compared to the draft legislation published in July which would have applied the changes to expenditure incurred on or after 1 April 2024.

This change will give businesses more time using the existing RDEC and SME rules depending on when their accounting period starts and ends, allowing them to get up to speed with the changes and it will simplify claims by removing the need to claim under different regimes for an accounting period that straddles 1 April 2024.

For accounting periods beginning on or after 1 April 2024 there will only be 2 R&D schemes available:

1. the merged scheme
2. SME intensive scheme

3. Additional tax relief for R&D intensive SMEs

The ‘SME intensive scheme’, for the most R&D intensive loss-making SMEs was announced at Spring Budget 2023 for R&D expenditure from 1 April 2023. As announced a company was considered R&D intensive where its qualifying R&D expenditure is 40% or more of its total expenditure.

At the Autumn Statement the Chancellor has confirmed the threshold to be considered R&D intensive will be reduced from 40% to 30% of total expenditure. The Autumn Finance Bill 2023 will contain the final clauses to bring this into effect.

During the technical consultation stakeholders flagged concerns about items of exceptional spending which might skew a SME’s intensity ratio for a year and lead to businesses moving into and out of the intensive SME regime creating uncertainty. To address this, we are introducing provisions to enable an intensive SME which has made a valid claim in the Intensive regime in one year to claim the intensive relief in year two.

To protect the R&D intensive scheme for genuine loss-making R&D intensive companies, rules will be introduced to prevent businesses from manipulating their intensity by using short APs.

The government will also legislate so that the rule that treats any expenditure as met directly or indirectly as subsidised will also be removed from the intensive scheme. Therefore, for accounting periods beginning on or after 1 April 2024, this legislation will no longer apply in the R&D credits which should simplify the overall process of making an R&D tax claim further.