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In an attempt to reshape the economic landscape, the UK’s HM Revenue & Customs instituted significant modifications to the tax relief regime associated with Research & Development (R&D) activities, starting 1 April 2023.
These changes, introduced since the Autumn Budget 2022, aim to boost UK competitiveness and optimise taxpayer funds.
How R&D Tax Relief Changes From April 2023
The alterations to the tax relief regime have implications for both Small and Medium Enterprises (SMEs) and larger corporations, notably impacting loss-making companies with high R&D intensity, wherein 40% or above of their expenditure is on R&D and that claim the SME R&D tax credit.
SMEs, traditionally securing relief through the R&D tax relief scheme, have seen the enhanced deduction for R&D relief slide from 130% to 86% since April. Furthermore, the credit rate has declined to 10% from 14.5%.
However, a lifeline has been offered to “R&D intensive” SMEs—those investing a minimum of 40% of their total expenditure on R&D—with a 14.5% payable credit rate. This move, however, has likely done little to placate the broader SMEs impacted by the relief reduction.
In an unexpected twist, the government has conveyed an intention to probe the feasibility of a single R&D tax relief scheme, similar to the R&D Expenditure Credit (RDEC). The RDEC primarily benefits larger entities but is available to certain SMEs under specific conditions. The absence of a concrete timeline for these proposed reforms, however, raises uncertainties about their actual materialisation.
Territorial Conditions & Qualifying Expenditure
Since April, fresh territorial conditions affecting subcontracted R&D work and payment to third-party employees have been in effect. The updated rules insist that subcontracted R&D tasks must be conducted in the UK and salaries be paid through the PAYE system. Limited exceptions are made for overseas R&D expenditure under strict conditions, curtailing the flexibility for claiming eligibility based on overseas spending.
Moreover, the new regulations have broadened the spectrum of qualifying expenditure for tax relief, covering data licensing, cloud computing, and mathematical advances. Despite this positive stride, it remains to be seen whether it can counterbalance the potential drawbacks posed by the new tax regime.
R&D Relief Claim Process & Size Threshold
The current tax relief regime mandates a pre-notification system for first-time claimants or those who haven’t claimed in the past three years. The six-month deadline for filing notifications, a reduction from two years, and the need for claims to be validated by a company officer, impose further administrative burdens.
SMEs hoping to claim R&D tax relief must meet rigorous criteria, including having fewer than 500 staff, a turnover of less than 100 million euros, and a balance sheet total below 86 million euros. External investments can, however, affect a company’s SME status. Companies also need to incorporate turnover, balance sheet totals and staff proportions in their calculations based on the voting rights held, potentially limiting the eligibility of several firms.
Overall, while the tax relief regime, effective since April, purports to energise the UK’s economic environment, its stringent regulations and diminished tax relief rates could impede R&D endeavours. Thus, the reforms’ real-world efficacy and impact on UK businesses’ competitiveness remains to be seen.
What Do Those Directly Affected Think About Additional Tax Relief?
UK Chancellor Jeremy Hunt’s decision to scale back R&D tax credits, a key financial support for Britain’s tech and biotech start-ups, has sparked criticism from tech founders and science chiefs.
Toby Austin, Co-founder of Tech Consultancy Beauhurst
Toby Austin criticises the UK’s new tax relief regime that debuted in April, asserting it contradicts the government’s ambition to transform Britain into a global tech hub. According to Austin, the decision to slash this significant tax incentive used by thousands of companies to finance their R&D activities could profoundly impede tech job creation and innovation progress. While government officials justify the cutback as a response to fraud concerns identified in HMRC’s 2021/22 report, Austin rejects this rationale as ‘ridiculous’, arguing that overall scheme reduction is an ineffective fraud mitigation strategy.
Viktar Prakapenia, Founder of Capital.com
Viktar Prakapenia in his recent essay mentioned that the UK government’s decision to reduce tax credits for Research and Development by small and medium-sized companies is a troubling blow to innovation. Drawing parallels with Charles Goodyear’s discovery of rubber vulcanization and the creation of OpenAI’s ChatGPT, both accidental breakthroughs, it’s clear that innovators need time, space, and financial backing to experiment and make potentially groundbreaking discoveries. Prakapenia admitted that recent policy changes must be revised to uphold innovations in the UK. Legislators should consider the potential implications of R&D tax credit changes and strive to foster an environment conducive to innovation.
Kate Bingham, Managing Partner at SV Health Investors
Kate Bingham, a venture capitalist, who led the UK’s Covid-19 vaccine task force, criticizes the government’s tax relief changes from April, highlighting their potential impact on cutting-edge research. Emphasizing the importance of R&D tax incentives in developing world-leading biotech firms in the UK, Bingham warns these alterations could make it tougher for small businesses. Considering the global biotech industry’s financial struggle and the existing competition from EU countries, she suggests that the R&D tax credits often factored into companies’ plans, were a lifeline for enterprises without revenue.
Conclusion
The UK’s R&D tax relief changes have raised valid concerns. Despite aims to optimize taxpayer funds and boost competitiveness, the revisions might inadvertently hamper R&D efforts. Particularly for SMEs, the new stringent regulations and diminished relief rates could be seen as a barrier. Uncertainty surrounds the government’s proposal for a single tax relief scheme and new territorial rules might limit claiming eligibility. Although efforts to broaden the spectrum of qualifying expenditures are noteworthy, their effectiveness in countering potential drawbacks is yet to be established.