Last year, the Government confirmed its intention to proceed with a single merged research and development (R&D) scheme for expenditure incurred in accounting periods beginning on or after the 1st of April 2024. As these reforms have now come into effect, in this article, we’ll be looking at what’s changed and how your business can adjust to the new rules.
Your Guide To The R&D Tax Relief Reform
The new scheme combines two of the UK’s current R&D tax relief incentives into a single scheme. The objective is to simplify the UK’s R&D systems by creating a single set of qualifying rules. If you’re claiming R&D tax relief, it is likely that you will be impacted by the introduction of the merged scheme, so keep reading to better understand the changes.
What’s Changed?
Previously, qualifying small and medium-sized enterprises (SMEs) were entitled to enhanced tax relief and payable credits for qualifying expenditures. Additionally, large businesses, SME subcontractors and subsidised R&D expenditures received tax relief in the form of R&D expenditure credit (RDEC). As of the 1st of April 2024, these schemes have merged.
For the most part, the merged scheme will follow the existing RDEC rules. This means that all companies, including those who previously claimed under the SME scheme, will benefit from the receipt of a 20% tax credit that can be recognised ‘above the line’ as taxable income, providing better visibility in their accounts.
Under the existing RDEC scheme, a notional tax at the main rate of corporation tax (currently 25%) is applied to the RDEC for loss-making companies. Under the new scheme, the rate will be reduced to 19%, accelerating the RDEC cash benefit for loss-making businesses. The net RDEC benefit for loss-making companies will, therefore, be up to 16.2% for every qualifying R&D £1 incurred (compared with 15% for profitable companies).
However, the new merged scheme rates disadvantage SMEs overall. They are lower than those in the existing SME scheme, which for expenditure incurred from the 1st of April 2023 are between 18.6% and 21.5%, depending on whether an SME is loss- or profit-making.
Contracted Out R&D
Subcontracted R&D is a particularly complex area and was a central consideration when it came to the merging of the SME and RDEC schemes. The merged scheme aims to target R&D tax relief for the company that makes the decision to carry out R&D and, in turn, bear the risk.
The subcontracted R&D rules incorporated into the merged scheme are modelled on the existing SME scheme rules. As such, companies generally won’t be able to make a claim for RDEC if R&D has been contracted to them. However, where a company with a valid R&D project contracts a third party to undertake R&D activities on its behalf, the company may claim the qualifying costs of that work.
There are some scenarios where a subcontractor can claim R&D tax relief. These include when a company carries out R&D for a contractor that is not a tax-paying entity, such as charities, universities, scientific research organisations, or overseas entities.
What Do I Need To Do?
In order to best position yourself under the new scheme, you’ll need to consider the size of your business and its profit margin.
Profit-Making & Non-R&D Intensive Loss-Making SMEs
If your business spends less than 30% of your total expenditure on qualifying R&D, then, for your first accounting period beginning on or after the 1st of April 2024, you will need to claim R&D via the merged scheme. You should be aware of the following important changes:
- The different mechanisms for calculating relief.
- The new definition of contracted out R&D.
- Restrictions on eligible expenditure for overseas EPWs and subcontractors.
- The removal of restrictions for subsidised R&D expenditure.
Large Companies, SME Subcontractors & SMEs With Subsidised R&D
Although the merged scheme is based on the RDEC relief scheme, there are some key areas of impact for large companies:
- New restrictions on claiming for R&D contracted out to the company.
- Changes to the PAYE/NIC cap on any payable RDEC.
- Eligibility of payments to R&D subcontractors.
- Restrictions on eligible expenditure for overseas EPWs.
Loss-Making R&D Intensive SMEs
Alongside the newly merged R&D scheme, the enhanced rate for R&D intensive loss-making SMEs (introduced in April 2023) continues to operate under the current SME model. For expenditure incurred on or after the 1st of April 2023, loss-making R&D intensive SMEs have been eligible for an expenditure enhancement of 86% and a payable credit of 14.5% (although this provision was retrospectively implemented as part of the Finance Act 2024).
For accounting periods beginning on or after the 1st of April 2024, if you’re a business spending 30% or more of your overall business expenditure on R&D, and you’re loss-making for tax purposes, then you will qualify for the enhanced rate. This intensity threshold is a reduction of 10% from the threshold introduced on the 1st of April 2023.
R&D Intensive SMEs
Loss-making R&D intensive SMEs who meet the 40% threshold have remained within the SME scheme post the 1st of April 2024. It’s still worth considering how the changes affect them.
Loss-making SMEs whose R&D expenditure is greater than 30% of total spend but less than 40% are eligible for the enhanced SME rate for their first accounting period beginning on or after the 1st of April 2024.
Key considerations for these companies include:
- The new definition of contracted out R&D.
- Restrictions on eligible expenditure for overseas EPWs and subcontractors.
- The removal of restrictions for subsidised R&D expenditure.
Further Support
Evidently, there’s a lot to consider under the newly merged R&D scheme. If you’re looking for support tailored to your circumstances, get in touch with our expert team of accountants at Digital Tax Matters . Our team has helped many businesses make the most of tax reforms like this in the past and is well-placed to help you make a seamless transition.