R&D: Two become one (but not quite…)

I’m always pleased to write something about tax that starts off with a song by The Spice Girls – but that is what jumped into my head as I read through today’s Autumn Statement tax documents.

R&D and the Autumn Statement

We knew it was coming – the SME and R&D expenditure credit (RDEC) regimes for R&D tax credits are merging into one from 1 April 2024 – albeit a new R&D intensive regime is being introduced which effectively means we have an SME credit for R&D intensive businesses …and so two probably remains two.

Whilst there appears to be plenty of detail to absorb around the detailed mechanics of both the new merged scheme and the R&D intensive scheme (see more on this below), the first thing that caught my eye was the following policy objective contained within the ‘Backing British Business’ section of the Autumn Statement document: 

“To help create the conditions for innovative and dynamic businesses to thrive, the government is bringing forward an ambitious package to supercharge small and medium sized enterprises as the engine room of the economy.” 

The experience of the last 12 months is that HM Revenue & Customs (HMRC) and HM Treasury are making it incredibly difficult for SMEs genuinely undertaking eligible R&D to access the R&D tax credit regime, overseeing a poorly thought through compliance campaign and repeatedly missing opportunities to redesign the R&D system and deal with problems which have contributed to increasingly poor claim standards – for the benefit of both Government and business alike.  

It is worth noting that as part of the Autumn Statement HMRC have announced the publication of a R&D ‘Compliance Action Plan’ in the near future – however, this would appear to have been developed without any structured involvement from the Chartered Institute of Taxation or Institute of Chartered Accountants in England and Wales (ICAEW), both of which have been seeking more proactive conversations with HMRC and HM Treasury in recent months on the topic of R&D. This is seriously disappointing when HMRC and HM Treasury repeatedly state that they are looking to collaborate with the representative bodies to achieve improvements.  

Key features of the R&D announcements

The key features of the R&D announcements in today’s Autumn Statement are as follows:  

• The SME and RDEC schemes will merge in respect of accounting periods beginning on or after 1 April 2024. For RDEC claimants the rate will increase and for SME claimants the rate will reduce

• The merged scheme will adopt the more generous PAYE cap currently in force within the SME regime 

• Subsidised (i.e. grant funded) expenditure will not be restricted in the merged scheme 

• There will be some clarification around the territorial restriction previously considered. In general companies will only be able to claim for expenditure associated with UK based R&D activities. This has been an area of policy design confusion for HM Treasury over the last 18 months as the legislation was developed – it will be interesting to see where the detail has taken us 

• There will be some clarification around sub-contracted activities. The notes released by HMRC indicate that R&D subcontracted to third parties can be included in the R&D principal’s claim, in a fashion similar to the current SME regime. This is major blow for those companies that currently undertake contracted out R&D for larger businesses where they are able to make RDEC claims. Further review of the detail here is going to be required 

• R&D boutiques will not be allowed to be nominated as the recipient of R&D refunds from HMRC – instead such payments will only be able to go to the company itself, who must then pay their R&D agent 

• There appears to be no mention of a minimum expenditure threshold for R&D claims (as there was for the first 10 years of the regime, when non-compliance was generally considered to be under control). Given HMRC’s view of the level of non-compliance in these smaller claims at a time when it lacks sufficient genuine technical R&D and corporate tax capability, the lack of a minimum threshold looks like a major omission in our view 

• R&D intensive companies will be able to make enhanced claims. The definition of an R&D intensive company was that at least 40% of its overall expenditure qualified for R&D relief – that percentage has now been reduced to 30% along with a year of grace recognising the challenges of identifying R&D intensive companies where the percentage is close to the threshold. However, just to make things unnecessarily difficult and confusing, the 40% threshold applies for expenditure incurred after 1 April 2023 (but cannot be claimed until Finance Act 2024 is given Royal Assent), whereas the 30% threshold applies to accounting periods beginning on or after 1 April 2024 

A simplified R&D tax credits regime?

The R&D environment remains exceptionally complex. The Government was advised by the House of Lords and the accounting and tax representative bodies to delay the implementation of these changes in order to improve their design and properly address non-compliance in R&D using proportionate and considered means – however it appears the Government was minded not to listen and has ploughed ahead regardless. There is a theme developing here.  

Whilst the stated intention of the merged regime was to reduce the complexity in the R&D regime, HM Treasury has merely made the system even more complicated. If you add into this HMRC’s interpretation of the subcontractor technical issue that will be heard in court in 2024, the introduction of an appallingly bad additional information form (a lost opportunity for a proper application form), the lack of skilled, trained R&D professionals within HMRC, the questionable approach of the ISBC Campaigns & Projects team, and the decade out of date HMRC R&D Manuals, then R&D tax credits remain in an exceptionally bad place.  

If left as is, as far as SMEs are concerned, R&D tax relief will become a relief not worth the hassle of claiming. In turn this will impact where increasingly internationally mobile SMEs locate new R&D jobs, both those currently here and those who might have been minded to set up or relocate here.  

In basic terms, in their current guise with HMRC adopting their current stance, it is my opinion that R&D tax credits will never achieve their intended policy objective at the SME level, no matter how important the Chancellor views the SME contribution. There is a growing view that those in Government value the R&D contribution of the large multinationals and so are redirecting a finite amount of R&D tax relief from SMEs to large business – that certainly looks to be true with these changes.  

As more detail emerges, we will update our analysis, but in the meantime for those of us who practice in the field of R&D, this latest round of change and uncertainty will certainly further spice up our lives. For more analysis, visit our Autumn Statement hub or find out more about our advisory services in support of all your R&D tax credits needs.