UK Enacts Significant Changes to Research & Development Tax Regime
Significant changes to the UK’s Research & Development (R&D) tax relief regime are being introduced with effect from 1 April 2023.
Changes to R&D tax relief rates
Relief is available for SMEs under the R&D tax relief regime effectively in the form of an enhanced corporation tax deduction of a percentage of qualifying R&D costs. Loss-making SMEs usually have the option of receiving a cash payment of an R&D credit in return for surrendering R&D-related losses. Any such payment is capped at a percentage of the losses available for surrender.
An R&D expenditure credit (RDEC) is also available, primarily targeted at larger companies, although it may be used by – and can prove valuable to – SMEs in certain circumstances. The RDEC uses a different method of calculating corporation tax relief on R&D expenditure. The “above-the-line” RDEC is effectively a taxable credit that may be used to offset liability to UK corporation tax or, in some circumstances, claimed as a cash payment.
| Pre-April 2023 | From April 2023 | |
| Loss-making SME | Enhanced deduction:130% R&D credit: 14.5% Benefit: 33.35% | Enhanced deduction: 86% R&D credit: 10% Benefit: 18.6% |
| Profit-making SME | Enhanced deduction:130% Corporation tax rate: 19% Benefit: (up to) 24.7% | Enhanced deduction: 86% Corporation tax rate: 25% Benefit: (up to) 21.5% |
| RDEC company | RDEC credit rate: 13% Corporation tax rate: 19% Benefit (after tax): 10.53% | RDEC credit rate: 20% Corporation tax rate: 25% Benefit (after tax): 15% |
Refocusing R&D relief toward activities undertaken in the UK
From April 2023, new territorial conditions will be introduced affecting subcontracted R&D expenditure (i.e., payments for services) and payments for externally provided workers (EPWs), which are workers provided by an external company. Subcontracted R&D activity will need to be performed within the UK, and EPWs will need to be subject to UK PAYE (pay as you earn).
However, expenditure in respect of overseas activity will qualify in limited circumstances – namely, where the conditions necessary for the R&D (such as geographical, environmental or social conditions) are not present in the UK whereas they are present in the location where the R&D is undertaken, and it would be wholly unreasonable to replicate the conditions in the UK, or where there are regulatory or other legal requirements for the R&D to be undertaken outside the UK.
As such, expenditure on overseas R&D activities can still potentially qualify for relief where, for example, a company runs clinical trials overseas to gain licensing approvals for new drugs or vaccines or undertakes deep ocean research. But the legislation makes it clear that neither the cost of the R&D nor the availability of qualified personnel will be considered as a relevant factor in determining whether the exception applies.
Expansion of the scope of qualifying expenditure
Currently, R&D relief can be claimed on the cost of computer software used directly for R&D purposes, which HM Revenue & Customs (HMRC) considers as meaning software license fees and the cost of certain mathematical advances “representing the nature and behavior of the physical and material universe”. The proposed extension is therefore a welcome change showing the government’s recognition that software can be provided as a service (i.e., SaaS) and not just by licensing of software copies, and that pure mathematical advances are often instrumental and underpin the development of machine learning, robotics and other big data solutions.
Changes to the process of making R&D claims
If a company seeks to make an R&D claim for the first time, or it has not made an R&D claim in any of its previous three accounting periods, then it will be subject to a new online pre-notification requirement, meaning that it must inform HMRC of its intention to make an R&D claim, as well as the R&D adviser it will be using, within six months following the end of the relevant accounting period (instead of the usual two-year window), unless the full claim has been submitted within the six-month deadline.