The Government has committed to making the UK a 'scientific superpower' by driving innovation to further enhance the competitiveness of the UK as a place for business. It has set a target to increase total investment in research and development to 2.4% of UK GDP by 2027.
R&D tax reliefs have an important role in incentivising this investment by reducing the costs of innovation. The government is looking at reforming R&D tax credits and has launched a consultation, which is a once in a lifetime opportunity to ensure that this valuable incentive remains a globally competitive regime and is suitably focussed to help businesses maximise their investment in R&D.
In addition, visa reforms to attract highly skilled migrants to the UK to focus on STEM jobs are aimed at boosting R&D activity and helping build the UK knowledge and IP economy. A range of other generous incentives such as the capital ‘super deduction’ and Freeports will stimulate large scale capital expenditure programs to drive further investment in R&D.
The new R&D consultation
The R&D consultation is wide ranging and whilst it is clear that the government is fully supportive of the R&D regimes, in a backdrop of record government borrowing, the R&D regimes must provide value for money both for the taxpayer and the government, and be highly effective at encouraging investment in innovation. The focus of the consultation can be segmented into the following key areas:
- Structure of the reliefs
This is likely to focus on whether the Small & Medium Sized Enterprise (SME) and large company R&D Expenditure Credit (RDEC) schemes should be combined. Internationally, the UK is unusual in having two different schemes. Combining the two regimes could result in “RDEC for all”, given that the RDEC regime is viewed as simpler and has the added attraction of being accounted for ‘above the line’. Different rates are still likely to be needed for different sized businesses’ R&D claims and there is the potential for different rates to be applied to different sectors and activity being undertaken.
- Ensuring the UK R&D credit system is internationally competitive
Compared to global competitors, the rate of relief provided by the SME scheme is significantly more generous, with the RDEC rate fairing less favourably. The consultation will explore to what extent the rate of relief is significant in influencing location decisions for R&D investment.
- Scope of the reliefs
There will be a wide-ranging review of the scope of the reliefs including potentially changing the definition of R&D and the types of expenditure that qualify to ensure they remain fit for purpose in the current R&D environment. The response to the recent consultation on expanding the reliefs to include data and cloud computing costs was also published and showed that there was significant stakeholder appetite for bringing these costs into the scope of the reliefs. However, there were mixed responses on the potential exclusion or restriction of Qualifying Indirect Activities (“QIAs”). This will now be picked up as part of the wider review.
- Operational effectiveness of the regimes
There is a focus on improving the administration of R&D credits for business and HMRC including:
- whether the R&D claim should be part of the tax return filing;
- the role and experience of agents in assisting R&D claimants;
- the fee structures of agents and the risk of boundary pushing it may encourage;
- making sure the responsibilities of HMRC, the agent and the company are clear;
- considering changes that might help claims to be dealt with more smoothly, while focussing on better compliance.
Overall the consultation is wide-ranging and has the potential to be the biggest reform of R&D credits since the R&D regime was introduced over 2 decades ago.
Amendments to the PAYE cap legislation
One of the ways HMRC is tackling abuse in the SME regime is through the SME cap which will apply from 1 April 2021. The amount of payable tax credit a qualifying loss-making business can receive is capped at three times the company’s total PAYE and NICs liability for that year. There is a threshold of £20,000 so that the smallest claims are uncapped (i.e. a company receiving a payable credit of below £20,000 for a 12-month period will be unimpacted by the cap).
Draft legislation was published last year (Finance Bill 2021) which included an exemption from the cap where a company is creating or managing intellectual property and where less than 15% of the R&D expenditure is contracted between other connected companies.
Following feedback on the draft legislation, further amendments to the legislation have now been announced:
- Where a company has an accounting period that straddles 1 April 2021, the measure will only apply for the next full period starting after that date. For example, for a company with a year ended 31 December 2021, the first year the rules will apply will be the year ended 31 December 2022.
- The definition of intellectual property for the purposes of the cap exemption will be widened to include, not only patents, but also know-how and trade secrets. This will broaden the exemption from the cap to include companies who are not able, or do not wish, to protect the results of their R&D.
Both these changes are welcome, particularly in expanding the cap exemption, which will help ensure most genuine R&D businesses are not impacted.
Impact of changing CT rates to R&D reliefs
The increase in the rate of Corporation Tax from April 2023 to 25% on profits over £250,000 will reduce the net benefit of the RDEC scheme from 2023. Under RDEC, large companies (and certain SMEs) can claim to receive a taxable credit of 13%. This equates currently to a 10.5% cash value after tax. This will reduce to 9.75% after April 2023 unless changes are made as a result of the above consultation.
SMEs can claim a super-deduction of 230% with the ability to surrender this for 14.5% cashback (equating to 33% of the qualifying expenditure). The Corporation Tax rate for small profits under £50,000 will remain at 19% and there will be taper relief for businesses with profits between £50,000 and £250,000, so that their average rate is less than the new main rate of 25%. The additional cash tax value of SME R&D claims for tax paying companies is £25 for every £100 of R&D spend (based on a 19% tax rate). This tax saving will be increased for those companies who pay the taper or 25% rate.
Patent Box & increase in CT rates
Businesses qualifying for the Patent Box regime benefit from an effective corporation tax rate of 10% on income derived from the commercial exploitation of patents. With the increase in corporation tax rates, the use of Patent Box will be even more beneficial for qualifying companies. The eligibility criteria can be complex, so if a company exploits a patent or similar IP, and generates taxable profits from doing so, then it is always beneficial to have an initial discussion with our team of specialists.