Following the conclusion of the consultation regarding the draft legislation for the forthcoming Finance Bill 22/23, businesses now need to prepare for the expected changes to R&D Tax Relief claims regime. While many of us have voiced our concerns regarding the requirement to pre-notify R&D Tax Credits claims, these measures are more than likely to come into effect from April 2023. In this article, we discuss some of the key changes and their impact for UK business.
Pre-notification of R&D claims – UK businesses must take action to notify HMRC of planned R&D claims in advance
The requirement to make a claim notification will only apply to new R&D claimants, and claimants who have not made an R&D claim in the last three accounting periods. This notification must be submitted not more than six months after the end of the accounting period to which the R&D claim relates, or the claim will be invalid. Secondary legislation will be introduced with effect from April 2023 setting out the information to be provided with the notification, and the form and manner in which the notification is to be made.
Businesses and advisers should now consider upcoming R&D expenditure and whether pre-notification is merited. Based on the current information, there does not appear to be any downside (e.g. penalties) for submitting a protective notification where there is uncertainty over whether the expenditure qualifies for R&D Tax Relief. Indeed, we expect HMRC will be swamped with protective notifications with no follow-up R&D claim once there has been sufficient time to analyse the expenditure. Of course, most impacted businesses will not be aware of the change as it has not been sufficiently publicised by HMRC.
By effectively artificially bringing forward the deadline for making a claim (which will not coincide with other relevant tax deadlines and therefore be easy to miss), the window to apply for tax relief is more restricted. This change will have the biggest impact on early-stage companies, which are often most in need of R&D Tax Relief. This is very concerning. From Leyton’s vast experience of engaging with small and medium-sized businesses across the UK, we know that R&D Tax Reliefs are still not widely understood (indeed, HMRC’s recent figures show most R&D expenditure (67%) was claimed by companies under the RDEC scheme) and we expect that many SMEs conducting R&D will miss out on the tax credits to which they are entitled.
Leyton strongly agrees that reform is needed to prevent the misuse of the R&D Tax Relief. However, instead of reducing abusive claims, the requirement to pre-notify claims is more likely to present an unnecessary barrier to businesses that are conducting genuine R&D from claiming tax relief. Beyond reducing funding for individual R&D projects, the change is counterproductive to the government’s strategy to boost productivity and economic growth in the UK. While we agree that R&D investment should be forward-looking, the immediate impact of this administrative burden will be detrimental to SMEs (particularly at the cusp of a widely-anticipated recession).
We have made the case before that a more effective way to reduce abuse of the scheme would be to enforce formal regulatory requirements or create a more informal code of conduct, such as the existing Professional Conduct in Relation to Taxation (PCRT), for providers.
UK Workers – new restrictions on EPWs for qualifying R&D activity
Restrictions will apply on the costs of externally provided workers (“EPWs”) that can qualify for R&D Tax Relief. The costs of such workers can only qualify for tax relief or credit where the EPWs or the company are taxed through PAYE or, alternatively, the R&D satisfies narrow exceptions for activity that cannot reasonably be undertaken in the UK. Businesses will now want to consider the impact of losing R&D Tax Relief for EPWs outside the UK and whether this merits a change in location of their EPWs.
Unfortunately, the new rules will exclude an integral part of a UK company’s R&D process. Indeed, it may reduce investment in the UK and be counterproductive to the government’s vision of a Global Britain. Limiting incentives for international cooperation could risk making UK SMEs less competitive and compromise the UK’s international reputation. We find it particularly unreasonable to deny relief where no suitable workers are available in the UK. By way of comparison, the Australian tax authorities explicitly allow R&D relief where no domestic labour is available. The changes are overly restrictive for work done with international businesses for commercial reasons, where it might not be practicable to conduct the work in the UK due to lack of facilities, expertise, equipment, or a combination thereof.
As a further point, this change will often give rise to practical issues where a claimant uses an unconnected EPW which invoices the claimant through its own personal service company, (“PSC”). The EPW remunerates themselves via a small salary and dividends. The draft legislation suggests that the claimant company will only be able to make a claim to the extent of costs which went through the PSC’s payroll. SMEs will not have the relevant information or even awareness of whether these EPWs are paid through a UK payroll. If the legislation is implemented as drafted, we foresee this new restriction extending to UK PSC labour. Businesses may therefore want to contact UK PSCs now to obtain details of costs which are taxed through PAYE. As a side point, and based on recent case law, payments to connected EPWs should be made before the R&D claim is submitted.
Data and cloud computing added to qualifying expenditure for R&D tax relief claims (but detailed cost breakdowns will be needed)
Businesses will welcome the expansion of qualifying expenditure for both the SME R&D Scheme and RDEC to include licence payments for datasets and cloud computing costs. Such costs are an integral and substantial cost for certain companies undertaking R&D and we consider that it is right that they be included in R&D claims. In preparation for this change, we note some practical points below regarding gathering relevant information in respect of these costs, asdetailed cost breakdowns will be needed for making R&D claims.
License payments for datasets
Qualifying datasets are those which are “used directly for R&D in a qualifying R&D project”. We note that where an end user access agreement covers multiple datasets, not all of which are to be used in a qualifying R&D project, or where access to data is granted as part of a wider package of services, the claimant will be required to apportion costs. Dataset access can be provided in a number of ways, for example an annual licence for unlimited access to real-time data or on an individual dataset licence basis. Due to the often significant annual license costs, we recommend that businesses start a process now to apportion costs which relate to R&D projects. Likewise, staffing costs should be identified where these relate to collecting data for R&D purposes.
Cloud computing and software
Our experience suggests that most suppliers traditionally provide a single line item charge for datasets and cloud computing services. Not many providers will show the necessary granularity of the kind provided by popular provider Amazon Web Services. Businesses should contact their providers now and request detailed breakdowns so that R&D expenditure can be more easily identified.
Multinational top-up tax – UK adoption of Organisation for Economic Co-operation and Development Pillar 2
While this article focuses on the changes to the R&D regime, we also briefly consider the interaction with the new tax on UK parent members within a multinational enterprise group (“MNE”). A top-up tax will be charged on UK parent members when a subsidiary is located in a non-UK jurisdiction, and the group’s profits arising in that jurisdiction are taxed at below the minimum rate of 15%. This is in accordance with the agreement (“BEPS”) made on 8 October 2021.
While we appreciate that the majority of R&D claimants are not MNEs, there are some MNEs which will have their innovation incentives undermined by these changes. Relief for MNE R&D expenditure may be extinguished by the top-up tax, thus inadvertently disincentivising job creation, economic growth, and innovation in the UK. Whilst the number of such MNEs is relatively small in the big picture, the investment made in R&D from those enterprises is likely very significant and integrally tied to economic growth in the UK.
What’s next for UK businesses conducting R&D?
Due to the above changes, the need to raise awareness of the scheme, particularly for SMEs who may be first-time claimants, is now more pressing than ever. As such, we will continue to provide detailed guidance to our clients and prospective companies seeking to claim R&D tax relief.
If your business has a query about how the proposed changes will affect the R&D Expenditure Credit or SME R&D Tax Relief, please get in touch.
