“L” day or Legislation Day was Wednesday last week – the day when the Government published the draft legislation that leads to the Finance Bill 2022/2023.
I have been waiting for this day for some time, not because I have a sad life with nothing else to do, but because of my interest in the legislative reforms to the R&D tax relief schemes, due to come into effect for accounting periods beginning on or after 1st April 2023.
The changes are fundamental and will affect all companies claiming R&D tax relief and their advisors. The reforms have been in the pipeline for some time. The Government announced a review of R&D tax reliefs at Budget 2021. On the agenda for reform were measures to improve compliance with the requirements of the R&D tax relief schemes and prevent abuse and possible fraud, an extension of the categories of R&D qualifying expenditure to include the costs of datasets and cloud computing, and measures to encourage companies to concentrate R&D activity in the U.K. rather than overseas.
At the heart of the review was an acknowledgement that the purpose of the schemes is to encourage U.K. companies to innovate through tax savings and that the innovation should properly benefit the United Kingdom – not only the economy but also the wider scientific/tech community. The Government has said repeatedly that it wants the U.K. to be a location for cutting-edge research. In addition, the Government emphasises that the reliefs should be fit-for-purpose and capture the real costs that are expended by companies carrying out R&D activity.
A formal consultation into the R&D tax relief schemes took place between March 2021 and June 2021 with stakeholders and interested parties encouraged to suggest ways in which the Government`s ambitions could be achieved. We contributed to the consultation and suggested improvements. The Government published its conclusions with information about what it intended to do next in its R&D Tax Reliefs report in November 2021. We were delighted to see that many of our suggestions were shared by others in the industry, particularly measures to improve compliance and prevent abuse/fraud and we now have draft legislation.
Key Changes for accounting periods beginning on or after 1st April 2023
Tackling Abuse and improving compliance
- Most R&D tax relief claims will have to be made digitally and digital claims will have to break down the costs across qualifying categories and provide a brief description of the R&D activity.
This will not be difficult for companies and agents to do. An analysis of each category of qualifying expenditure and enquiry into the R&D/non-R&D contribution is always carried out to compute the claim however disclosing the calculation used to compute the benefit provides transparency and will discourage abuse.
- A senior officer of the company will need to endorse the claim and each claim will need to include details of the agent who has advised the company on compiling the claim.
I welcome this measure. I have heard horror stories where companies have not seen copies of R&D reports prepared on their behalf before they are submitted to HMRC or not been advised of the amount of qualifying expenditure included in claims and the tax benefit expected. This reform demands that a company takes ownership of their claim. In addition, if there is an agent, HMRC will be able to see who that is and be able to more easily enquire into claims. HMRC will also, in future, be able to track and trace undesirable agent behaviour.
- All companies claiming R&D tax relief will need to inform HMRC, in advance, that they plan to make a claim. This will need to happen within six months of the end of an accounting period to which the claim relates and if not done, the claim will be disallowed. Companies that have claimed R&D tax relief for the preceding three years will be exempt from this requirement.
This is a major change and will trouble many companies that want to claim R&D tax relief within the two-year window following an accounting period because they will no longer be able to do so unless they have notified HMRC beforehand. The new requirement does not affect the statutory time limit for the amendment of a company tax return.
I think that this change is designed to encourage a claimant company to identify for itself whether it is carrying out R&D activity, close to the time when it was carried out, rather than be persuaded retrospectively that it was by an R&D ‘adviser’. HMRC does receive genuine claims for qualifying R&D activity during the two years from the end of an accounting period however there are claims where the R&D activity is dubious, a company itself does not recognise its activity as innovative and it is persuaded that it qualifies because of an over-enthusiastic R&D sales agent. This change is designed to weed out those claims and improve overall quality and compliance.
Refocussing the reliefs towards innovation in the U.K.
The Government wants more companies to conduct R&D activity here and not overseas so that employee skills and industrial know-how are retained in the U.K. The Government has been seeking opinion as to how to achieve this. The Government has decided that the best way is to prevent a company from being able to claim for subcontracted expenditure where the R&D activity has not been undertaken in the U.K. The same applies to externally provided workers.
There are exceptions to the rule, where factors such as geography, environment, populations or other conditions that are not present in the U.K. are required for research, and if the case, subcontracted expenditure incurred from carrying out R&D activity overseas is allowed. It is noted that cost and availability of workers is not an exception to the rule. This means that if a company wants to subcontract R&D activity overseas because it is cheaper to do so, the cost is not allowable. Equally, if a company wants to subcontract R&D activity overseas because of a lack of workers in the U.K., that is also not allowable. The usual rule is that for subcontracted R&D expenditure to be included in a claim for R&D tax relief, the sub-contractor should be based in the U.K.
Extending qualifying expenditure
The rules concerning software and consumable items have been amended to include the cost of datasets and cloud computing as qualifying R&D expenditure. These costs have been introduced to reflect the fact that they are a common cost to companies carrying out R&D activity and to disallow them would be unfair.
In the same vein, the Government recognises that much R&D activity is now centred around pure mathematics and the definition of R&D activity will be amended to include pure mathematics.
Other matters
Other changes include:
- A change to the definition of “going concern” to allow a company to be treated as a going concern if its accounts have not been prepared on a going concern basis but the only reason for this is that its trade has been transferred to another group company.
- Power for HMRC to allow a company to make a claim for RDEC where it is incorrectly claimed for SME relief
- Emphasis that for expenditure to qualify for relief, it does not have to have been both incurred and paid during the relevant accounting period to which it relates. The liability has to have arisen during the accounting period, but it does not need to have been paid during the accounting period. It must have been paid in the two years following the end of an accounting period and before the R&D tax relief claim is submitted.
- Clarification concerning the time limit for making a claim for R&D tax relief. The time limit is generally two years from the end of an accounting period to which the claim relates however if an accounting period is longer than 18 months, a claimant has up to 42 months from the start of a period.
- Power for HMRC to remove a claim for R&D tax relief from a return where certain conditions are not met, for example- the requirement to notify the intention to make a claim in advance.
- Clarification concerning the SME status of companies for SME R&D tax relief purposes where linked/partner enterprises become large in a period which could potentially take the SME over the exceeded limits for R&D tax relief or where another group company becomes large in the period and could potentially takes the SME over the SME limits. In both scenarios, the SME will retain SME status for the purposes of the threshold limits for SME R&D tax relief.
The legislation has been published in draft form and the Government invites comments up to 14th September.
