The government has announced plans to change the research and development (R&D) tax incentive scheme.
There are currently three schemes in operation. One for large companies (called the R&D Expenditure Credit (RDEC) scheme), another for small and medium size companies (the SME scheme) and a third for SMEs that pursue R&D intensive activities (the SME R&D intensive scheme).
The government’s plan is to merge the RDEC and SME schemes into one scheme which is based on the current RDEC scheme, with a headline rate of relief of 20%. The merged scheme will take effect for accounting periods beginning on or after 1 April 2024. The SME R&D intensive scheme will continue to run alongside the new merged scheme.
What will change?
The merged scheme will principally be based mainly on the current RDEC rules, but with a few elements borrowed from the current SME regime.
The RDEC scheme is the current scheme under which large companies can claim tax relief for their qualifying R&D. The RDEC relief is given via a taxable credit which is a proportion (currently 20%) of the qualifying expenditure. This is recognised in a company’s pre-tax income.
The merged scheme will follow this approach. Whilst its similarity to the current RDEC scheme will make it easier for larger businesses to make the transition to the merged scheme, it is very different to what SMEs are currently used to.
Under the new merged scheme the credit itself will be taxable so will appear as taxable income in company accounts. There is a seven-step process for calculating the relief and, as part of this, the notional tax rate applied to the RDEC for loss-making companies will be set at the small profits rate of 19%. For profit making companies it will continue to be at the main rate of corporation tax of 25% or the small companies’ rate of 19% where this applies.
The net effect of the calculation will give R&D relief to loss-making companies of 16.2p for every £1 of qualifying spend and profitable ones will get effective relief at 15p in the £ (16.2p for companies paying the small companies rate). The overall impact for SMEs is that will they receive less relief than under the current rules unless they qualify for the separate SME R&D intensive scheme.
Contracted-out R&D
Companies claiming under RDEC can currently only claim for the costs of outsourcing their R&D when the work is sub-contracted to a limited number of ‘qualifying bodies’ (e.g. universities and other not for profit organisations), to individuals or partnerships. SMEs can claim 65% of the costs of most subcontractor payments under the SME scheme.
Under the new merged R&D regime, all companies will be able to claim for qualifying subcontractor payments where the principal ‘intended or contemplated’ at the time the contract was entered into, that the subcontractor would be required to undertake R&D to satisfy the contract. This does though cause issues for unforeseen R&D which occurs after a contracted has been entered into.
SME R&D intensive scheme
It had previously been announced that loss-making SMEs whose R&D expenditure constitutes at least 40% of their total expenditure (incurred on or after 1 April 2023), would continue to receive relief in the form of an SME tax credit. This will continue and give an effective rate of relief of 26.97% of allowable R&D expenditure.
However, the R&D Intensive rules have been amended to reduce the required R&D ‘intensity’ threshold from 40% to 30% for accounting periods beginning on or after 1 April 2024 and a one-year grace period will be applied where a company’s R&D intensity falls below 30%.
For this SME R&D intensive scheme, relief will be reported in the tax line of companies’ accounts (in contrast with the above the line treatment of the merged scheme).