“Ineligible, irrelievable and inalienable” – all terms within the new merged R&D regime!

Within the Autumn Statement the Government announced reforms to the R&D tax reliefs to simplify and improve the system from 1 April 2024. Legislated for this was released today (29^th November 2023) in the Autumn Finance Bill.

Here’s what we think you need to know.

Subcontracted R&D – who’s claim?

The rules are written to ensure there should be only one claimant, generally favouring the decision maker / risk taker (the ‘customer’ paying for the R&D).

Subcontractors will only be able to claim R&D relief for:

their own in-house R&D that is unrelated to a customer contract; or
where the work is for an “irrelievable client”, defined as an “ineligible company” (a charity, higher education institute, SRO, health service body) or person not chargeable to UK Corporation Tax (e.g. an overseas entity);

That said, per the Technical Note issued by Treasury last week:

If a company is contracted to do work for another company, but the work does not form part of R&D for the customer and was instead initiated by the contractor, then the contractor may be able to claim relief for their work, if they meet the requirements of having valid R&D which is otherwise eligible for tax relief.
If a company is contracted to provide a product or service which is not R&D, such as constructing a building or a software product, if they undertake R&D in delivering that product or service, they would be able to claim relief even though they are undertaking R&D on an activity contracted to them.

This seems to introduce ‘wiggle room’, ambiguity and therefore uncertainty in our view.

Where a customer enters into a contract to subcontract a piece of work to another party and it is reasonable to assume that it was intended or contemplated that R&D would be undertaken to fulfil the contract, then the customer can claim R&D tax relief for the qualifying elements of the subcontractor payment (if UK based).

This assessment should be made (and ideally documented within the contract) at the time the contract is entered into.

Where one group company subcontracts to another it will be possible for the first to elect to be an “ineligible company”, such that the second can claim R&D tax relief, if preferred.

Hidden consequences

Wording has been introduced to give Treasury power to further limit the relief to exclude companies, R&D projects or expenditure of a prescribed description. This is a marked change from the policy approach to date of the credit being open to all.
SMEs used to be able to claim even if R&D was undertaken prior to commencing trading activities. The merged regime requires all claimants to be carrying on a trade, so SMEs could lose out unless they qualify for the R&D intensive regime.
Contributions to universities/qualifying bodies in respect of independent R&D no longer qualify (but subcontracted R&D would). Bad news for some, including our Universities.

A reminder of the key headlines

All changes will come into effect for accounting periods starting on or after 1 April 2024 (avoiding claims falling into both the old and new regimes).
There will be a single merged ‘above the line’ regime giving a gross 20% R&D Expenditure Credit. After tax, large profitable companies receive a 15% net benefit (no change). The small profits rate, currently 19% will be applied to loss making companies, giving a slightly higher net benefit of 16.2%. HMRC have said that they are content that this doesn’t cause a wider accounting problem (there was a concern back in 2013 that RDEC might not be recognised as an ‘above the line’ credit if not all claimants receive the same benefit).
Subsidised R&D, for example partially grant funded can still be claimed, based on the gross expenditure incurred.
Overseas subcontractor and Externally Provided Worker R&D expenditure will not qualify unless it is ‘qualifying overseas expenditure’, broadly defined as R&D that cannot be undertaken in the UK, as per the draft legislation issued in July.
Whilst overseas subcontractor/EPW expenditure will not qualify for RDEC purposes, this will still be treated as ‘good’ expenditure for patent box R&D fraction purposes. This was a problem we flagged to them in September that they have resolved within the final legislation.
An SME intensive scheme will apply for companies spending 30% or more of total expenditure on R&D (reduced from 40% to broaden its relevance). Provisions are introduced to smooth companies qualifying for the regime in year 1 also qualifying in year 2 even if R&D spend falls below the 30% threshold.