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Guest blog: All change for UK R&D tax credits – again!

Carrie Rutland, Partner at BDO LLP, provides a useful overview of the changes to the UK's tax reliefs for R&D

Carrie Rutland, Partner, BDOInnovation is vital to any financial services business but it doesn’t come cheap, so it is important to keep up with changes that affect development costs – such as changes to the UK’s tax reliefs for R&D.

The UK government is merging the current SME and R&D Expenditure Credit (RDEC) R&D schemes into a single above-the-line credit scheme – the aim is intended to “simplify and improve” the R&D tax incentive schemes in the UK – although not every business will see the new rules that way.

The new merged scheme will take effect for accounting periods beginning on or after 1 April 2024 and will largely follow the current RDEC rules, with a headline rate of relief of 20%. However, it will also incorporate some beneficial elements from the SME regime, making it more generous than the existing RDEC scheme that building societies will be used to. 

As a reminder, RDEC is the current scheme under which large companies can claim tax relief for their qualifying R&D. The relief is given as a taxable credit, which is a proportion of the qualifying expenditure. This approach will be followed for all companies claiming under the merged scheme, raising the prominence of the R&D function within a business as the credit will appear as taxable income in the claimant’s accounts.

There is a seven-step process for determining how the R&D relief is used – this includes the ability to group relieve it in certain circumstances. 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. This means that the new post tax R&D Expenditure credit will be worth 16.2% of qualifying expenditure for loss making companies and 15% for profit making companies.

What’s new? 

The merged scheme will also allow companies to claim for qualifying subcontractor payments where the principal “intended or contemplated” at the time the contract was entered into, that the contractor would be required to undertake R&D to satisfy the contract. In most current scenarios, claiming for contracted out R&D is not currently possible for large businesses, so this is a welcome development. However, the principal must satisfy a number of stringent conditions in order to claim for contracted-out R&D. 

It’s also important to remember that R&D expenditure categories have recently been extended to include the costs of datasets and cloud computing as well as work on ‘pure mathematics’ (such as complex proprietary modelling for internal risk and external regulatory reporting purposes, as well as any quantitative analysis and actuarial science).

The bad news is that the merged scheme will also reflect HMRC’s recent concern over the costs claimed for externally provided workers: such costs will only be claimable if they related to UK workers and where the worker is part of (and paid through) a PAYE scheme. The government had already proposed a ban claiming for overseas costs (apart from a few limited exceptions) and, after a one-year delay, this is also now due to take effect for accounting periods starting on or after 1 April 2024 as a feature of the new merged scheme, although the original ‘exceptions’ will also apply. This means that the costs associated with using overseas software developers, on a UK technology project will no longer be eligible for R&D tax relief. 

Impact on your suppliers

The change on overseas costs, combined with a fall in effective tax relief for SMEs claiming R&D relief is likely to put smaller R&D contractors under cost pressures going forward. Larger businesses will also be affected. Therefore, depending on the size of the business you use for external software development or systems integration, building societies are likely to see project costs rise by varying levels over time. 

Your plans for 2024

If you haven’t done so already, it’s probably a good time to revisit cost projections for ongoing and long term projects and discuss the position with suppliers. 

Cost quotes for new projects may be surprising so it makes sense to consider things carefully in advance: will it be more cost effective to contract-out work overseas and forego an R&D claim or to engage a technical expert to act as your ‘competent professional’ and brief the R&D project precisely to a UK based contractor so you can claim UK R&D relief? 

Summary

Innovation is the life-blood of all growing financial services businesses and regardless of the new R&D tax relief environment in the UK that is bound to continue. However, the costs of innovating rarely remain the same, and 2024 will bring more challenges for business innovators to grapple with. 

If you would like to discuss how the new R&D rules will affect your claims going forward, please reach out to Carrie Rutland.