Navigating the new merged R&D system
Introduction
From 1 April 2024, the Government introduced a new merged R&D tax relief scheme.
The aim is to simplify the R&D Tax Incentive Scheme process by introducing a combination of existing enhanced tax reliefs and payable credits for SMEs and the R&D Expenditure Credit (RDEC) for large businesses.
The aim of the new regime is to ensure simplification, consistency and to protect the regime against abusive claims.
For those who have already applied under the SME scheme, this represents a considerable change. Companies therefore have a lot to consider and plan for when it comes to their R&D requests, and requests are likely to be subject to more scrutiny than ever before.
How does the device work?
The new merged regime will follow similar principles to the RDEC regime in providing a tax credit of 20% of qualifying expenditure, which is recognized as deemed trading income of the company before application of corporation tax. The business can then use this credit to cover its debts or possibly as a cash payment into its business.
This new regime applies to all companies regardless of their size. The exception is for R&D-intensive SMEs (see below) where a more generous scheme will exist alongside the new merged scheme.
The table below shows the evolution of the effective rates of R&D tax relief over recent years as well as the new rates under the merged scheme.
The merged regime applies to accounting periods commencing on or after 1 April 2024. This means that for businesses whose accounting period ends on 31 December, they will fall under the merged regime for the year ending 31 December 2025.
What are the main differences?
1 Lower effective rate for SMEs
For the purposes of the old SME regime, an SME must have fewer than 500 employees and either a turnover of less than €100 million or gross assets of less than €86 million.
The proposed changes will mean the tax benefit for SMEs will be reduced to 16.2% of their eligible R&D expenditure, compared to previously higher amounts of up to 33.35% for loss-making businesses.
They will need to change how the credit is applied in their tax calculations and tax returns. The RDEC credit may also be reflected as an “above the line” credit in the SME’s accounts if it chooses to do so.
Unless they are considered R&D-intensive SMEs, as explained below.
2 Strengthened support for R&D-intensive SMEs (ERIS)
As an SME, you should ask yourself whether your total eligible R&D expenditure represents 30% or more of your total expenditure.
If this is the case, the business will be considered a ‘knowledge intensive’ business for R&D purposes and will still be eligible for relief under the similar old rules of the SME regime.
This is an alternative scheme which will operate alongside the merged scheme and will only apply to highly loss-making SMEs. It allows an effective tax saving of 27%, compared to 16.2% for the merged regime.
It is not mandatory to apply under this scheme and businesses can still opt for the merged scheme. They cannot claim both schemes for the same expenses.
We expect HMRC to consider these applications with great care, particularly where eligible expenditure is close to the 30% threshold, so it is advisable to ensure that the conditions are met.
3 Payment steps
To explain another change resulting from the merged system, it is best presented by an example.
Example
A Ltd undertakes R&D. Their profits, before claims under the merged project, amounted to £25,000. It is considered a small profit business as its profits are less than £50,000.
Its eligible R&D expenditure for the financial year ending 31 March 2024 is £50,000.
They can include credit above the line of 20% = £10,000.
This increases their taxable profits to £35,000, resulting in a corporation tax charge of 19% of taxable income. £6,650.
To offset this credit, the company must apply the following steps:
Step 1 – Offset the credit against the corporation tax liability for the accounting period.
• £6,650 – £10,000 = (£3,350) remaining credit
• If there is credit remaining, go to step 2.
Step 2 – Compare the remaining credit with the “net” amount of expenses claimed.
• It is the smaller of the two numbers that is carried over to step 3.
1 The remaining credit = £3,350
2 The ‘net’ amount of expenses claimed is the amount you claimed (£10,000) less the 19% notional tax (£1,900) = £8,100
The bottom number here is £3,350.
• The £3,350 is then carried forward to the usual RDEC stages and either used against other CT debts, assigned to other members of the group or, so long as the ‘going concern’ condition is met, paid directly to the company.
As you can see, the notional tax restriction that applies when considering business credit payment will now depend on whether or not the business is making small profits. If the business makes profits of less than £50,000 or has made a loss, a rate of 19% will be used, as above.
Under the RDEC regime, it was always assumed that a rate of 25% was used regardless of the level of profit.
4 PAYR Cap
The amount of credit available is subject to a PAYE cap of £20,000 plus 3 x the company’s PAYE and NIC debts for the year. This may limit the amount of payable credit you can receive during the accounting period for which you are claiming.
Any excess credit above the ceiling may be carried over to the following financial year.
This is a more generous ceiling than that previously applied to the RDEC system.
5 Subsidized expenditure
There are no restrictions on applying for subsidized expenditure under the merged scheme or ERIS, unlike what was previously in place for SMEs.
6 Outsourced R&D
The new regime and guidance aim to provide greater certainty as to which company should apply for R&D relief where a series of contractors are all working to resolve the same scientific or technological uncertainty.
The approach has changed, so that it is now the party that decides to undertake R&D that can claim R&D. You can still claim R&D if you have been assigned work and it was your company that took the initiative to carry out the R&D.
It should be noted however that during the transition, where a contractor or client is still able to claim for work they carry out for you under the old RDEC or SME rules, this claim will not be available to your business.
HMRC has published draft guidance in this area and careful consideration is required to ensure that a correct assertion is made.
7 Overseas R&D costs and subcontractors
Under previous schemes there were minimal restrictions on overseas spending costs, meaning contractors and EPWs could claim benefits regardless of where the work took place .
From April 2024, expenses relating to R&D activities carried out abroad will generally not be eligible for the credit., unless covered by a specific exception. The exception for eligible overseas expenses applies if they meet the following three conditions:
- The conditions necessary for R&D are not met in the United Kingdom;
- Conditions are present where R&D is undertaken;
- It would be completely unreasonable to replicate the conditions in the UK.
Different rules apply depending on the outsourced work and EPWs for overseas business. This should be carefully considered to ensure the claim is maximized to its full potential.
How can I apply for R&D under the new regime?
The application submission process has not changed since the introduction of the new procedure on August 8, 2023.
If a business has not made an R&D claim previously, or has not made a claim in the last three years, it will need to notify HMRC in advance by submitting an Advance Claim Notification to HMRC. This must be done no later than six months after the end of the financial year.
As part of submitting the corporate income tax return, a mandatory additional information form must be submitted to accompany the application.
Next steps…Seek professional advice
HMRC currently verifies 20% of R&D claims and this figure is expected to increase as compliance and challenging abusive claims remains a high priority.
Be sure to prepare your request carefully and speak to us as your professional tax advisors, to ensure your compliance obligations are met. Contact us here!
