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Reviewed by Akshay Thaman, IP & Policy Lead | 20 March 2024

The new merged R&D tax relief scheme - what you need to know

2023’s Autumn Statement delivered by the Chancellor Jeremy Hunt, confirmed that the two R&D tax credit schemes (SME and RDEC) will be combined to form a new merged R&D scheme. This merged scheme R&D expenditure credit will apply to accounting periods beginning on or after 1 April 2024 and will not discriminate based on the size of the business, both SMEs and large businesses will claim under the same scheme and at the same above-the-line credit rate of 20%.

The HMRC guidance for the merged scheme is still being finalised and will impact companies in different ways. To find out how it might effect your business, contact us.

What qualifies as an R&D project under the merged scheme?

The merged scheme will continue with largely the same assessment criteria, to have a qualifying R&D project the project must satisfy three conditions:

  1. The project must have achieved, or is seeking to achieve, an advance in the overall knowledge or capability of a field of science and technology.
  2. There must have been a scientific or technological uncertainty.
  3. It must not be readily deducible to a competent professional working in the field to carry out the work.

New merged scheme R&D tax relief rate

As explained above, the merged scheme will follow the RDEC payment model of an above-the-line expenditure credit at a rate of 20% for most businesses. However, the UK Government wants to reward the most R&D intensive businesses and incentivise those on the cusp of being R&D intensive to reach that threshold. Therefore, there is a second ‘scheme’ or ‘rate’ for loss-making R&D intensive businesses, called the Enhanced R&D Intensive Support (ERIS) scheme, that follows the previous SME calculation at a 14.5% rate. The threshold to meet the R&D intensity condition is at least 30% of a company’s total expenditure to be related to R&D.

How the effective R&D tax relief rates will impact your business

Rules of subsidisation under the new merged scheme

The previous SME scheme penalised businesses that received a form of subsidisation to offset the costs of their R&D project(s), perhaps in the form of grants or other funding. This limitation will be removed from the merged scheme, businesses with subsidised R&D projects will be able the full amount entitled to them should they meet the existing rules of the scheme.

Overseas restrictions under the new merged scheme

2021’s Autumn Budget saw Rishi Sunak announce the UK’s R&D reliefs will be focused to limit benefit to R&D done in the UK. This will be in force as part of the merged scheme. The idea behind this is to encourage the use of UK workforce and, in the long term, boost skills and jobs in the science and technology sector. Therefore, as a rule of thumb, overseas R&D costs will not be qualifying R&D expenditure under the merged scheme. However, there are exclusions to this rule in the form of a three-step test, should a claimant be able to satisfy all steps, the related overseas costs may be eligible:

  1. Conditions necessary for R&D are not present in the UK.
  2. Conditions necessary are present in the location of undertaken R&D; and
  3. It would be wholly unreasonable for the company to replicate conditions in the UK.

HMRC sets out two main condition categories that may deem overseas expenditure allowable:

  1. Geographical, environmental, and social conditions i.e. climate, sustainability, machinery location, IP ownership.
  2. Legal or regulatory requirements i.e. contractual obligations or regulatory rules including guidance from regulatory bodies.

Draft guidance explains that this list is not exhaustive and states that a valid condition may fall under both the above conditions or neither the above conditions. This gives the impression that HMRC are understanding of the complex situations likely to be at play and will be willing to hear a claimant make their case based on their specific circumstances.

HMRC set out two conditions excluded from meeting the allowable overseas expenditure test, these are:

  1. Cost of the R&D activity; and
  2. Availability of workers to carry out the R&D.

The draft guidance explains that if either the cost of carrying out the R&D activity or the availability of workers are the main reason or the only reason for contracting out overseas, the expenditure will not qualify. Claimants are likely to need show evidence of this should the claim go into enquiry.

Contracted out R&D rules under the new merged scheme (subcontractor rules)

In November 2023, HM Treasury set out a technical note clarifying that in the merged scheme rules, the entity contracting out the R&D (customer) would be the entity eligible to claim R&D relief, not the subcontractor. The reasoning behind this principle is that it allows the company making the decision to do the R&D and bearing the financial risk to claim R&D relief.

It was further explained that subcontractors could claim R&D relief under exceptional circumstances, these are summarised below:

  1. If the R&D project is initiated by the subcontractor and not the customer and does not relate to the customer’s R&D; or
  2. If the customer is an overseas entity not paying UK corporation tax; or
  3. If the subcontractor is contracted to provide a product or service that is not R&D but undertakes R&D for that product or service.

HMRC recently released draft guidance that expands on point 1 by stating that:

‘R&D is defined as contracted out where it is reasonable to assume that the customer intended or contemplated this sort of R&D would be done’.

In short, if the customer intended or contemplated that R&D would be done as part of the contract, the customer would be able to claim, not the subcontractor. Intended and contemplated is explained to not mean a minor or fleeting consideration but to be able to specify and understand the R&D that needs to be done by the subcontractor.

For the customer to be eligible to claim relief for subcontracted costs under the proposed merged scheme or the loss-making R&D intensive scheme, it must satisfy 3 criteria, these are:

  1. There must be a contract, i.e. either for a product or service to include R&D or for specific R&D activities.
  2. R&D is undertaken as part of the activities within the contract; and
  3. It is reasonable to assume that the customer intended or contemplated that R&D would be undertaken to meet the obligations of the contract.

It is not enough for the customer to show that there ‘could’ be R&D carried out as part of the contract, the customer needs to show that it intends or contemplates for work to be carried out. The main way the customer could evidence that is through its contract with the subcontractor or in negotiations/planning documents leading up to the contract. HMRC expect that several commercial factors may align or show that the customer intends for R&D to be carried out, this includes but is not limited to:

  • IP ownership
  • Financial risk in undertaking the work
  • Autonomy in how the activity is executed
  • Means by which the R&D is likely to be exploited
  • The decision making process
  • The experience and seniority of decision makers
  • Nature of the parties (is the contractor a specialist in R&D activities?)

HMRC go on to explain that high level wording regarding R&D being required within the contract is not enough to show that the customer intended or contemplated R&D taking place.

The nature of the R&D that is to be undertaken (such as a statement of the advance in science or technology and what uncertainties need to be addressed) would need to be articulated to show that it is intended or contemplated that R&D of a particular sort should be undertaken.

HMRC state that this might be done in the contract itself, or in discussions leading to the contract, or in internal customer documents showing how the activity was required as part of the wider R&D.

The competent professional could have a role to play in establishing intent and contemplation. HMRC state that they may expect that the customer may ask the competent professional to set and outline the terms of the contract from an R&D perspective. Like any R&D claim the competent professional must be a competent professional in the field of the R&D activity being claimed for.

Contact us to find out how you can make the most of your claim

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