Earlier this month, HMRC released draft guidance around two key restrictions coming into force as part of the new merged R&D tax relief scheme scheduled for April 2024. HMRC is seeking views from industry and has invited consultation on the draft guidance. As a reminder, the consultation period ends tomorrow.
In this blog, I focus on the highlights, however, the guidance is detailed and provides useful examples, I recommend reading the full document if overseas costs and contracted out R&D are of particular relevance to your business. It is important to note that the consultation is only around the interpretation of the rules as the Finance Bill received Royal Assent earlier this week. Hence, there is limited time allocated for this consultation and the guidance needs to be confirmed and in place in a matter of weeks, not months. As we have seen over the past couple of years when it comes to R&D tax relief, change is constant and speedy.
The background to the launch of merged R&D scheme
Draft legislation for both the new overseas expenditure rules and contracting out R&D rules (subcontractor rules) were initially published in July 2023. HMRC invited consultation over the summer period on draft legislation for a merged R&D scheme.
The Autumn Statement confirmed a merged R&D tax relief scheme to start for accounting periods starting on or after 1 April 2024, as part of the Autumn Statement, HM Treasury set out guidance for how the new subcontractor rules will work from 1 April onwards.
These changes, including the merged scheme more broadly, are covered by the Finance Bill 2023/24 and achieved Royal Assent earlier this week. With time not on HMRC’s side, this consultation will end on 1 March 2024.
Draft guidance on the allowable R&D costs for work contracted overseas
As an overview, the draft legislation, if enacted, will restrict claimants from claiming R&D costs related to subcontracted work overseas. The guidance sets out the three circumstances need to be satisfied for overseas expenditure to be allowable.
HMRC also set out two conditions that are excluded from meeting the allowable overseas expenditure test; the cost of the R&D activity and the availability of workers to carry out the R&D. The draft guidance explains that if either the cost of carrying out the R&D activity or the availability of workers are the main reason or the only reason for contracting out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, then the relevant expenditure will not qualify.
Draft guidance on contracting out rules
In November 2023, HM Treasury set out a technical note clarifying that in the merged R&D scheme rules, the entity contracting out the R&D (customer), in most cases, 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.
The draft guidance goes one step further to clarify that the customer is required to show it ‘intended or contemplated’ that R&D would take place as part of the contracted work. ,
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. If the customer cannot show this, and qualifying R&D took place, the subcontractor may be eligible to claim.
This change ultimately rests the burden of proof with the customer, therefore, under the proposed rules, should a business wish to claim back subcontractor costs, it must show sufficient evidence to show intention or contemplation.
If you think the change in rules may affect your business, please get in touch.
