What are the 2023/2024 changes to the UK R&D Tax Relief Scheme?

HMRC has recently unveiled several adjustments to the UK's R&D tax incentive scheme. These changes include a lowered benefit rate for the SME Scheme, increased benefit rate for the RDEC Scheme, restrictions on grant-funded projects, and changes on claims for subcontracted work. How will these reforms affect the tech sector in particular?

On top of implementation of the Additional Information Form (AIF) in August 2023, there are a number of additional changes which Tech companies will need to be aware of, brought in as a measure to combat fraud:

Lowered Benefit Rate from 1 April 2023

Previously, the SME scheme provided vital support to loss making companies of up to 33% of the Qualifying Expenditure, in cash. This proved particularly useful for companies in the startup phase that may not have begun commercialising their developments, however under new legislation, that maximum rate is being reduced to just 18% for most claimants. Whilst HMRC have taken some measures to address this in keeping a more generous surrender rate for ‘R&D intensive companies’, the overall benefit is still lower than the current regime (at approximately 27%). There are also concerns that some companies in the tech sector requiring substantial expenditure on maintenance, or other costs often relating to R&D (such as IP protection or commercial / legal costs), may fall outside of this despite core activities being R&D related.

Impacts on the Tech Sector

Like all sectors, Tech companies are struggling with recruitment, however, this is leading to an upward drive-in salary costs more so than other sectors. The extreme expenditure in the early-stage research means that a generous R&D scheme is crucial to funding development, however the reduction in rate is compounded by the restriction in international expenditure set to come in force from Spring 2024 onwards. It’s understandable to some degree that HMRC want to reward UK expenditure, however if that rate is lower surely it becomes more tempting to source a team from Tech centres abroad, rather than hiring locally.

A decrease in overall SME R&D benefit might mean companies are be forced to seek additional / alternative funding – possibly losing autonomy in the process, diverting funds from non-core activities, or cutting down on R&D efforts. Whilst grant funding can be used to bridge the gap, this might impact any subsequent R&D claim as per the below:

What are the new restrictions on Grant-Funded Projects?

Before the planned changes, an SME company could receive grant funding or subsidies and still claim R&D tax benefits in the less generous RDEC scheme. Under draft legislation for the new ‘RDEC Style’ unified Scheme, companies receiving grant funding will no longer be able to receive any R&D tax credits for that project (if a notified state aid).

Whilst a grant can provide up to 100% of the funding, they are also far more restrictive in terms of application / success, and require significant time and effort up front. In contrast, waiting to complete an R&D claim may mean cash flow issues, or possibly wider financial problems.

Startups often juggle multiple sources of funding to keep their operations running. With this change, they may be forced to pick one or the other. It seems overly harsh to punish companies that are clearly doing high quality work, by restricting their access to additional benefits which can then be used to expand operations. The current system allows a combination of upfront funding and the added benefit as work is ongoing. If the government is serious about supporting growth in the economy, given tech startups are one of the highest growth sectors, it should reconsider these restrictions and ensure that assistance is provided throughout the lifecycle of a project.

Claims for Contracted Work

In a more positive move, the Government intends to allow companies to claim for Subcontracted activities within the new scheme, which is currently only allowed in very limited circumstances within the existing RDEC scheme.

However, the subtext for this threatens claims, particularly for smaller companies. Previously, SME company ‘A’ would be able to claim on work subcontracted to it by Large Company ‘B’. Under the draft legislation, this is no longer the case, with Large Company B entitled to claim under the new merged scheme. It seems counterproductive that HMRC would make changes in support of large, established companies rather than smaller companies who need support the most. It is possible this could lead to a change in landscape as companies raise prices to offset the lack of R&D relief. In addition, there has been a change in what constitutes ‘Subcontracted R&D’ in the first place.

HMRC have been attempting to apply the notion that if there is a contract, the work has been subcontracted. In reality this is far from always the case, and this is a highly complex area, however HMRC seem insistent on keeping this stance. Previously, analysing the ‘risk’ in undertaking work was the generally accepted approach, and one which considers the complexities of contractual situations, rather than attempting to apply a broad-brush approach which is not always suitable.

Companies may elect therefore to undertake work completely outside of contract where possible, however this is not always possible and will significantly increase the burden of risk.