The release of the Draft Finance Bill legislation on 20th July confirmed that the R&D rules are set to see major changes for periods starting from 1 April 2023, affecting both the RDEC and SME R&D regimes. As expected, the draft legislation refocuses the R&D rules on UK innovation, with significant tightening of the rules to counter abuse, however the news is not all bad for clients, as there is a welcome extension to the R&D schemes to bring them more in line with the modern world.
What is the good news?
Cloud computing and Data costs
- Qualifying expenditure will be extended to include direct R&D expenditure on access and use of digital data and cloud computing services
- Currently firms can claim for ‘software’, however this is limited to the costs of the programmes used for R&D purposes.
- The extension to cloud computing is a real opportunity for many clients, as while HMRC’s earlier consultation indicated it would be restricted to online software (meaning no real change), the draft legislation allows companies to claim for the provision and maintenance of data storage, operating systems, hardware facilities and of course, software.
- This is extraordinarily broad, and provides scope for some of our tech clients to significantly increase the amounts they claim in relation to their network and hosting costs.
Extension of the R&D definition to include maths
- Currently pure mathematics is excluded from the R&D rules, which focus on advances in science and technology. However with the development of the complex algorithms required for many areas of modern technology, increasingly dependent on the underlying maths, this distinction is becoming increasingly hard to maintain and so this is a welcome change.
- No details are yet provided but this will be addressed via secondary legislation in due course.
Staff Costs expended to include the Health and Social Care Levy (HSCL)
- This will add an additional 1.25% of the wage costs for each employee involved in the R&D
What is the bad news?
Subcontractor/Externally Provided Workers
- Currently there is no restriction on where subcontractor services must be provided, or where ‘EPWs’ are situated.
New Restrictions on overseas activity
- After 1 April 2023, R&D relief will be restricted where it relates to overseas activity as part of a drive to focus R&D relief more tightly on UK innovation
- Subcontracted R&D and Contributions to independent R&D (RDEC only) may only be claimed where the R&D is undertaken in the UK
- For EPW services to be eligible, the third party who employs the worker is required to account for PAYE on the worker’s income in relation to the R&D they undertake. The R&D must therefore be undertaken by a UK resident worker on a UK payroll (even if part of the work is overseas) or in the UK by a non-resident EPW.
Are there any exceptions?
- As expected, there is a limited exception to this, however under the draft legislation, this would only apply where it is necessary to undertake the R&D overseas e.g. to access geographic or environmental conditions, or for regulatory reasons. The rules specifically note that lower prices and most relevantly, lack of suitable skills, would not be included.
- This will have a particular impact on multinational groups, or tech firms who increasingly take advantage of a globalised world to source skills where available.
What is the ugly news?
From 1 April 2023, companies wishing to make an R&D claim for the first time (or that have not made a claim in the previous three accounting periods) must notify HMRC within 6 months of the end of the relevant accounting period.
- Currently, no prior notification is required, meaning a company can submit a claim right up to the deadline of 2 years after the accounting period end.
- This is a significant reduction in the timeframe for making claims, and means new R&D claimants will not be able to go back 2 years in the first year of making a claim
- It will also require companies and their advisors to be more alert to the possibility of making an R&D claim, even if the accounts are not to be prepared for a few months yet.
- The professional bodies have already protested against this proposal on the basis that it would restrict access for small businesses and start-ups, and so hopefully we may see some changes but this cannot be guaranteed.
- No details are provided yet regarding the information to be provided as these powers are to be delegated to HMRC.
Further changes are to be introduced, aimed at targeting abuse of both RDEC and SME schemes. The information to be provided along with a tax return is be made mandatory. Details will be set out in secondary legislation, however HMRC’s recent report indicated that this would include:
- Claims to be made digitally
- Additional information must be provided, including details of the costs and narrative with details of R&D projects
- The claim should be endorsed by a named senior officer of the company
- Any agent advising the company should be identified
- This will help HMRC to target those agents promoting spurious claims, emphasising the value of high quality advice.
- Relaxation of the current requirement for companies to be a Going Concern such that companies that have transferred a trade to a connected party can still be eligible for R&D relief.
- Clarification that R&D expenditure must be paid prior to submitting an R&D claim, where HMRC’s published practice has previously been at odds with the stricter precedent set by the Tribunal.
- There are a number of small clarifications to the transitional rules for SME claims, including enabling companies sold from a large group to an SME to access SME relief in the year of the sale.
HMRC have requested feedback on the draft legislation by 24th September, with the proposals set to be enacted in Finance Bill 2022-2023 in the Spring.