The new ‘simplified’ merged R&D scheme

The past few years have brought about some significant tax changes for companies carrying out research and development (R&D).

The objective of these changes has been to simplify the scheme to make it easier for claimants, while also attempting to reduce the levels of error and fraud seen in claims. From the introduction of caps on payable credits for SMEs to new online filing requirements, adjustments to the definition of qualifying R&D costs and changes in rates. There has been a lot to keep up with, therefore it is not a surprise that many claimants have felt overwhelmed and put off by the additional administrative requirements.

Since the March 2021 R&D Tax Reliefs consultation it has become apparent that HMRC have been taking steps to merge the existing R&D schemes and during the 2023 Autumn Statement, the Chancellor confirmed that the two existing schemes will be merging for accounting periods from 1 April 2024.

What do the changes mean for companies claiming R&D tax credits and do they go far enough to help simplify the process?

Current schemes and the relief available

Currently, there are two schemes that provide tax relief for qualifying R&D costs:

• enhanced tax relief and payable credits for qualifying SME expenditure – for small to medium sized entities
• R&D expenditure credit (RDEC) - claimed by large corporates and certain SMEs that have subsidised expenditure or are sub-contractors.

Historically the relief available for SMEs has been more generous, however, the rates have become more closely aligned in 2023, in anticipation of the merged scheme coming into effect from April 2024.

Is the ‘merged scheme’ simply just RDEC?

It seems that the merged scheme will be implemented in a similar way to the RDEC scheme. Key similarities include:

• Relief – the calculation for the merged scheme will follow a seven-step process as used for the current RDEC scheme, and relief will be receivable at the RDEC rate.
• Above the line - the credit is to be accounted for above the line and therefore it will be included in taxable operating income. For SMEs, this will be new and will need to be factored into future forecasts.
• Subsidised expenditure – there will be no subsidised R&D restrictions as is the case under the current SME regime, this will mean that if you are in receipt of a subsidy or grant funding then you will no longer see a reduction in the amount of relief available as is currently the case under the SME scheme.

However, there are some noticeable differences between the current RDEC and the merged schemes:

• PAYE/NIC – the merged scheme will be implementing the more favourable PAYE/NIC cap from the SME regime, which will be welcome news for many large corporates as the existing RDEC cap only looks at the employees engaged in the R&D activity rather than all employees. It is also an easier calculation, relying on readily available data for companies, and therefore any effect can be estimated earlier.
• Subcontracted R&D – under the RDEC scheme claimants have only been able to claim relief on outsourcing their activities in very restricted circumstances. It is expected that subcontracted rules under the merged scheme will be similar to the SME regime.

HMRC have also sought to try and clarify which entities can claim for R&D contracted out. Broadly the merged scheme focuses on providing relief to the entity that makes the initial decision to carry out the R&D and bear the risk.

This may mean in many cases that SMEs who are sub-contractors and can currently claim under the RDEC scheme will be unable to claim in the merged scheme because their costs will form part of the claim made by the contracting party.

Who stands to benefit from the change?

For claimants under the RDEC regime, the new changes will be widely welcomed as the new scheme builds on from the existing RDEC scheme with a few beneficial changes implemented from the SME scheme, mainly the increase in rates seen in 2023, PAYE/NIC cap increase and subcontractor costs which can now be claimed.

However, it seems that SMEs will lose out from the merged scheme as we will see a further reduction in claim values. Broadly, this is as expected given HMRC’s findings have pointed towards smaller claims being more likely to contain error and fraud, and the changes represent work done to prevent this non-compliance.

However, it is not all bad news for R&D intensive SMEs as they will be able to receive a tax credit of up to 27p for every £1 spent on R&D activities if they are loss-making in the period. For accounting periods starting on or after 1 April 2023, you will need to be spending 40% of your overall tax-deductible expenditure on qualifying R&D costs to qualify, and it is expected that this rate will drop to 30% for periods starting on or after 1 April 2024.

The merged system will also allow for a greater understanding of expected benefits. The amount of relief received under the SME scheme is dependent on the taxable profit or loss position, making it difficult to undertake cash flow and budgetary forecasting.

Summary

In summary, the new merged R&D tax relief regime aims to streamline the process, whether it achieves this is debatable. It is still disappointing to see the seven-step process for calculating the credit and this may add additional complexities for many smaller SMEs. It is also not clear why HMRC did not include the R&D intensive relief as part of the merged scheme rather than maintaining a separate scheme.

Certainly, for larger corporates or entities receiving subsidised expenditure that previously fell into the RDEC scheme the changes will be widely welcomed. It is also hoped that the merged scheme will bring some certainty and stability to the relief moving forward which will aid SMEs and large corporates alike. Despite the changes for SMEs the merged scheme shouldn’t be overlooked as it still remains an attractive opportunity.

Crowe’s experienced R&D team would be delighted to start the conversation with you. Please contact Stuart Weekes or your usual Crowe contact.