We have already blogged about the measures announced in November 2021, that are being put in place to target abuse of the R&D tax credit system and to improve compliance with the DTI conditions.
HM Treasury states in their Autumn Statement report that “This reform ensures that taxpayer support is as effective as possible, improves the competitiveness of the RDEC scheme, and is a step towards a simplified, single RDEC-like scheme for all. The government will consult on the design of a single scheme, and ahead of Budget work with industry to understand whether further support is necessary for R&D intensive SMEs, without significant change to the overall cost envelope for supporting R&D. As previously announced at Autumn Budget 2021, the R&D tax reliefs will be reformed by expanding qualifying expenditure to include data and cloud costs, refocusing support towards innovation in the UK, and targeting abuse and improving compliance.”
However, I can’t help but think this could have been done in a way that would not impact on genuine R&D tech-start ups and SME’s carrying out work that makes an advance in overall knowledge or capability in science or technology. Most abusive R&D claims are low in value but high in volume and so a de mininimis R&D expenditure limit (of say £20,000) would have removed a high proportion of the problem claims without the collateral damage. I believe it is also unlikely that a company spending less than £20,000 on R&D over a 12-month period would meet the DTI guidelines in the first place.
To explain the collateral damage further, I have undertaken the following four example calculations to illustrate the changes from 01 April 2023 onwards, under the iconic film title ‘The Good, the Bad and the Ugly’: -
- The Good - Large companies (including SMEs claiming under the RDEC): The Research and Development Expenditure Credit (‘RDEC’) rate will increase from the current 13% to 20%. This is nearly double the 11% rate from when it was first introduced in 2016. As the RDEC is taxable income (akin to grant income in the accounts), the net benefit, after next year’s corporation tax rise to 25%, will increase from 10.53% to 15%. A large company spending £1m on qualifying R&D would receive a credit of £150,000, an increase of 42% from the previous rate of 10.53%, irrespective of whether it is profit or loss-making.
- The Bad - Profitable SME with a taxable profit of £500,000: The additional R&D deduction will decrease from 130% to 86%, the lowest it has ever been. This will result in the corporation tax benefit reducing from 24.7% to 21.5%. An SME with profits of £500,000 and qualifying R&D expenditure of £100k would see a tax saving of £21,500, rather than the previous £24,700, which is a reduction of approximately 13%.
- The Ugly - SME at break-even point – Unrelieved trading losses: This is by far the worst-case scenario as the loss restriction has the greatest impact. The fall in the enhanced deduction rate (from 130% to 86%), together with the fall in the cash credit rate (from 14.5% to 10%) will see an SME with £100k of R&D expenditure claim a cash credit of only £8,600 compared with £18,850 previously! This is a huge reduction for claimants to bear the brunt of at almost 55%.
- Still Ugly - SME with trading losses (no unrelieved loss restriction): Where an SME is no longer restricted by the losses, it could previously claim an R&D cash credit of 33.35%. Under the new measures, this will reduce this to only 18.6%. Clearly, cash refunds are the main target of HM Treasury’s anti-fraud measures, and it will reduce the cash benefit to by around 44% (from £33,350 to £18,600 on R&D expenditure of £100,000).
As indicated above, the biggest reduction in tax benefit is to loss-making SMEs, which are typically investing heavily in R&D. This is particularly the case for companies in the UK’s vibrant tech sector and software sectors where there is generally a long period of pre-revenue development.
SMEs are going to be hit by this in terms of their cashflow forecasts that will now need to be revised downwards and this will no doubt cause concern for both lenders and potential investors alike. There will clearly be some R&D tax planning opportunities available for some, but the longer-term outlook appears gloomier for SMEs investing in R&D.
The next step
For more information about how to manage HMRC’s R&D tax credit changes on your own business, or to discuss your potential for an R&D claim, please contact Kevin Edwards, or your usual UHY adviser.