R&D Tax Credits Changes Coming Into Effect Next Year
The highly anticipated reform of the R&D Tax Credits schemes is now official. HMRC has announced major changes that the Chancellor had announced during the 2022 Spring Statement—but that had been in the works for the past few months.
The reform is part of the government’s ambitious aim to foster investment in R&D up to 2.4% of UK GDP by 2027. Given the central role that R&D Tax Credits play in reaching this target, starting last year the government has carried out several consultations with stakeholders—including Finerva, who provided feedback to make sure the views of our clients were heard—to identify the measures needed to ensure the R&D tax relief schemes are up-to-date.
These new measures, as specified in the official policy paper, will affect both the Research and Development Expenditure Credit (RDEC) and the small or medium enterprises (SME) R&D relief, starting 1 April 2023.
Below is a summary of the four key measures that the change involves, which are analysed more in depth throughout this blog:
- Introduction of two new categories of qualifying expenditure:
- Cloud computing costs
Including purchase, access and maintenance of both software and hardware used for remote data storage and systems operation.
- Data costs
Including licences for access and collection of datasets used in R&D, like the ones used for machine learning.
- Cloud computing costs
- Amendment of the definition of R&D to include “pure mathematics” as a qualifying activity to the purposes of the relief.
- Requirement for all subcontracted work or externally provided workers to be located in the UK in order to qualify for the scheme—with some very narrow exceptions for activities that absolutely require geographical, environmental, demographic or regulatory conditions that are not present in the UK.
- R&D claims to be filed digitally, breaking costs down across qualifying categories. Companies that have not made a claim in the past 3 years are also required to notify HMRC in advance of their intention to make a claim, within 6 months of the end of the accounting period that the claim relates to. Finerva already adopts this approach with our current clients, so if you filed an R&D claim with us in the past this will not affect you.
Extension Of Qualifying Expenditure Categories And R&D Definition
Tech companies—particularly the ones operating in the realm of AI, machine learning and any other sector that requires heavy usage of computing power—have long argued that cloud computing costs should be eligible as qualifying expenditure for R&D Tax Credits.
The same applies to data costs, like licenses to use or collect datasets to use for clinical trials, to train AI models, to conduct statistical analyses and so on.
This has now been made official and will apply starting in the new tax year, with the official definitions yet to be updated in section 1125 of the Corporation Tax Act 2009.
Along with these two additions, HMRC is also set to remove the exclusion of “pure mathematics” from the definition of R&D activities to the purposes of tax reliefs. Although only “applied maths” research was originally eligible for the scheme, many companies pointed out that the development of purely mathematical models is pivotal towards innovation in fields such as Finance and Insurance.
Tax Reliefs To Focus On UK-based R&D Only
In order to ensure that the R&D Tax Credits schemes benefit the UK wherever possible, subcontracted work as well as the cost of any externally provided workers located outside of the UK will no longer be considered a qualifying expense.
A new requirement for subcontracted R&D work to qualify towards tax reliefs is that this is carried out within the UK, and that any externally provided workers’ earnings are taxed through PAYE.
Very few exceptions to this requirement will be conceded, only in scenarios where R&D work outside of the UK is strictly necessary for one of the following:
- geographical, environmental, demographic or other material conditions that are necessary to R&D are not present in the UK—an example of this would be deep ocean research;
- regulatory or legal requirements that are necessary for the R&D project — for example, clinical trials.
Improving Compliance Through Digital Claims
In order to further avoid any abuse of the schemes, all R&D tax relief claims will have to be made digitally starting from the next tax year. Digital claims will require a cost break-down across qualifying categories, as well as a brief description of the R&D project(s) in question.
All claims will have to be endorsed by a named senior officer in the company, and details of any agent who has advised the company on filing the claim will have to be included.
This will not apply to companies that are not required to deliver a Company Tax Return online.
Additionally, companies will need to inform HMRC in advance—through a dedicated digital services—within 6 months of the end of the period for which they want to file their first R&D claim. Companies that have claimed in one of the previous three accounting periods are exempt from this requirement.