HMRC currently encourages innovation via two different R&D schemes, one for SMEs and a separate one for large companies. The SME scheme currently enhances R&D qualifying expenditure by 130%, so for every £100 spent, the company benefits from a deduction of £230 from its taxable profits. This deduction may either decrease their profit, switch their profit to a loss, or increase the losses of an already loss-making company.
Where R&D has taken the company into a loss or increased their loss, the company can choose to surrender the loss to HMRC in exchange for a payable tax credit at 14.5%. This tax credit is particularly common in start-ups and early-stage companies which have not yet made a profit and is a direct cash injection to the company.
The SME R&D scheme has been subject to misuse and abuse, with HMRC dramatically increasing the number of compliance notices issued over the past 12 months, which has been widely covered by the media. Jeremy Hunt referenced the misuse of the SME scheme during his Autumn Statement in November, as a precursor to the government’s changes.
From April 2023, the additional deduction will reduce from 130% to 86% and the payable tax credit will decrease from 14.5% to 10%. The impact of these changes depends on whether your business is profit making, loss making or breaking even.
While the SME scheme is set to decrease from April 2023, the large company scheme, known as RDEC, where companies receive a taxable expenditure credit for qualifying R&D, is set to increase from 13% to 20%.
It could be perceived that these changes to both the SME and RDEC schemes are the early signs of reforming HMRC’s policy into a single scheme for small, medium and large companies.
What does it mean in real terms?
Although on the face of it, the SME scheme tax benefit has been reduced, with the reduction of percentages to the cash credit and enhanced expenditure, as the tax relief is based on Corporation Tax, some of the reduction to the scheme will be mitigated by the increase in Corporation Tax rate to 25% from April 2023.
We have calculated how SMEs will be affected from April 2023, taking into consideration the reduced enhancement to 86% and reduction in tax credit to 10%, and the changes effectively reduce the tax benefit to profit making businesses by 13%, loss making businesses by 44% and break-even business by 54%.
As well as the changes announced within the Autumn Statement, several proposed changes were also put forward by HMRC on ‘legislation day’ in July 2022. These proposed changes are designed to expand the scope of qualifying expenditure, refocus the reliefs towards innovation in the UK and tackle abuse of the R&D scheme.
To expand the scope of qualifying expenditure, HMRC have proposed to encompass the cost of acquiring datasets and cloud computing costs, allowing software-based R&D projects to include the ever-increasing cost of hosting and on-demand cloud computing platforms into their qualifying expenditure.
To refocus the ‘run-off’ benefits of the R&D scheme back to the UK, the Government have proposed limiting the inclusion of externally provided worker and subcontractor costs, to only those undertaking the work in the UK.
To reduce the risk of misuse of the scheme, companies will need to pre-notify HMRC of their intent to make an R&D claim, within six months of the end of the relevant accounting period, unless they have previously made a claim in any of the three preceding periods.
It is worth noting that these changes proposed on legislation day are currently draft and therefore may change before they come into effect.
If you have any questions regarding these changes, we would be more than happy to discuss these with you.