R&D merged scheme

Unless qualifying as an intensive SME and therefore being eligible for the enhanced R&D intensive support scheme (ERIS), for accounting periods beginning on or after 1 April 2024, the merged scheme applies to all claimants regardless of size.

This replaces the previous SME scheme and Research and Development Expenditure Credit (RDEC) scheme, and broadly seeks to retain the best parts of both schemes, while introducing a greater focus on supporting UK-based R&D expenditure.

Unlike the SME scheme, there are no restrictions on claiming for subsidised expenditure under the merged scheme. This removes complexity from the regime and no longer penalises recipients of grant funding, subsidies, customer contributions, etc.

Merged R&D scheme – the tax benefit

The merged scheme adopts an expenditure credit calculation closely resembling the previous RDEC scheme, in the form of a tax credit calculated as 20% of the qualifying R&D expenditure. The credit is accounted for ‘above the line’ for accounting purposes and is taxable.

As an example, assuming qualifying expenditure of £100,000, the gross credit available would be £20,000. Assuming the main corporation tax rate of 25% applies, the benefit to the company is £15,000 (calculated as the £20,000 credit less tax at 25% of £5,000). As such, the effective tax benefit the company could receive is 15% of its qualifying expenditure. This increases up to 16.2% of qualifying expenditure if the company falls under the small profits tax rate of 19%.

Similar again to the previous RDEC scheme, there are seven steps which must be applied to determine how the tax credit is relieved:

1. The gross credit is used to discharge the company’s corporation tax liability for the accounting period to which the R&D claim relates.
2. Any credit remaining after step 1 is compared with the net expenditure credit (gross credit less applicable corporation tax). Any excess over the net expenditure credit is withheld and may be group relieved or carried forward to future periods. The balance is carried forward to step 3.
3. The amount brought forward from step 2 may be capped, based on the company’s total PAYE and National Insurance contributions (NICs) for the period. Should the credit be capped at this stage, IP-based exemptions can be considered to prevent the cap from applying. Any excess credit over this cap is otherwise carried forward to future accounting periods, while the balance is carried forward to step 4.
4. The remaining credit is offset by HMRC against any outstanding corporation tax liabilities which the company has for any other accounting periods.
5. Any remaining credit may be group relieved at the option of the claimant.
6. Any remaining credit is offset by HMRC against any other liabilities that the company owes to HMRC, such as VAT or PAYE.
7. Any remaining credit is payable to the company as a cash credit, provided the company is a going concern.

Additional provisions – contracted out R&D

A significant change and one which requires careful consideration, concerns contracted out R&D. This applies where a company has work contracted to it by a customer and the contractor seeks to claim relief, or where a company is undertaking a project and engages sub-contractors to perform discrete deliverables.

The objective of the R&D tax relief schemes is to increase the overall levels of R&D in the UK economy, and generate productivity growth by reducing the cost and risk of R&D. The objective of the new contracted-out R&D rules is therefore to reward the party making the decision to undertake R&D, encouraging it to undertake more R&D in the future. The right to claim will therefore generally sit with the customer provided the customer intended or contemplated R&D would be undertaken by the contractor, and it can articulate the sort of R&D to be undertaken.

The contractor can only claim if it can demonstrate that it has initiated R&D of its own volition in order to fulfil the commercial contract, or if it has been engaged by an entity unable to claim UK R&D tax relief (examples include overseas companies, government departments, charities, and higher education institutions. This will be a complex and subjective area and determinations will need to be considered and well-documented, based on the wording of the contract between the two parties, and wider surrounding circumstances; a key area that Saffery can help clarify.

Additional provisions – overseas contracted out expenditure

A further significant change introduced by the merged scheme and for accounting periods beginning on or after 1 April 2024, the intensive SME scheme, is a restriction on claiming payments for contracted out R&D performed overseas, and externally provided workers provided to the claimant from overseas.

Overseas expenditure is only permitted where a claimant can evidence that:

• The conditions necessary for the R&D are not present in the UK,
• The conditions necessary for the R&D are present in the location where the R&D is undertaken, and
• It would be wholly unreasonable for the company to replicate the conditions in the UK.

The classification of whether an activity would be wholly unreasonable to replicate will depend on the R&D activity undertaken, the circumstances of the company, and the reason for taking the work overseas. Evidence of why these conditions are all met should be maintained. A pharmaceutical company that engages an overseas contractor to carry out clinical trials on its behalf, which requires a specific demographic of subjects to test its health care treatment upon, should evidence that the demographic required are not present in the UK, but are present overseas, and that it is clearly unreasonable to replicate such conditions.

Undertaking the R&D activities overseas simply to save cost, or because workers are more readily available, will not qualify.

Eligible expenditure for merged scheme and ERIS

The main costs which are eligible for R&D relief are:

• The costs of employing staff who are directly engaged in carrying out the R&D itself, as well as indirect costs related to some necessary supporting and ancillary activities (eg administration or maintenance activities insofar as undertaken for R&D).
• Sub-contracted activities. Payments made to sub-contractors undertaking R&D activities contracted to them, or undertaking routine activities essential to the principal company’s R&D can be claimed, subject to a restriction to 65%. Different rules apply where the claimant and sub-contractor are connected. For accounting periods beginning on or after 1 April 2024, claimable contracted out activities are limited to those undertaken in the UK. Overseas costs are only claimable in very limited circumstances.

• Externally provided workers. Payments made for workers provided to the claimant by a staff provider (eg agency or personal services company) can be claimed so far as those workers are engaged in undertaking R&D activities under the supervision, direction, and control of the claimant. Qualifying expenditure is restricted to 65%, although different rules apply where the claimant and staff provider are connected. For accounting periods beginning on or after 1 April 2024, claimable expenditure is limited to payments for workers whose earnings are subject to PAYE/NIC. Overseas costs are only claimable in very limited circumstances.
• Consumable items. Expenditure incurred on, for example, materials, or light, heat, power and water may be claimed, provided that they are consumed or transformed in the R&D process. Expenditure incurred on consumable items which form part of goods later sold or transferred as part of the company’s ordinary business cannot be included.
• Computer software. Payments for licences are claimable so far as the software is used in the R&D activities. This does not include expenditure on hardware, domains, certificates, or internet fees.
• For accounting periods beginning on or after 1 April 2023, costs of data licences and of cloud computing services (including remote data storage) are eligible so far as employed in the R&D (and subject to some cost-recouperation exclusions).

• Payments to participants of a clinical trial, provided the trial is undertaken in connection with the development of a health care treatment or procedure.

How Saffery can help

Having undertaken claims for companies of all sizes from all sectors (including but not limited to manufacturing, IT, pharmaceutical, construction, food, and beverage and agricultural), Saffery ensures that claims are both maximised and robust.

Our approach is flexible and tailored to your company’s requirements to ensure that the process is cost and time efficient. Our involvement can vary from initial workshops and feasibility work, to reviewing a claim prepared by your company, to preparing the supporting claim documentation alongside you. Our work can help you to identify whether any of your company’s activities might constitute R&D for tax purposes, which scheme is appropriate to claim under, and the quantum of the claim.

Alternatively, if you have already submitted R&D tax credit claims but HMRC has opened an enquiry into your claim, we can work with you to bring this to a conclusion.

If you have any questions on the matters discussed, please get in touch with either Rachel Chappell or Ollie Bull.

Further information:

R&D Tax Relief

R&D Tax Relief for SMEs

Enhanced R&D intensive support (ERIS)

RDEC: Research and Development Expenditure Credit