How R&D tax relief reforms will affect accountants

Accountants worry reforms will discourage innovation and undermine messages about the UK being a good place to invest.

One of the major changes announced in Jeremy Hunt’s Autumn Statement 2022 included a significant overhaul of the Research & Development (R&D) tax credit system, as part of continued R&D reforms first announced in Budget 2021.

Currently, UK businesses that have invested in research and development activities including new and/or existing product development and/or systems or processes are eligible for tax relief.

Tax relief is available for any UK business that pays Corporation Tax. Companies receive either a cash payment from HMRC or a reduction in Corporation Tax.

Larger companies claim for R&D Expenditure Credit (RDEC) while R&D tax relief is aimed at small and mid-size enterprises (SMEs).

The reforms, which will take effect from April 2023, primarily target the SME part of the scheme, and involve:

• Reducing the deduction rate for SMEs from 130% to 86%.
• Reducing the credit rate from 14.5% to 10%.

However, larger companies eligible for RDEC are set to benefit from an increased rate from 13% to 20%.

The proposals have been met with widespread criticism from SME business groups and industry bodies, which say it could cause many SMEs – and especially start-ups – to struggle to survive. 

We spoke to accountants across the UK to find out how the reforms are likely to affect their clients.

Reforms will have huge repercussions for genuine SMEs involved in R&D

Claire Lea, Director and Head of Advisory Tax, Prime

The Autumn Statement included measures intended to reduce abuse of R&D tax claims by cutting the deduction rate for the SME scheme to 86% and the credit rate to 10%.

This will have huge repercussions for genuine SMEs, many of which plough the money generated from the R&D credits straight back into business, reinvesting in staff recruitment and capital equipment to grow and develop.

It appears the new chancellor is trying to balance the impact this will have by offering a 7% increase in RDEC expenditure credit. RDEC is a tax relief primarily used by larger companies and a small minority of SMEs where they do not qualify for the more generous SME scheme.

R&D relief has been a lifeline for some of our SME clients who have struggled following the pandemic and it’s a shame to see this support being curtailed when we have seen it help to keep fledgling, innovative SMEs on their feet.

At a time when the Government itself is championing innovation in particular, it seems a knock to those enterprising individuals who will ultimately make this possible.

Verdict: This change will have huge repercussions for genuine SMEs involved in R&D.

Cutting R&D is counterproductive and has little fiscal benefit in the short term

Chris Denning, Corporate and International Tax Partner, MHA

The Government bangs the drum regarding greater sector innovation but reducing the tax benefits of undertaking R&D in the UK is wholly counterproductive. It has little fiscal benefit in the short term and, coupled with the increase in Corporation Tax to 25% from 1 April next year, doesn’t send out the message that the UK is open for business and is a good place in which to invest.

Verdict: Cutting R&D is counterproductive and has little fiscal benefit in the short term.

The reforms aren’t there to disincentivise innovation, but they will impact genuine loss makers

David Herd, Group Director, Champion Group

There are two main drivers for the changes announced in the Autumn Statement: firstly, to tackle error and fraud and secondly, to simplify the scheme by reducing SME relief and increasing the RDEC rate to bring them more in line with one another.

For profit-making companies with R&D claims, this isn’t particularly bad news: although the rate of relief has decreased, the increase in Corporation Tax to 25% sees overall relief on a per-£-spent basis actually increase. Loss-making companies, however, will see their relief cut greatly due to the sharp cash credit reduction, and this could severely impact start-up businesses.

Companies that haven’t ever submitted a claim risk losing out significantly. Companies that don’t know about R&D tax relief, don’t act on it within six months of their accounting year-end or don’t make the required pre-notification in time will lose the ability to claim for that year.

Companies do have the option of innovation grants, but these are targeted, project-driven grants and involve an all-or-nothing outcome based on a long list of conditions.

Ultimately, the reforms are not there to disincentivise innovation, but they do impact genuine loss-makers adversely. Businesses that need to innovate to compete, such as software companies, will however continue to claim. It’s all about encouraging businesses to claim for the right projects for the right reasons, and ensuring specialist professional advisors operate with integrity and transparency – ultimately stamping out what HMRC describes as ‘rogue agents’.

Verdict: The reforms aren’t there to disincentivise innovation but they will impact genuine loss-makers.

Reduction in appetite for business to undertake R&D projects is likely but alternative funding options are available

Rob Hackney, Tax Manager, DSG

The Autumn Statement 2022 included changes to the rates of relief. For SMEs, the rate of additional deduction will reduce by a third and the rate of credit available for surrender of losses will reduce from 14.5% to 10%. For larger corporate businesses, the credit available under the RDEC scheme will increase from 13% to 20%.

Business appetite for more speculative R&D projects is likely to reduce due to these changes, but there are still significant tax (and other) incentives for UK-based innovation. There are a variety of grant awards available to help fund R&D projects, particularly from Innovate UK – as well as various regional schemes.

For companies where R&D activity includes an invention that the business can patent, the Patent Box regime can provide significant tax benefits, achieving an effective 10% Corporation Tax on revenue streams attributable to the patented invention. For capital expenditure on R&D, 100% first-year capital allowances are available, allowing immediate relief above the £1m limit of the annual investment allowance.

Verdict: Reduction in appetite for business to undertake R&D projects is likely but there are still alternative funding opportunities are available.

Reforms could hinder UK innovation and have big impact on SMEs

Iain Wheat, Tax Manager, UHY

The reforms will have a big impact on SMEs especially those carrying out R&D and surrendering the loss for a repayment, as they will be negatively impacted in the P&L and the bottom-line cash repayment – which has decreased from 14.5% to 10%.

An alternative tax relief that companies can claim is Patent Box relief, which enables companies that have UK patented products to claim a beneficial tax rate on profits from the patented product. This is a very underused relief and can be very complex in its nature.

Overall, I imagine that the reforms will hinder future UK innovation given that companies will have fewer resources with which to invest. Couple the R&D reforms with soaring energy costs and the cost-of-living crisis, and times will definitely get harder before they are to get better.

Verdict: The reforms will have a big impact on SMEs and could hinder UK innovation due to reduction in tax credits.

Businesses with genuine R&D tax relief schemes are penalised while tackling erroneous and fraudulent claims

Sarah Gardner, Founder, Allegro Tax

Although the R&D tax relief scheme is still available, the Corporation Tax reduction and the repayable cash credit will be significantly lower than at present. This will have a direct impact on the cash flow of businesses making the claims.

Clients are understandably disappointed, and some are baffled by the motivation behind the changes. It does not appear fair that businesses making genuine, accurate claims in good faith are losing benefits due to attempts to tackle erroneous and fraudulent claims.

The general consensus is that it would have made much more sense for HMRC to tackle the unscrupulous advisers and fraudulent claims head-on rather than simply making the scheme less appealing.

Although there are still grants available to fund R&D, companies should be aware that receiving these can have an impact on the level of R&D relief available.

Verdict: Businesses with genuine R&D tax relief schemes are being penalised in order to tackle erroneous and fraudulent claims, which does not appear fair.

The rate of relief for SMEs is decreasing but it’s still worth claiming

Stephanie Hurst, Tax Director for Corporate Tax Consultancy and Personal Tax Compliance, Monahans

Any reduction in relief relating to R&D activities may cause businesses to re-think their activities, particularly those that are already in the midst of an innovative project.

UK R&D businesses are generally small start-ups that are loss-making, so it’s likely they have been benefitting from the 14.5% payable credit option for SMEs. This payable credit is usually reinvested into the R&D project, so a reduction in the rate from April 2023 may impact plans to invest in further innovation or may delay certain stages of the activities.

These reforms may spark some hesitation from new claimants, but the scheme still remains very competitive, providing a significant amount of tax relief and, in some cases, funding for innovative businesses. It is absolutely still worthwhile making a claim for R&D tax relief if you qualify.

Businesses seeking alternative funding sources should always review the impact this has on any R&D tax relief claim.

Verdict: The rate of relief for SMEs is decreasing but claiming is still worthwhile.

AAT Comment offers news and opinion on the world of business and finance from the Association of Accounting Technicians.