How a single R&D tax relief scheme could affect SMEs

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Merging the two schemes could simplify access but complicate matters for SMEs.

Government proposals to merge the two Research and Development (R&D) tax relief schemes into one single scheme has been met with mixed responses by accountancy bodies including AAT.

Under the plans, which form part of the government’s ongoing review into R&D tax relief, the Research and Development Expenditure Credit (RDEC) and the SME R&D relief would be combined under one umbrella by April 2024 in order to ‘simplify’ the existing system.

Both schemes currently work slightly differently: the SME scheme enables eligible businesses to claim additional tax relief via enhanced deductions whereas the RDEC scheme offers tax credits.

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The new scheme would be based on the existing RDEC system. Supporters of the new proposals say the new system would enable SMEs to know upfront the amount of tax relief they can claim, rather than having to wait until the end of the next accounting period to find out, as is currently the case. However, others believe that a blanket approach will prevent otherwise eligible businesses from accessing tax relief.

Features of the proposed scheme could include:

  • above the line credit
  • same treatment of subcontractors would apply to all claimants
  • a PAYE/NIC cap
  • new restrictions on claiming R&D relief for some overseas activities
  • aim for start date of 1 April 2024.

We spoke to accountants to find out how these plans are likely to affect UK businesses.

Business will find it easier to access tax relief under reforms

Andy Smith FMAAT,  Founder, Abbeygate Accountancy

I believe the proposed reforms have the potential to make it easier for businesses to access tax relief and promote more investment in R&D activities. Ongoing tax uncertainties may be holding businesses back from doing more R&D, especially around the eligibility criteria for tax relief and the amount they can claim. But I’m aware there may be other factors holding clients back too, such as lack of resources, expertise or access to funding.

So for those who are put off from investing in R&D due to tax uncertainties, I’m hopeful the reforms will address these issues by improving awareness and simplifying the process.

However, I do acknowledge there may be concerns around the administrative burden of implementing the changes and ensuring compliance with new regulations. It’s important for businesses to stay informed about the proposed reforms and how they may affect their operations to ensure they are compliant.

Verdict: The reforms will make it easier for businesses to access tax relief by simplifying the process.

R&D merge will reduce barriers to claiming but details and implementation remain concerns

Tom Biggs, Associate, Wellers

A simplified R&D scheme that removes the intricacies of moving between two differing schemes for SMEs can only be a good thing in the long run.  Also, removing the need to identify which projects fall within which R&D scheme will make the claim process significantly more straightforward and reduce the barriers to making a claim.

We do however, have concerns. The consultation suggests that the SME scheme has been unsuccessful in encouraging R&D claims. It implies that an above-the-line scheme offers more incentives, but it’s not clear how moving to the RDEC scheme will incentivise clients further.

Due to corporation tax changes, there are likely to be differences in the amount of relief  SMEs obtain due to above-the-line credit mechanism. This will particularly affect SMEs within the marginal relief band. 

There is a significant education gap that needs addressing: some SMEs don’t fully understand the R&D scheme. For example, there’s an assumption that a business must undertake cutting-edge scientific projects to qualify, but the R&D criteria has a much wider reach than this.

The proposal of a de minimis expenditure amount also needs careful consideration. The scheme was designed to subsidise R&D expenditure, yet many start-up companies do not have the funds to contribute in the beginning. Introducing a de minimis level of expenditure is likely to exclude many of these companies and potentially stifle R&D from the outset.

Finally, April 2024 doesn’t give SMEs enough time to prepare. Businesses are already experiencing radical changes to the SME R&D scheme starting this year. A further change one year later is a significant amount of disruption.

Verdict: The overall proposal itself will remove intricacies, but concern around the detail and implementation of the scheme remains.

A single scheme based on both RDEC and SME systems is the way forward  

Ludovic Black, Partner in the Life Sciences and Pharma department, Mazars

A single scheme based on the existing RDEC regime is a sensible way forward, provided it takes account of the particular features of the current SME regime.

For example, in respect of subcontracted expenditure, we believe that all companies claiming R&D tax relief, whether small or large, should be able to claim for such qualifying costs.

Furthermore, we expect that the best value for the taxpayer will come from those that are incentivised to optimise their cost base, rather than those incentivised to increase the level of their qualifying expenditure. As a result, we believe it would be best to allow those customers claiming for qualifying R&D costs to be able to claim such costs, rather than the business which is the subcontractor.

In conclusion, the merger will make things easier in so far as it will remove the need for companies to assess whether they are regarded as an SME or large (claiming under the RDEC regime) for R&D purposes. However, uncertainty and complexity is still likely to arise when determining (a) whether a company has undertaken qualifying R&D activities in accordance with the BEIS guidelines, and (b) what costs can be included in a claim, particularly if the legislation is not clear in terms of the subcontracted point outlined above.

Verdict: A single scheme based on existing RDEC, which takes the SME scheme into account, is the way forward.

Improving regulatory frameworks should be the priority

Jenny Tragner, Director and Head of Policy, ForrestBrown

If the single scheme is modelled on the more recently designed RDEC structure, it should provide more certainty and visibility, and boost access to the R&D tax relief scheme for innovative businesses. With RDEC, the benefit of a claim is consistently proportional to the qualifying R&D expenditure incurred, so businesses can easily factor the benefits of the scheme into future investment decisions and financial planning.

That said, rather than making piecemeal changes to R&D tax relief, an overarching priority should be improving the regulatory framework for professional tax advisers. Abuse of the relief can be mitigated with the right resources – we cannot let a minority of fraudulent claims impact innovation if we want the UK to cement its place as a science and technology superpower.

Furthermore, a major concern is that the single scheme will come at the expense of reduced generosity for SMEs. While enhancing support for R&D-intensive SMEs is welcomed, the qualifying criteria invites too much ambiguity for businesses that are already struggling to understand the rate decrease last Autumn. We need a coherent strategy to support SMEs that face considerable barriers in undertaking R&D, including finance and cashflow constraints.

The Government should establish a clear roadmap for design and implementation of the single scheme, including consideration of the rates of relief. There’s still an opportunity to shape a future incentive that incorporates both a more generous rate of relief for genuine R&D carried out by SMEs and specific rates for different types of R&D projects.

Verdict: The single scheme will help boost access to R&D tax relief but the overarching priority should be to improve regulatory frameworks. 

Scheme will be simpler for filing claims but will disproportionately affect SMEs

Jamie McLellan, Senior Manager, Haines Watts

The scheme could have a disproportionate impact on SMEs if the merger abolished the SME scheme, effectively shifting those companies onto the RDEC scheme.

In practical terms, it will be easier to just follow one set of rules. However, the Government has now introduced a new one – an enhanced rate for R&D-intensive companies (where 40%+ of trading expenses are R&D related). There is a risk that this could be seen by some as a target, increasing the scope for manipulation and abuse.

Two prominent factors have yet to be publicly addressed, which could heavily impact SMEs:

PAYE/NIC Cap – Both schemes run with caps on the tax credit that can be paid (to ensure that the bulk of R&D work is undertaken by UK-employed staff) as follows:

  • SME – £20,000 plus 300% x all PAYE and NIC incurred in the period
  • RDEC – all PAYE/NIC incurred by staff involved in R&D during the period (regardless of their level of involvement)

If only one approach is carried forward, this will either create a huge increase in the potential level of credit that large companies can claim, or a drastic reduction in the amount of credit payable to SMEs.

We’d recommend creating a hybrid scheme, to balance the level of benefit between the two groups.

Subcontractor Costs – Currently, an SME can claim for R&D activities that it has subcontracted to other businesses but RDEC does not allow this (although SME subcontractors can claim for that work under the RDEC scheme). As many small companies are contracted to larger ones, it’s likely the rule could be extended so that all companies undertaking subcontracted R&D can claim.

This could result in:

  1. larger companies becoming eligible to claim for R&D costs they are contracted to undertake
  2. smaller companies feeling deterred if incurred costs are now claimed by the subcontractor
  3. ineligibility where specialist subcontractors are not companies.

Verdict: Scheme will be simpler for those filing claims but will disproportionately affect SMEs

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Annie Makoff is a freelance journalist and editor.

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