By Christian Doherty MembersResearch & Development tax relief changes fallout for SMEs21 Jan 2025 What’s happened since the R&D tax credit shakeup in 2024? We take a look at the consequences for HMRC and small- and medium-size enterprises.The UK’s position as a leader in innovation has been the subject of much debate in recent years, particularly post-Brexit. And while disagreement rages over the details, all agree that British firms must be encouraged to develop new and innovative products and services. Since its launch in 2000, one of the key vehicles for that has been R&D Tax credits.2024 saw a major shake up the administration of R&D tax credits, with the biggest change being the creation of a merged scheme R&D expenditure credit (RDEC) and enhanced R&D intensive support (ERIS) replacing the old RDEC and small and medium-sized enterprise (SME) schemes for accounting periods beginning on or after 1 April 2024. So, unless companies have a shortened accounting period, the chances are they won’t have seen any of these things take effect yet.“Seismic shift”But changes are afoot: “The merger will bring the SME scheme and the RDEC scheme together to basically say that we’re going to only incentivize businesses to claim above the line, like a 20% rate,” explains Akshay Thaman, IP and Policy Lead for Source Advisors.“So what they’re basically saying is if you’re a customer, i.e. the business that’s contracting that R&D out, then you’re most likely to be able to claim because you’ll take the financial risk. You should be aware of what R&D activities you’re contracting out, and so you’ll be the one to claim, but there are some exceptions around that rule, but it follows the old SME rules rather than the old RDEC rules.”The second main change under the new regime covers overseas expenditure on R&D, which is no longer allowable. “That means if you’re contracting out R&D activity to an overseas entity, then you won’t be able to, in most cases, claim for those costs back to using this scheme,” says Thaman.It adds up to a seismic shift, says Jennifer Tragner, Partner, R&D Incentives Advisory at Evelyn Partners and a seasoned observer of the R&D relief space. “Although I’m not sure I’ve got any benchmark for what a small year looks like, it has been a busy period, in terms of culmination of the consultation and the implementation of the merged scheme.“That’s along with an increase in awareness around compliance activity and the debate around the impact of that, with around 10 tribunal judgments in one year. If nothing else, I think that makes it quite a big year.”HMRC’s new approachThe most immediate impact has been a significant change in tone and intensity of HMRC’s implementation of its compliance activity and how it assesses claims. And that has not been met with universal approval, with a growing consensus that more claims are being rejected, often unfairly.“There seems to be a presumption of the claim being incorrect at the beginning,” says Thomas Hayden, Research & Development Director at Moore Kingston Smith. “That means the inspector is not there to determine what the correct answer is, but rather is there to argue the point that the claim is invalid. And this seems to be regardless of any sort of logic or real substance behind these arguments.”Jenny Tragner argues this could have been handled better. “Had HMRC ensured that it had sufficiently experienced compliance officers to deploy that level of increase in compliance cases and keep the service levels high, then I think they could have managed the collateral damage much better,” she says.“I expect HMRC would say that something had to be done at scale and very, very quickly. And the cost of that was that we ended up with very inexperienced case workers on those compliance cases, largely unsupervised, and we had lots of instances of poor-quality work.”“Perception of a hostile environment”Many agree a stronger approach to compliance should tackle the issue of fraud. This includes putting out of business some of the boutique firms indulging in speculative and spurious R&D relief claims.But there is another side to it: “We’ve already seen quite a few cases of businesses dropping out of inquiry just because it’s too much effort,” reports Akshay Thaman.“I’ve had people write to me saying that we’re not going to be claiming any more because of what HMRC is doing. We’ve also got a couple of examples of businesses that have gone abroad as a result of the changes. I don’t know if that’s completely the reason, but it’s probably one factor as to why they decided to do that.Tragner is keen to point out that it’s too soon to tell what the changes will mean in the long term, but does draw some conclusions as to whether the changes have had the desired effect: “I think when it comes to those changes specifically targeted at reducing error and fraud, it probably depends on your viewpoint.”“I’m convinced that there were fewer fraudulent and speculative claims submitted than previously.“However, having supported businesses with dispute resolution, I’m also aware that there are plenty of cases in there of claims being reduced or rejected entirely incorrectly by HMRC because of poor compliance activity.“And I’ve spoken to businesspeople who have said that they’re going to opt not to claim relief for work that they believe qualifies just because of that perception of a hostile environment.”Landscape for accountantsThe changes won’t just affect businesses claiming (or deciding against claiming) R&D relief – accountants will also probably feel the impact. “I think that there will still be a need for R&D advisors while the relief is still available, but what would happen is we’d probably have to change our talent and go and do more larger claims and maybe fewer smaller claims if it goes as it looks like it’s going to go,” says Iain Wheat Senior Tax Manager at UHY Hacker Young.“But I still think many of the SMEs do good R&D, and if the claim is sizable enough it warrants paying a fee to an advisor. I don’t see that changing anytime soon. So it’s possible we’d have more specialist R&D because the rules are a bit tighter.”What’s nextBut despite that, Wheat believes things will get worse before they get better: “So, speaking from experience, my view is we’re actually not really falling foul of these rules as of yet, and hopefully won’t. However, I do know of people, and I’ve read cases on LinkedIn and other business websites where there are some absolute calamities from HMRC’s point of view.”Thomas Hayden sums up the worry many feel around the chilling effect the changes may have on smaller firms in particular: “Anecdotally I know of companies that are confident they qualify and have had inquiries go in their favour. In spite of that, they’re not going to bother making future claims because it’s just not worth the effort if it does go to inquiry for them again.“It feels SMEs are being clobbered from that perspective. And then, they’re also being clobbered from the perspective that HMRC are far more likely to open the inquiry on an SME in the first place. So it’s a double whammy.” Christian Doherty is a business journalist and freelance writer for AAT.