Lee Sharpe looks at the latest issues for small businesses hoping to benefit from this valuable relief.
HMRC is becoming increasingly concerned that many small and medium enterprise (SME) research and development (R&D) claims are ‘speculative’ with little justification. This is problematic for HMRC, which has limited appetite to review claims in detail.
The government has announced various measures intended to refine the regime, as outlined in this article.
Basic mechanics of the standard SME regime
There are a great many conditions, but essentially:
- The company must have a defined project to resolve a ‘technological uncertainty’ for commercial application – where an expert (a competent professional in that particular field) might say: “I don’t know precisely how to achieve the project aims. It is not common knowledge amongst my fellow professionals. I have some ideas; some may work, others may not.”
- The company must incur certain types of cost – only certain categories can be subject to a claim:
- Staff costs, including directors’ salaries and employers’ NICs.
- Costs for certain types of work subcontracted to other firms or brought-in workers.
- Consumables: heat, light and power consumed as part of the project; software and materials needed for prototyping, testing, etc.
Example: New R&D project
Cabaret Voltaire Ltd specialises in stage lighting. They not only re-sell lighting solutions from other firms but design their own – not the LEDs themselves, which are mass-manufactured, but the lenses and the housings, to ensure that they are able to dissipate heat effectively (excessive heat build-up reduces an LED’s working life). They have an in-house expert and occasionally hire materials specialists as and when required. They outsource the actual fabrication of prototypes but have a small studio for testing.
Their latest goal is a heavy-duty but hand-portable lighting unit in a housing that can sit on the ground and withstand rough handling, splashes or rain, with a guaranteed mean runtime of 10,000 hours and 20,000 switches. The technical challenge is balancing a heavy-duty sealed housing that is still capable of dissipating heat so that the LEDs do not fail too quickly. But it is not mere trial and error; the in-house expert has a background in materials engineering and several years’ experience of designing for this and a previous company:
*The calculations for payments for sub-contracting or externally provided workers, licensing and prototyping can become involved or restricted but this is only a simple illustrative example.
Many readers will be aware that the usual approach for SMEs is to uprate the eligible expenditure by 130% (but only in the tax computations; the alternative ‘above-the-line credit’ route is not covered here). To the extent that this enhanced cost of £115,000 creates or increases a tax loss, that amount may be surrendered for a payable tax credit, currently at 14.5%.
PAYE cap
There used to be a rule that any payable tax credit was capped at no more than the total PAYE and National Insurance contributions (NICs) paid by the company in the period, but this was considered too restrictive and was abolished (in FA 2012).
However, HMRC has been panicking ever since about an ‘explosion’ in micro-claims now that directors’ modest salaries are no longer a major stumbling block. The government has set a new cap (in FA 2021), for accounting periods commencing on or after 1 April 2021 of:
£20,000 + 3 x (PAYE+NICs for the period).
This seems a reasonable threshold, particularly when the claimant company is allowed to augment the cap by reference to work done by connected parties – or bypass it completely if the company is working on creating intellectual property (so long as, broadly, its outsourced costs amount to no more than 15% of total spend).
Imminent changes
At the time of writing, the following changes (expected to be included in Finance Bill 2022-23) will apply to accounting periods starting on or after 1 April 2023:
- The scope of eligible R&D itself will be widened to include pure mathematics – deemed essential for the UK to press ahead in fields such as artificial intelligence, machine learning, robotics, etc.
- The scope of eligible categories of expenditure has also been broadened to include expenditure on cloud computing and data hosting, and licence payments to access datasets.
- However, eligible R&D activities will in future be largely constrained to the UK, so that work cannot be conducted overseas unless those workers are subject to PAYE in the UK or there is some geographical, environmental or social condition that is not replicable in the UK, such as volcanic research or (hopefully!) the next zombie virus (one might hope that HMRC would not be too keen to see if it could be replicated in the UK, before allowing the relief!).
More seriously, there were suggestions that some larger multinationals were conducting substantive R&D activities elsewhere but effectively recharging such costs to affiliated UK companies to access R&D relief in the UK. One infers that the UK would not be the primary beneficiary of any intellectual property developed from such work – which is the whole point of the regime!
- All R&D claims must be submitted digitally. This will include where the claim is submitted by way of a repair to a CT600.
- Additional supporting information – HMRC is to set out the kind of information that it wants to receive in support of a claim, likely:
- Summary of the basis of the claim and the work undertaken.
- Breakdown of the costs across categories.
- Endorsement of a named senior representative of the company or any advisory agent.
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Pre-notification – A company will have to warn HMRC that it intends to file an R&D claim within six months of the end of the relevant accounting period that is the source of the claim unless a claim has previously been made in the previous three accounting periods
There are several minor changes or clarifications as well, not mentioned here.
Conclusion
It seems most of the beneficial changes are aimed at larger companies – or at least, not primarily at SMEs. Having said that, the new ‘UK-centric’ condition could dissuade large, genuinely international R&D collaborations from wanting to base their operations in the UK in the future. And if, following the change, HMRC starts insisting on evidence that payments to all externally provided workers have been subjected to UK PAYE, this could become a significant administrative burden for claimant companies across the board.
The pre-notification requirement seems designed simply to trip up small companies that have only just set up. Certainly, it seems to militate against R&D specialist firms trying to promote the relief. The argument that “you didn’t know about the relief before undertaking the project, so why should you be able to claim it afterwards?” seems rather harsh. In particular, start-ups often have a long first period of account and in such scenarios seem almost doomed to forfeit a claim. Perhaps the answer is for agents to send in a protective notice for every new company client, etc. by default. This would soon show HMRC the error of its ways.
More broadly, note the government has expressed no desire to increase the payable credit, despite the main corporation tax rate being set to rise from 19% to 25% from 1 April 2023 (at least while I write this). While some companies will prioritise the payable credit for cashflow reasons, the basic calculus has shifted even further in favour of simply holding the losses to offset future profits. Simply put, 14.5% today versus a saving of 25% or even 26.5% tomorrow, assuming profits will arise, of course.
