Policy paper

Explanatory note (accessible version)

Published 18 July 2023

Clause 1: Corporation Tax: Research and Development

Summary

1. This measure provides a new merged research and development (R&D) scheme (“the Merged Scheme”), replacing both the current R&D tax relief for small or medium-sized companies (SMEs) - the (“SME Scheme”) - and the R&D Expenditure Credit (RDEC), mainly claimed by larger companies. The Merged Scheme would apply from April 2024, should Government decide to introduce it.

2. The measure also provides additional relief for R&D intensive SMEs through a higher rate of payable credit (“the Intensives Scheme”) from April 2023. Those entitled to this higher rate would, from April 2024, continue to claim under rules similar to the current SME scheme rather than under the merged scheme, should it be introduced.

Detail of the Schedules

Schedule 2: Part 1: Amendments of CTA 2009

3. Paragraph 2 removes Chapter 6A of CTA 2009, the existing legislation covering RDEC.

4. Paragraph 3 amends the heading of Part 13 CTA 2009, the existing legislation for the SME Scheme, to remove the words ‘Additional relief for’. This is because Part 13 will contain rules for both the new Merged Scheme and the Intensives Scheme.

5. Paragraph 4 amends chapter 1 of Part 13. It replaces existing section 1039 with an updated section 1039 – the updated section lists the new contents of Part 13, being the Merged Scheme rules and the Intensives Scheme rules.

6. Paragraph 4 also adds a new section 1040 to CTA 2009, preventing customers from claiming relief under both Chapters 1A (the Merged Scheme) and 2 (the Intensives Scheme) at the same time.

7. Paragraph 5 inserts the new Chapter 1A into Part 13 of CTA 2009, providing the rules for the new Merged Scheme.

8. New section 1042A lists the contents of Chapter 1A.

9. New section 1042B provides that companies carrying out a trade and incurring qualifying expenditure can claim R&D expenditure credit on that expenditure. Subsection (4) excludes from entitlement higher education establishments, charities and any companies specified by the Treasury in regulations.

10. New section 1042C sets out conditions for qualifying expenditure. To qualify for relief expenditure must not be linked to activities that have been contracted out to the company, subsidised by another party, or attributable to an exempt foreign permanent establishment. Condition A makes an exemption for activities that have been contracted out to the company when the other person is not a UK Corporation Taxpayer (e.g. is an overseas company.) [The subsidy provision is in square brackets because it is still under consideration].

11. New section 1042D provides that expenditure that relates to relevant R&D undertaken by the company itself (“in-house”) is eligible for relief so long as it falls under one of the specified categories of qualifying expenditure.

12. New section 1042E provides that contracted out expenditure is eligible for relief so long as it relates to relevant R&D undertaken on behalf of the company and is either UK expenditure or qualifying overseas expenditure.

13. New section 1042F provides the rate of credit available for trades subject to the main rate of CT (20%), and for ring-fenced trades (49%). It also provides a power for the Treasury to make regulations to vary these percentages.

14. New section 1042G provides that a claimant company must bring the amount of credit claimed into account as a receipt in calculating its trading profits.

15. New section 1042H sets out the 7 payment steps, which are the same as the current Chapter 6A provisions. It has the same effect as these provisions.

16. New section 1042I provides for the treatment of an excess at Step 3 to be treated as an amount of tax credit to which the company is entitled for the next accounting period. It has the same effect as the provision which is contained within Step 3 of section 104N.

17. New section 1042J provides the method used to calculate the amount of notional tax for the purposes of Step 2 in section 1042H. It has the same effect as Step 2 in section 104N(2), and replaces s104N(3).

18. New section 1042K permits the company to surrender all or part of an amount deducted at Step 2 in section 1042H(2) to another group company. Any excess that is not surrendered will be used to discharge the company’s own CT liability in any later accounting period.

19. New section 1042L provides that the notional tax deduction from Step 2 in section 1042H must be applied as far as possible under section 1042K before any excess expenditure credit can be used at Step 4 or Step 5 in section 1042H(2). It has the same effect as the current provisions.

20. New section 1042M provides the method used to surrender amounts of expenditure credit to other group companies.

21. New section 1042N provides for the situation where a company is claiming for work subcontracted to it other than in the course of the customer’s chargeable trade (see Condition of new section 1042C). It replicates current section 104W which applies where the two parties are members of the same group, and allows R&D of the customer to be treated as if it were R&D of the subcontractor in certain circumstances. The government would like further discussions to understand how a potential merged scheme could distinguish between ‘normal’ contracts and ‘subcontracted out R&D’ so that those undertaking qualifying R&D are enabled to claim relief, whilst avoiding double claims.

22. New section 1042O makes specific provision for insurance companies, maintaining the current treatment set out at s104V, Paragraph 6 amends Chapter 2 of Part 13 CTA 2009.

23. Paragraph 6(2) amends the heading of Chapter 2, replacing ‘relief for SMEs on the cost of R&D’ with ‘Relief for R&D-intensive SMEs’’.

24. Paragraph (3) amends section 1043 (overview of Chapter) in line with the amended Chapter 2, in particular adding in the R&D intensity threshold and providing that Chapter 2 should be read with Chapter 8.

25. Paragraph 6(4) amends section 1044 to require that a company claiming the additional deduction meets the intensity threshold in the period.

26. Paragraph 6(5) makes a similar change to section 1045. It provides for a company that is pre-trading in respect of a deemed trading loss

27. Paragraph 6(6) inserts new section 1045ZA which sets out the new intensity condition. Subsections (1) to (8) of the new section 1045ZA set out the conditions which determine whether a company/connected company meet the 40% relevant expenditure rule, and what constitutes relevant expenditure in an accounting period.

28. Paragraph 6(7) omits section 1046, and subparagraph 9, section 1057 from the legislation. These sections limit relief to companies that are going concerns. This limitation is now provided elsewhere in the legislation.

29. Paragraph 6(8) amends references to ss1057 and 1060 to refer instead to new sections 1112F and 1112H.

30. Paragraph 6(10) amends section 1058 to provide the higher rate of payable credit for R&D intensive companies (14.5%, rather than 10%) and, with subsection (11), removes the PAYE/ NIC cap which is, again, provided elsewhere in the legislation.

31. Paragraph 6(12) makes consequential amendments to section 1060.

32. Paragraph 6(13) inserts new section 1062A which excludes insurance companies carrying on life assurance business from the scope of the relief, as is currently the case in the SME Scheme.

33. Paragraph 7 omits Chapter 6 of Part 13.

34. Paragraph 8 amends Chapter 8 of Part 13 and renames it “Restrictions on credits and relief under this Part”. It inserts a number of new sections that introduce limits and restrictions on the availability and amount of relief available under certain conditions. Some of these restate rules in the current RDEC and SME Schemes.

35. New section 1112A provides an overview of the Chapter 8.

36. New sections 1112B to E provide a cap on the amount of R&D expenditure credit or payable tax credit based on the company’s PAYE and NIC liabilities (a “PAYE/ NIC cap”) similar to that which currently exists in the R&D tax relief for SME companies.

37. New section 1112F provides that a company which is not a going concern cannot claim relief. Subsection (3) disapplies this rule if the company becomes a going concern by the last date for amending its company tax return for the claim period. Subsection (5) provides that a company which ceases to be a going concern after claiming relief will not receive any amount that has not yet been paid or applied.

38. New section 1112G defines the meaning of “going concern” as relating to a company’s latest accounts, and excludes companies either in administration or in liquidation. Subsection (5) treats a company as a going concern if its trade and research and development was transferred to another group company.

39. New section 1112H provides that HMRC does not have to pay any payable R&D credit while the company’s tax return for the claim period is under enquiry. Subsections (3) and (4) extend this rule if the company has any outstanding PAYE or Class 1 NICs for the same accounting period.

40. New section 1112I is an anti-avoidance provision that prevents relief being given where it would arise from transactions that have a “disqualifying purpose”, being one where a main purpose was to obtain relief the company was not otherwise entitled to.

41. Paragraph 8(4) applies the cap on total R&D aid under section 1113 of Chapter 2 to the new Intensives Scheme.

42. Paragraph 8(5) amends section 1118(1) so that it refers to the new Chapter 1A of Part 13 and amends the definition of “notional R&D expenditure credit” to refer to the credit that could have been claimed by a company that had ‘not claimed qualifying R&D relief in respect of that expenditure’.

43. Paragraph 9 amends Chapter 9 of Part 13.

44. Paragraph 9(2) omits s1126B(3)(b), removing the Treasury’s power to issue regulations to “make incidental, consequential, supplementary or transitional provision or savings”.

45. Paragraph 9(3) substitutes “1132A” for “1131” in s1127(3), applying the definitions of “staff provider” and “staff provision payment” to additional sections.

46. Paragraph 9(4) substitutes “1132A” for “1131” in s1128(9), applying the definition of “staff controller” to additional sections.

47. Paragraph 9(5) amends section 1129(3), adding a condition (d) that qualifying expenditure on connected externally provided workers (EPWs) must be incurred in respect of “qualifying earnings”.

48. Paragraph 9(6)(a) amends section 1131(2), restricting qualifying expenditure to 65% of the amount of expenditure on an unconnected EPW payment incurred in respect of “qualifying earnings”.

49. Paragraph 9(6)(b) amends section 1131, adding a requirement (4) that any apportionment necessitated by this section should be made on a just and reasonable basis.

50. Paragraph 9(7) inserts a new section 1132A after section 1132, which defines the term “qualifying earnings”. This restricts relief to that portion of an EPW payment that relates to earnings liable to PAYE and NICs in the hands of the claimant (“company”) or EPW provider (“staff controller”).

51. Paragraph 9(8) makes consequential amendment to section 1133(3).

52. Paragraph 9(9) amends section 1134(3), adding a condition (d) that the qualifying element of the connected subcontractor payment must constitute UK expenditure or qualifying overseas expenditure.

53. Paragraph 9(10)(a) amends section 1136(2), restricting the qualifying element of an unconnected subcontractor payment to 65% of the amount comprising UK expenditure or qualifying overseas expenditure.

54. Paragraph 9(10)(b) amends section 1136, adding a condition (3) that any apportionment necessitated by this section should be made on a just and reasonable basis.

55. Paragraph 9(11)(a) amends section 1138, inserting a new section (A1) which will provide the definition of subsidised expenditure, if needed, for the Merged Scheme (Chapter 1A). Paragraph 9(11)(a) is in square brackets because this issue is still under consideration. The Government would like further discussions to understand how the subsidy rules would apply in a potential merged scheme.

56. Paragraph 9(11)(b) amends section 1138(1) to apply the current SME scheme definition of subsidised expenditure given in that section to the Intensive Scheme (Chapter 2).

57. Paragraph 9(12) inserts two new sections.

58. Section 1138A, which defines UK expenditure and qualifying overseas expenditure (UKE and QOE respectively). UKE is expenditure on R&D undertaken in the UK. QOE is overseas expenditure which meets the conditions at section 1138A(2)(a)-(c), as qualified by (3), or by any regulations issued by the Treasury under (4).

59. Section 1138B, which defines “expenditure attributable to an exempt foreign permanent establishment”. This interprets condition C at section 1042C(5).

60. Paragraph 9(13) inserts a new section 1140A which defines when two companies are members of the same group.

61. Paragraph 9(14) removes section 1142 which provides the definition of a “qualifying body”.

62. Paragraph 9(15) updates the reference at section 1142B to point to section 1042B.

63. Paragraph 9(16) inserts a new section 1142C which makes general provision for orders and regulations

Schedule 2: Part 2: Consequential Amendments

64. Paragraph 10 substitutes references to Chapter 6A of Part 3 with references to Chapter 1A of Part 13 so that it continues to refer to the correct part of the CTA 2009.

65. Paragraph 10(a) substitutes the reference in paragraph 52(2A)((b) which refers to the application of discovery assessments to amounts paid by way of R&D expenditure credit.

66. Paragraph 10(b) substitutes the reference in paragraph 83A(a), which refers to the application of Part 9A of the Schedule to claims for R&D expenditure credit.

67. Paragraph 10(c) substitutes the reference in paragraph 83E(3), which refers to the ability to claim R&D expenditure credit out of time where the claim for credit was rejected.

68. Paragraph 11 substitutes reference to Chapter 6A of Part 3 with reference to Chapter 1A of Part 13 so that paragraph 28(fa)(ii) continues to refer to the correct part of the CTA 2009.

69. Paragraph 12 amends Corporation Tax Act 2009.

70. Paragraph 12(2) substitutes references to Chapter 6A of Part 3 with references to Chapter 1A of Part 13 so that it continues to refer to the correct part of the CTA 2009

71. Paragraph 12(2)(a) substitutes the reference in section 1217JA(2)(a), expenditure eligible to R&D expenditure credit is not eligible for theatre tax relief.

72. Paragraph 12(2)(b) substitutes the reference in section 1218ZCG(2)(a), expenditure eligible for R&D expenditure credit is not eligible for museums and galleries exhibition tax relief.

73. Paragraph 12(3) amends s1310(4).

74. Paragraph 12(3)(a) omits paragraph (zzza), which refers to companies ineligible for R&D expenditure credit.

75. Paragraph 12(3)(b) inserts paragraph (zaa), which refers to section1042B((4)(c) , which refers to companies ineligible for R&D expenditure credit.

76. Paragraph 13 amends Corporation Tax Act 2010.

77. Paragraph 13(2) substitutes reference to Chapter 6A of Part 3 CTA 2009 with reference to Chapter 1A of Part 13 CTA 2009 so that section 269DA(2) continues to refer to the correct part of the CTA 2009.

78. Paragraph 13(3) substitutes reference to Chapter 6A of Part 3 CTA 2009 with reference to Chapter 1A of Part 13 CTA 2009 so that section 357BJB(3) continues to refer to the correct part of the CTA 2009.

79. Paragraph 13(4) substitutes reference to Chapter 6A of Part 3 CTA 2009 with reference to Chapter 1A of Part 13 CTA 2009 so that section 357CG(4)(a) continues to refer to the correct part of the CTA 2009.

80. Paragraph 13(5) amends Chapter 9 of Part 8B.

81. Paragraph 13(5)(a) amends section 357P(1) so that it continues to refer to the correct part of CTA 2009.

82. Paragraph 13(5)(b) omits reference to Chapter 6A of Part 3 CTA 2009 in the italic heading before section 357PA.

83. Paragraph 13(5)(c) substitutes reference to Chapter 6A of Part 3 CTA 2009 with reference to Chapter 1A of Part 13 CTA 2009 so that section 357PA continues to refer to the correct part of the CTA 2009.

84. Paragraph 13(5)(d)(i) substitutes references to section 1058(1A) CTA 2009 with references to “the cap by reference to the company’s employment tax liabilities for the accounting period” in subsections (2)(b), (3)(b) and (4)(b) of section 357PD.

85. Paragraph 13(5)(ii) omits subsections (2A), (3A) and (4A) of section 357PD.

86. Paragraph 13(5)(iii) states that sections 1112B to 1112E of CTA 2009 apply for the purposes of subsections (2)(b), (3)(b) and (4)(b) of section 357PD.

87. Paragraph 14 substitutes provisions in the Taxation (International and Other Provisions) Act 2010 so that it continues to refer to the correct part of the CTA 2009.

88. Paragraph 14(a) substitutes the reference in s407(3)(a) (which refers to EBITDA).

89. Paragraph 14(b) substitutes the reference in s416(2A) (which refers to worldwide profits).

90. Paragraph 15 substitutes the reference in the Schedule 43C Finance Act 2013 so that it continues to refer to the Part of CTA 2009 which provides for R&D expenditure credit.

Schedule 2: Part 2: Consequential Amendments

91. Paragraph 16 provides the general commencement rules which apply to this Schedule. These general rules are that the amendments made in the schedule apply to expenditure incurred on or after 1 April 2024.

92. Paragraph 17 provides the commencement rules for the higher rate of payable tax credit and the conditions which must be met in order for the higher rate of payable tax credit introduced by this schedule to apply.

93. Paragraph 17(1) provides the commencement rules. These are that they apply if the accounting period begins before 1 April 2023 and ends on or after that date. The conditions which must be met for the higher rate of payable tax credit to be available are that the company has both a ‘Chapter 2 surrenderable loss’ and meets the ‘R&D intensity’ condition.

94. Paragraph 17(2) provides for a higher rate of payable tax credit (14.5% as opposed to 10%) if the required conditions are met.

95. Paragraph 17(3) provides the method for establishing whether the R&D intensity condition is met.

96. Paragraph 17(4) applies the legislation which defines the terms ‘Chapter 2 surrenderable loss’ and ‘R&D tax credit’ for the purposes of this subparagraph.

97. Paragraph 18 provides for transitional provisions which apply to the ‘Cap on aid for R&D’ which is found in Chapter 8 of Part 13 CTA 2009.

98. Paragraph 18(1) applies the transitional provisions to projects in respect of which expenditure was incurred in an accounting period beginning before 1 April 2024.

99. Paragraph 18(2) provides the transitional provisions, which are to carry out the ‘notional R&D expenditure credit’ calculation at s1118 as if s1118(1) had not been amended by paragraph 8(5) of this Schedule.

Background note

100. The intensive scheme was announced at Spring Budget 2023 and has been introduced to target government support towards R&D Intensive SMEs to ensure taxpayers’ money is used as effectively as possible to support innovation.

101. Draft legislation on a potential merged scheme is also being published for technical consultation as part of the ongoing R&D tax reliefs review. The UK is unusual internationally in having two different R&D tax relief schemes. Following the changes at Autumn Statement 2022, the generosities of the two R&D tax schemes are broadly aligned. There is now scope to simplify the R&D tax system and merge schemes.

102. If you have any questions about this change, or comments on the legislation, please contact David Harris on 03000 586834 (email: [email protected]).