Policy paper

Research and Development Tax Relief reform

Updated 21 July 2022

Who is likely to be affected

These changes will affect companies that carry out research and development and claim Research and Development (R&D) Tax Relief under either of two schemes — the Research and Development Expenditure Credit (RDEC) and the small or medium enterprises (SME) R&D relief.

It will also affect some companies which have made a Patent Box election.

General description of the measure

Following the review of R&D tax reliefs launched at Budget 2021, the government announced the following measures, which will apply for accounting periods beginning on or after 1 April 2023:

Extending qualifying expenditure

To incentivise R&D using modern computational approaches, the government is extending the scope of qualifying expenditures to include the costs of datasets and of cloud computing.

To further support cutting edge R&D, the government will make changes to the definition of R&D for the tax reliefs, to remove the exclusion of pure mathematics.

Refocusing the reliefs towards innovation in the UK

To ensure the maximum benefit to the UK from the spillovers of R&D activity incentivised by the reliefs, relief for subcontracted work and the cost of externally provided workers will be limited to focus it on UK activity. There will be some narrow exemptions where factors such as geography, environment, population or other conditions that are not present in the UK are required for research (for example, deep ocean research) and where there are regulatory or other legal requirements for certain activities to take place in specific territories (for example, clinical trials). The exemptions will not include cost, or workforce availability.

Tackling abuse and improving compliance

To tackle abuse of the reliefs, all claims to the R&D reliefs — either for a deduction or a tax credit — will in future have to be made digitally (except from those companies exempt from the requirement to deliver a Company Tax Return online)

These digital claims will have to break the costs down across qualifying categories and provide a brief description of the R&D. Each claim will need to be endorsed by a named senior officer of the company.

Companies will need to inform HMRC, in advance, that they plan to make a claim. They will need to do this, using a digital service, within 6 months of the end of the period to which the claim relates. Companies that have claimed in one of the preceding three periods will not need to pre-notify.

Claims will need to include details of any agent who has advised the company on compiling the claim.

Previously announced measures to address anomalies and unforeseen consequences

A number of changes will be made to correct anomalies and ensure the reliefs operate as intended. These include:

• allowing companies to make or increase a claim for RDEC where HMRC makes certain types of assessment, as allowed by paragraphs 61 to 65 of Schedule 18 to Finance Act 1998
• allowing companies to claim RDEC instead where they had previously erroneously claimed SME relief and the time limit for amending claims has expired
• clarifying that expenditure generally qualifies where a payment is made within two years of the end of the accounting period in which the expenditure was incurred — this is in response to a Tribunal finding of 2016 (TC/2015/06833)
• amending the time limit for making a claim to two years from the end of the period of account to which they relate, rather than 12 months from the statutory filing date as defined by paragraph 14 of Schedule 18 to Finance Act 1998 — this will prevent companies which do not receive a notice to file, either because they fail to register or notify HMRC that they are dormant, from benefiting by having more time to make a claim
• supporting businesses growing and transitioning from the SME scheme to RDEC, by providing that where an SME within a group exceeds the size thresholds for an SME, all companies in the group will retain SME status for one year afterwards — under the current legislation, while the company itself retains its status, other companies in the same group lose their SME status straight away
• amending the rule preventing relief for a company which is not a “going concern” so that where a company ceases to be going concern solely because of the transfer of a trade, and is otherwise viable, it may still claim
• expanding the scope of rules in the Self Assessment legislation so that they (rather than common law) can be used to recover overpaid SME payable tax credit and RDEC to allow HMRC to recover such amounts where the taxpayer made a mistake despite taking reasonable care

Further consequential measures

The following further changes are being made to ensure the reliefs operate as intended:

• the level of National Insurance contributions made by a company on its employees’ and its own behalf feeds into the calculation of a company’s staffing costs, and potentially its payable credit cap, and so affects the amount of any R&D reliefs that it can claim. As the Health and Social Care Levy represents a new cost, sections of the R&D rules that currently refer only to ‘National Insurance contributions’ will be amended to also refer to the Health and Social Care Levy
• the Patent Box regime uses R&D definitions of qualifying expenditure as part of its calculations — as this package of R&D changes expands the categories of qualifying expenditure to include data and cloud computing costs, the relevant sections of the Patent Box rules require consequential amendment

Policy objective

The government has an ambitious target to raise total investment in research and development to 2.4% of UK GDP by 2027. R&D tax reliefs have a key role in incentivising this investment by reducing the costs of innovation. It is therefore important to ensure that the reliefs remain up-to-date, competitive and well-targeted.

Background to the measure

The two schemes offer generous support to incentivise firms investing in R&D. At Budget 2021 the government announced a review of the reliefs, supported by a consultation with stakeholders. This consultation explored the nature of private-sector R&D investment in the UK, how that is supported or otherwise influenced by the R&D relief schemes, and where changes may be appropriate.

Following the consultation, at Autumn Budget 2021, the government announced reforms to R&D tax reliefs and published a report in November 2021 setting out detail on a series of initial measures to reform the R&D tax relief system. These measures included the expansion of qualifying expenditures to cover data and some cloud computing costs, refocusing R&D relief on activity carried out in the UK and a package of measures to target abuse and improve compliance.

Following stakeholder feedback, Spring Statement 2022 announced further detail on these measures.

Recognising that there are cases where it is necessary to undertake R&D outside of the UK, the government announced that overseas subcontracted expenditure and the costs of overseas externally provided workers can still qualify where there are:

• material factors such as geography, environment, population or other conditions that are not present in the UK and are required for the research, meaning expenditure must take place outside of the UK — for example, deep ocean research
• regulatory or other legal requirements that activities must take place outside of the UK — for example, clinical trials

The government intends to include all cloud costs incurred directly for R&D in the scope of qualifying expenditure.

The government recognises the growing volume of R&D being undertaken which is underpinned by mathematics. To support this work, the definition of R&D for tax reliefs will be expanded to include all mathematics — clarifying in particular that ‘pure maths’ can qualify.

The government has published draft legislation for stakeholder input for these measures, to come into effect from April 2023 with necessary legislation in Finance Bill 2022-23. Some of the changes will be delivered through supporting Statutory Instruments to follow the same timescale.

Detailed proposal

Operative date

The measures will have effect for accounting periods beginning on or after 1 April 2023.

Current law

The R&D tax relief for SMEs is set out in Part 13 of CTA 2009.

The RDEC is provided for in Chapter 6A of Part 3 of CTA 2009.

R&D is defined for tax purposes in section 1138 of CTA 2010, together with section 1006 Income Tax Act 2007 which confers powers on the Treasury to specify in regulations activities that are and are not R&D for corporation tax purposes.

Paragraphs 83A to 83E of Schedule 18 to Finance Act 1998 set out the administrative provisions for both RDEC and the SME R&D relief.

Patent Box legislation is set out in Part 8A of CTA 2010

Proposed revisions

All references are to CTA 2009 unless otherwise stated.

Extending qualifying expenditure

New definitions of data costs and of cloud computing costs will be added to section 1125 of CTA 2009, which at present defines both consumables and software costs for both reliefs.

Secondary legislation will be introduced to extend, with effect from April 2023, the scope of R&D relief to cover mathematical advances in and of themselves.

Refocusing the reliefs towards innovation undertaken in the UK

A new condition will be added to sections 104E, 104K, 104L (contracted out R&D in RDEC, and contributions to independent R&D) and to sections 1134 and 1136 (contracted out R&D in the SME scheme) that the expenditure must either be UK expenditure or qualifying overseas expenditure.

A new section 1138A will define UK expenditure as that attributable to relevant research and development undertaken in the United Kingdom and qualifying overseas expenditure as that attributable to activity undertaken overseas which is necessary due to geographical, environmental or social conditions not present or replicable in the UK. Cost of the work, and availability of workers, are specifically excluded as factors.

Similarly, where a company engages externally provided workers to carry out R&D, expenditure on those workers will only qualify to the extent that those workers’ earnings are taxed through PAYE, or attributable to R&D activity outside the UK that is covered by the new section 1138A.

Tackling abuse and improving compliance

R&D claims: Mandating digital claims

Secondary legislation will be introduced with effect from April 2023 to require that all Corporation Tax returns that contain an R&D claim, including amended returns, must be submitted digitally through HMRC’s tax return portal.

R&D claims: provision of additional information

This measure inserts a new paragraph into Part 15A of Schedule 18 to FA 1998 (company tax returns etc: claims for R&D expenditure credits or R&D tax relief). After paragraph 83E (time limit for claims) it adds a new condition at section 83EA which provides HMRC with the power to make regulations setting out additional information to be provided in relation to a claim.

Secondary legislation will be introduced with effect from April 2023 setting out the additional information to be provided in relation to an R&D claim. This information will include a description of the R&D undertaken, breakdown of qualifying costs, detail of any agent who has advised on the R&D claim and space for sign off from a senior officer of the company.

Pre-notification of claims

This measure amends Chapter 6A of Part 3 of CTA 2009 (trade profits: R&D expenditure credits). The requirement for companies to make a claim notification will be given effect by legislation inserted: after section 104A (R&D expenditure credits) at new section 104AA; before section 1046 (relief only available where company is going concern) at new section 1045A; and, after section 1054 (entitlement to and payment of tax credit) at new section 1054A.

After section 1142 (“qualifying body”) new section “1142A “Claim notification” will be inserted providing HMRC with the power to make regulations setting out the form of the claim notification.

Secondary legislation will be introduced with effect from April 2023 setting out the information to be provided with the notification, and the form and manner in which the notification is to be made.

Previously announced measures to address anomalies and unforeseen consequences

1. Paragraph 62 of Schedule 18 to Finance Act 1998 (consequential claims that may be made) will be amended to allow a claim for RDEC where the conditions described in Paragraph 61(1) of that Schedule are met.
2. Paragraph 83E of Schedule 18 to Finance Act 1998 will be amended to permit a claim for RDEC to be made where the claimant made a claim for SME relief under Part 13 of CTA 2009 but was not entitled to do so.
3. New legislation (ss104Y(4) and 1139A(1)) will clarify that references to expenditure incurred on payments refer to payments that are made before a claim is made in respect of that expenditure.
4. Paragraph 83E(1) of Schedule 18 to Finance Act 1998 (Time limit for claims) will be amended to define the time limit for making a claim.
5. New legislation (section 1120A of CTA 2009) will clarify that where an enterprise was treated as an SME and a linked enterprise becomes large the first enterprise will continue to be treated as an SME for that accounting period and the following accounting period.
6. New legislation (section 1120B of CTA09) will clarify that an enterprise, which was treated as large only because a linked or partner enterprise was large, is acquired by an SME, that enterprise will be treated as an SME in the accounting period in which the acquisition is made.
7. The definition of “going concern” (sections 104T, 1046 and 1057 CTA 2009) will be amended to clarify that if a company’s accounts are not prepared on a going concern basis only because the company’s trade was transferred to another member of the group the accounts are to be treated as if prepared on a going concern basis.
8. Paragraph 52 of Schedule 18 to Finance Act 1998 will be amended so that the restrictions on the making of a discovery assessment in Paragraphs 42 to 44 of that Schedule do not apply in the case of overpaid R&D tax relief or expenditure credit.

Further consequential measures

HSCL

Sections104P to 104S, 1058A to 1058C, 1060, 1123 and 1131A of CTA 2009 will be amended to extend existing references to National Insurance contributions to include the new Health and Social Care Levy.

Patent Box

Section 357BLB(5) and (7) of CTA 2010 will be amended to include the revised definition of R&D qualifying expenditure to include the new definitions for datasets and cloud costs.

Summary of impacts

Exchequer impact (£million)

2022 to 2023	2023 to 2024	2024 to 2025	2025 to 2026	2026 to 2027	2027 to 2028
Empty	Empty	Empty	Empty	Empty	Empty

The final costing will be subject to scrutiny by the Office for Budget Responsibility and will be set out at the next fiscal event.

Economic impact

These measures will incentivise R&D spending on qualifying activities in the new tax relief regime, though are not expected on their own to have a significant macroeconomic impact.

Impact on individuals, households and families

The measures are not expected to impact on family formation, stability or breakdown.

There is no impact on individuals as these measures affect businesses.

Equalities impacts

It is not anticipated that there will be impacts on groups of people sharing protected characteristics.

Impact on business including civil society organisations

This measure is expected to have significant business impact on approximately 90,000 businesses claiming R&D tax reliefs. One-off costs could include familiarisation with the changes and updating systems to reflect them. These costs are estimated to be negligible.

Continuing costs include a requirement to provide additional information to HMRC in the company tax return. These costs are estimated to be £0.4 million.

Estimated one-off impact on businesses (£million)

One-off impact	£(m)
Costs	negligible
Savings	—

Estimated continuing impact on administrative burden (£million)

Continuing average annual impact	£(m)
Costs	0.4
Savings	—
Net impact on annual administrative burden	+0.4

These measures could negatively affect businesses’ experience of dealing with HMRC as the changes are complex and require additional tax admin tasks to be completed. This will be addressed by clear guidance to advise of changes and by communications including through the Research and Development Communication Forum (RDCF).

Operational impact (£million) (HMRC or other)

The estimated operational costs for HMRC are in the region of £23m covering both IT and staff costs.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

The measures will be monitored through information collected from tax returns.

The current R&D reliefs have been subject to period econometric evaluation, providing a good baseline for future evaluations. HMRC are collecting more information which enables HMRC to better monitor the relief through, for example, clearer data on what is being claimed.

Consideration will be given to evaluating the policy after 5 years of monitoring data have been analysed and collected.

Further advice

If you have any questions about this change, contact Yasmin Achha or David Harris on Telephone: 03000 592504 or 03000 586834, or email: [email protected] or [email protected]