Merger of current small or medium enterprise (SME) and Research and Development Expenditure Credit (RDEC) schemes
Updated 23 November 2023
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This publication is available at https://www.gov.uk/government/publications/research-development-rd-tax-relief-reforms/merger-of-current-small-or-medium-enterprise-sme-and-research-and-development-expenditure-credit-rdec-schemes
Who is likely to be affected
These changes will affect companies claiming Research & Development (R&D) tax relief under either of the 2 current schemes, the Research and Development Expenditure Credit (RDEC) and the small or medium enterprise (SME) R&D relief.
General description of the measure
This measure combines the current RDEC and R&D SME scheme into a merged scheme. The measure establishes an above the line credit that allows companies to claim for their qualifying R&D costs, including contracted out R&D, and incorporates the more generous SME scheme PAYE and National insurance contributions cap. It also includes restrictions on relief for overseas expenditure which will come into effect for accounting periods beginning on or after 1 April 2024.
The rate offered under the merged scheme will be implemented at the current RDEC rate of 20%.
The notional tax rate applied to loss-makers in the merged scheme will be the small profits rate of 19%, rather than the 25% main rate set in the current RDEC.
Policy objective
The government recognises the important role that R&D plays in driving innovation and economic growth, as well as the benefits it can bring for society. Even in extremely challenging fiscal circumstances the government remains committed to supporting R&D.
Merging the current SME and RDEC schemes will simplify and improve the system, helping to drive innovation in the UK.
This will include boosting certainty by moving to an above the line mechanism and a single set of qualifying rules for most R&D businesses, adopting an approach to contracted out R&D which allows more large companies to claim for the costs of the work contracted out, while also removing the complex rules around qualifying bodies.
In a further simplification, the rules relating to subsidised expenditure in the existing SME scheme will not be carried forward into the new merged scheme, meaning that where a company receives a grant covering part of the costs of their R&D (for example), the amount of relief available will not be reduced.
Background to the measure
At Spring Budget 2021, the government launched a review of R&D tax reliefs to ensure the UK remains a competitive location for cutting edge research, the reliefs continue to be fit for purpose and taxpayer money is effectively targeted. The government is now concluding that review with the announcement of the merged scheme.
The government has consulted on proposed changes to the R&D tax credit schemes over a considerable period. This included a broad consultation in Spring 2021, a policy consultation on merging schemes in winter 2023, and a technical consultation on the draft legislation for a merged scheme in summer 2023.
At Autumn Statement 2023, the government announced it will legislate in Autumn Finance Bill 2023 to merge the current RDEC and R&D SME schemes for accounting periods beginning on or after 1 April 2024.
Further action may be needed to reduce the unacceptably high levels of non-compliance in the R&D reliefs, and HMRC will be publishing a compliance action plan in due course. The government will also continue working with industry to develop the enhanced support for R&D intensive SMEs, and consider further simplifications.
Detailed proposal
Operative date
The measure will take effect in relation to accounting periods beginning on or after 1 April 2024.
Current law
The R&D tax relief for SMEs is set out in Part 13 of the Corporation Tax Act (CTA) 2009.
The RDEC is provided for in Chapter 6A of Part 3 of CTA 2009.
Proposed revisions
There are currently two separate reliefs which operate differently in both how they give relief and what can be claimed for. This legislation will replace them with a merged scheme operating as follows:
Customers will note that there are new rules which allow the small profits rate to be used when calculating relief unless the company would, ignoring any amount of expenditure credit to which it might be entitled under Chapter 1A, be liable to CT at the main rate.
New rules will also be added which set out how any work that is contracted out is to be treated or relieved. These rules seek to combine the existing rules: setting out where a person is contracted to undertake R&D or R&D activities (and so is unable to claim relief for the work done because the customer is claiming relief as part of their R&D project) and where they are contracted to provide a service which, if they undertake R&D to complete, is relievable on the contractor.
The merged scheme will adopt the more generous PAYE and National Insurance contributions cap which is currently applied in the SME scheme, meaning that fewer businesses will need to consider whether they are at risk of hitting it.
The SME rules restricting relief where part of the project expenditure has been subsidised have been removed.
A new section will be added to define qualifying earnings in relation to ‘Externally Provided Workers’. This has been amended since the draft published in the summer, which clarifies how the rules are intended to work.
A new section will define UK expenditure as that attributable to relevant research and development undertaken in the UK; 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.
A technical note will be published alongside this note to provide additional information about the some of the changes outlined above.
Summary of impacts
Exchequer impact (£ million)
| 2023 to 2024 | 2024 to 2025 | 2025 to 2026 | 2026 to 2027 | 2027 to 2028 | 2028 to 2029 |
|---|---|---|---|---|---|
| — | -15 | -35 | -155 | -200 | -205 |
These figures are set out in Table 5.1 of Autumn Statement 2023 and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Autumn Statement 2023.
Economic impact
This measure is not expected to have any significant macroeconomic impact.
Adjustments were made to take account of behavioural effects, including businesses adjusting their R&D expenditure in response to the measure.
Impact on individuals, households and families
There is expected to be no impact on individuals as this measure only affects businesses.
There is expected to be no impact on family formation, stability or breakdown.
Equalities impacts
It is not expected that there will be adverse effects on any group sharing protected characteristics.
Impact on business including civil society organisations
This measure is expected to have a positive impact on businesses by providing a single set of qualifying rules for all claimants of the merged scheme. The above the line mechanism provides more clarity for businesses and the removal of the subsidised expenditure rules will enable SMEs to claim relief for work for which they receive a grant or other subsidy. The measure also removes the situation where companies have to transition between the SME and RDEC scheme, with different rules applied to each.
One-off costs could include familiarisation with the changes and updating systems to reflect them. There is expected to be some continuing costs as a result of this change for the approximately 87,000 companies that will be required to provide more information when claiming the relief.
The measure is not expected to impact on civil society organisations
Estimates of the costs are shown in the tables below:
Estimated one-off impact on businesses (£m)
| One-off impact | £ million |
|---|---|
| Costs | 7 |
| Savings | — |
Estimated continuing impact on administrative burden (£m)
| Continuing average annual impact | £ million |
|---|---|
| Costs | 0.3 |
| Savings | — |
| Net impact on annual administrative burden | 0.3 |
Operational impact (£ million) (HMRC or other)
The estimated operational costs for HMRC are in the region of £4.6m covering both IT and staff costs.
Other impacts
Other impacts have been considered and none have been identified.
Monitoring and evaluation
The measure will be monitored through information collected from claims and claim notifications.
The current R&D reliefs have been subject to periodic 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 sufficient years of monitoring data from claims and claims notifications have been collected and analysed, as part of HMRC’s ongoing programme of tax relief evaluation.
Further advice
If you have any questions about this change, please contact HMRC R&D Policy Team on email: [email protected]