Chancellor in partial retreat to R&D Tax Credit cuts

The Chancellor Jeremy Hunt used his Spring budget statement today to announce a widely anticipated concession to loss-making R&D-intensive SMEs, which are facing drastic cuts to their R&D Tax Credits.

Following an outcry amongst business leaders, trade bodies, start-ups and their investors, the Chancellor has created a new category of claimant – an “R&D intensive company” – which will be able to claim an enhanced R&D Tax Credit equivalent to 27% of its R&D expenditure.

Whilst this still represents a reduction from the current 33.35% credit rate, it is a significant improvement on the reduced 18.6% rate being applied from 1 April 2023.

An R&D intensive company is defined as one where its qualifying R&D expenditure is at least 40% of its total expenditure.

With the Chancellor’s announcement being made only a few hours ago, we are still assessing the measures, but at first sight, the timing of this relief looks like it will create some issues.

The Chancellor wants it to start for expenditure from 1 April 2023 – ie almost immediately – but the legislation is not ready, even in draft form, and so this will not actually be legislated until Finance Act 2024.?

Draft legislation for Finance Bill 2024 will be published in Summer 2023 but it will not become law as Finance Act 2024 until it has gone through Committee stages and then received Royal assent which would mean that the legislation will not be enacted until around July 2024. At that time, it will become retrospective to 1 April 2023.

Here are some of the key points to note.

• This extension only applies to research intensive R&D intensive SMEs that are loss making – so it is aimed mainly at early stage companies.
• It is not apparently going to be sector limited. Instead the test will be whether the loss making SME is “R&D intensive”. That means that qualifying R&D expenditure (including amounts claimed under s1308 CTA2009) will have to be at least 40% of the total P&L expenditure.
• The existing rules regarding eligible expenditure will apply.
• HMRC says that the R&D intensive test will be applied to connected companies in aggregate. This is a complicating feature which means that any company claiming the R&D intensive enhanced SME relief will have to perform a composite calculation of R&D intensity over all its connected entities. This is presumably designed to stop companies channelling group R&D through one claimant company in order to benefit from the enhanced relief. However, that could also mean the need to examine qualifying R&D expenditure in non-claimant companies. This might include non-resident companies which would not be eligible for the relief.
• The existing draft measures in Finance Bill 2023 will still go into force so the SME enhanced deduction will become 86% and the payable credit will be cut to 10%. Until the new legislation is in force this is all that will be claimable by R&D intensive companies. They will subsequently have to amend their claims once the new legislation is in place to claim the additional amount. They will however be invited to signal their intention to claim the additional relief as an R&D intensive company on the digital Additional Information form that is to be introduced from 1 August 2023.?(HMRC has already announced that payment of the additional sums will likely take longer than the current SME claims because of the need to carry out additional checks).
• The new payable R&D intensive SME credit claim will compute losses using a 186% enhanced deduction and then apply a 14.5% payable credit – giving the 27% figure mentioned by the Chancellor.
• There will be additional anti-avoidance measures to be introduced. These have yet to be specified.?
• R&D intensive companies will need to be tracking their R&D expenditure from 1 April 2023.
• There is an ongoing consultation concerning merging the SME and RDEC schemes. The Government says that “in order to keep the merger option open” it will publish a summary of responses and draft legislation for this in July 2023 so it seems likely that if the R&D regimes are to be merged in April 2024 there will still be a need to preserve the SME definition.

The decision to backdate the change is unusual and suggests that a somewhat hasty decision to extend the SME relief has been taken, with legislative or computer system bottlenecks still needing to be addressed.

It also seems likely that further development work will be needed to flesh out the details of the new relief – for example on commencements or insolvencies, international groups, or companies becoming or ceasing to be connected.?HMRC will clearly find this a challenging exercise and it would not be surprising if there are design troubles yet to be encountered.

The new measures have produced a mixed reaction in the R&D advisory field.

Suzanne Clements, an ex-HMRC inspector who now works on Quality Assurance at MSC R&D said:

“It’s disappointing that the chance was not taken to roll back on the proposed cuts to the SME scheme. This peace offering regarding the enhanced relief will benefit only a few.

There will be a delay and some bureaucratic complications as companies will need to have it on their radar that legislation for the enhanced relief will not be enacted immediately and companies may need to amend their returns to claim it.

I also foresee complications arising from the aggregation of results for connected companies.

The changes to restrictions on overseas expenditure will now be delayed, which is a good thing to some extent, but it all adds up to an increased burden of awareness and reportage for companies to claim the reliefs to which they are entitled”

Jonny Brewster, Head of Tech & High Growth R&D at Cooper Parry told the R&D Tax Credit Insider that:

“All of my clients are venture-backed, tech-based scaling businesses, meaning they're constantly keeping an eye on their runway to avoid running out of cash before bringing their idea to the market.?Last Autumn's slashing of the R&D credit rate caused a lot of worry and led to businesses considering having to raise funds on unfavourable terms to fill the shortfall.?

Today's Budget did - at least from an R&D perspective - look to ease some of that worry, as a number will fall into the category that will able to benefit from the enhanced credit.?

The problem will, as ever, come with policing the new system.?For instance, the cliff-edge at 40% will inevitably increase temptation and push businesses (and potentially their advisors) to include extra costs within their R&D claims to get to the magic figure”.

Rufus Meakin is a specialist in helping companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.

If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to call me on 0794 110 3285.