Major Change to the R&D Rules

Will Sweeney Associate Director Corporate Tax, explains the significant overhaul of R&D regulations

Again, we hear you say? But yes, Finance Act 2024 incorporated some of the biggest changes yet seen, with a complete restructuring of the way R&D relief is claimed.

The headline is that SME and RDEC company schemes will be combined into a merged R&D scheme, with relief provided through a taxable ‘R&D Expenditure Credit’, in a similar way to the existing RDEC scheme, for all eligible companies. Separate rules will exist, to provide enhanced support to loss-making R&D intensive SMEs based on the existing SME scheme.

Bringing together the existing R&D schemes under one merged scheme creates issues where different eligibility criteria previously applied. As a result, there will be some winners and some losers.

One of the biggest changes is to the subcontracting rules, and so it is vital that companies are aware of these now so that they can plan accordingly

• The rules will be based on the SME scheme, with the claimant company able to include subcontractor costs in its R&D claim, however companies undertaking contracted out R&D will not be eligible to make a claim. This is a definite plus for many as subcontractor costs have always been restricted under the RDEC scheme, however for companies undertaking contracted out R&D that were able to claim under the RDEC scheme, the changes may see them lose their R&D claims!
• As it is now so important to be clear whether R&D is subcontracted or not, the government has attempted to provide some clarity by introducing a new definition:

A person “contracts out” research and development if:?

• They enter into a contract under which activities are to be undertaken for them (this may include the provision of any goods or services)
• The activities undertaken in order to fulfil the contract include R&D; and
• It is reasonable to assume (giving regard to the contract and supporting circumstances) that the person intended or contemplated when entering into the contract that R&D of that sort would be undertaken in order to meet those obligations.

The key point is clearly when it is reasonable to assume that the person engaging the subcontractor ‘intended or contemplated’ that R&D would be required. Initially, the concern was that large companies at the top of supply chains would use their size and bargaining power to claim all R&D was intended, but HMRC have clarified that ‘intended or contemplated’ is meant to be a high threshold.

The rules aim to identify which party took the decision to undertake the specific R&D that was subsequently carried out. This means that if the customer wishes to claim they intended that specific R&D would be required, they will need to show they had a thorough “appreciation of what R&D will be done and therefore the ability to understand and specify that”, going as far as describing the technological advances sought and the uncertainties this involved. This will require detailed technical expertise, and not just that the work was ‘challenging’. Moreover, if the R&D undertaken is different from that intended, then the right to claim would rest with the subcontractor as they would be the party who took the decision to carry out this work.

So what do I need to do now?

The new merged R&D scheme will take effect for periods starting on or after 1 April 2024. However, this does not mean that companies can sit back and relax. With HMRC undertaking an increasing level of enquiries, it is likely companies will be required to show contemporaneous evidence of their entitlement to relief. Companies should therefore review their contractual arrangements and supporting documents now to ensure they have the evidence in place to support their future R&D claims.

If you are subcontracting out work:

?We recommend that you are clear when entering into a new project that:

i) the contract,

ii) any pre-contract documentation (such as scopes of work): and

iii)?the supporting circumstances under which the work is to be carried out (such as how the R&D is to be exploited, the decision making process, the experience and seniority of the decision takers, IP ownership, financial risk, degree of autonomy in carrying out the work) reflect the fact that you intended for specific R&D to be undertaken, and how the subcontracted work fitted into this. The supporting documentation may be internal or external, as long as the company can produce contemporaneous evidence to support their case if required by HMRC

If you are undertaking work for a customer

?If you believe you are undertaking R&D of your own volition, we recommend that you ensure that:

i)?the contract and pre-contract documentation is clear as to the scope of work and expectations of their customer.

ii)?you discuss whether the customer expects this work to include R&D, and ask them to set out details in writing

This will provide a record of your joint understanding of any R&D that was intended to be undertaken in order to deliver the contract. Any R&D outside this, or that cannot be fully specified can be claimed.

For more information or advice in complying with this change or if you would like support on R&D in general please contact Will Sweeney