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UK: Research & Development Reforms From 1 April 2023

published on 30 March 2023 | reading time approx. 5 minutes

From 1 April 2023, HMRC has introduced significant changes to the tax relief regime related to Research and Development (R&D) activities. While some reforms were announced in the Autumn Budget in 2021, further changes were introduced in the 2022 Autumn Statement and 2023 Spring Budget. These reforms affect the relief claimable, qualifying activities, and the process through which eligible businesses can claim. The intention is to improve the competitiveness of the UK as a research location and to revise reliefs to reflect the economic environment while utilising taxpayer funds efficiently, according to the government.

R&D Tax Relief Rate Changes »
Territorial Conditions for Subcontracted R&D Expenditure »
Changes to Qualifying Expenditure »
Changes to the R&D Relief Claim Process »
R&D Tax Relief Size Thresholds »
Eligibility for RDEC »

R&D Tax Relief Rate Changes

There are two tax relief mechanisms available for R&D, depending on the size and structure of the company.

Small and Medium Enterprises (SMEs) normally claim relief through the R&D tax relief scheme, which effectively provides a deduction in corporation tax liabilities based on a percentage of qualifying costs. If the SME is loss-making, they may opt to receive an R&D credit as a cash payment but must surrender R&D losses. Cash payments are capped based on the percentage of losses surrendered.

An alternative is an R&D expenditure credit (RDEC), primarily used by larger entities but accessible by SMEs depending on the circumstances.

The RDEC offers corporation tax relief against R&D spending but has a different calculation basis. This taxable credit can offset corporation tax liabilities or may be claimable as a cash payment.

From April onward, the enhanced deduction for SME R&D relief will fall from 130 per cent to 86 per cent, and the credit rate for SMEs will decrease from 14.5 per cent to 10 per cent in general.

However, a new scheme for loss-making, "R&D intensive" SMEs was announced in the 2023 Spring Budget. Companies that spend at least 40 per cent of their total expenditure on R&D will be considered R&D intensive. These R&D-focused SMEs will be able to claim a higher payable credit rate of 14.5 per cent* (rather than the reduced 10 per cent announced in the 2022 Autumn Statement).

RDEC relief rates will increase from 13 per cent to 20 per cent, with impacts as below, depending on the size of the company and whether they claim through the R&D tax relief scheme for SMEs or the RDEC route.

Company size and position	Up to 31 March 2023	From 1 April 2023 onward
SME – loss-making (*if “R&D intensive” SME, higher credit)	130 per cent enhanced deduction 14.5 per cent R&D credit 33.35 per cent benefit	86 per cent enhanced deduction 10 per cent R&D credit (14.5 per cent) 18.6 per cent benefit (27 per cent)
SME - profitable	130 per cent enhanced deduction 19 per cent corporation tax rate 24.7 per cent maximum benefit	86 per cent enhanced deduction 25 per cent corporation tax rate 21.5 per cent maximum benefit
RDEC claimant	13 per cent RDEC credit 19 per cent corporation tax 10.53 per cent post-tax benefit	20 per cent RDEC credit 25 per cent corporation tax 15 per cent post-tax benefit

The UK government has announced that it will consult and investigate the potential for a single R&D tax relief scheme similar to the RDEC. Still, dates or projections about when further reforms are likely to be introduced are yet to be confirmed.

Territorial Conditions for Subcontracted R&D Expenditure

Also, from April 2023, changes will be introduced around territorial conditions, which impact R&D expenditure that is subcontracted to external providers and the costs of paying staff employed by a third party.

Subcontracted R&D work must be conducted within the UK to be eligible, with external workers paid through the PAYE system. In some circumstances, R&D expenditure in overseas regions will qualify, where conditions dictate the necessity of performing R&D in another country.

These exemptions are limited and will only apply if a condition linked to the UK's environment, geography or society makes it impossible to conduct R&D anywhere but overseas or where legal or regulatory requirements apply.

Examples may include overseas-located clinical trials or ocean research. However, the investment in R&D and access to suitably qualified personnel will not be a justification for claiming eligibility where a company believes an exemption may apply.

Changes to Qualifying Expenditure

Some additional costs linked to R&D expenditure will qualify for tax relief, including:

Data licensing
Cloud computing
Mathematical advances.

Under the current system, R&D expenditure on computing software used specifically for R&D activities is claimable, which can include software licensing and some mathematical advances. The new rules will expand the scope of qualifying expenditure.

Changes to the R&D Relief Claim Process

Companies submitting an R&D tax relief claim for the first time or that have not filed a claim within the last three accounting years will need to inform HMRC of the intention to claim through a new pre-notification system, along with information about the R&D advisor the company intends to use.

Notifications must be filed within six months of the accounting period end date, reduced from a two-year time frame unless a full R&D claim has been submitted within the six-month period.

First-time claimants may need to consider whether a pre-notification is necessary to protect the ability of the company to apply for R&D relief on forthcoming expenditures.

Claimants must also provide additional details to HMRC, including:

The R&D project costs
Workers used
Details of the R&D agent.

Relief claims must be approved by a named officer of the company.

R&D Tax Relief Size Threshold

SMEs may claim R&D tax relief if they have fewer than 500 staff, a turnover of less than 100 million euros, and a balance sheet total of under 86 million euros.

External investment in the business can impact the company's position as an SME. Claimants must disclose connected and partner companies when establishing their status as an SME to claim relief.

A company is considered connected if it holds 50 per cent of the voting rights or more, or the subject company holds at least 50 per cent of the voting rights in the other. Companies are considered in partnership if either company holds 25 per cent or more of the capital and voting rights of the other.

R&D tax relief claimants must include a proportion of the turnover, balance sheet total and staff in their calculations based on the proportional voting rights held and the capital connecting the two entities.

A company establishing eligibility for R&D tax relief holding 30 per cent of the capital in other must therefore include 30 per cent of all staff, balance sheet totals and turnover in their assessment to determine whether they fall within the SME thresholds.

Eligibility for RDEC

The RDEC replaced the previous scheme for large companies in 2016 and can be claimed by SMEs where they have been subcontracted to carry out R&D work by a large company and receive:

A grant or subsidy
Expenditure over the SME threshold.

Companies can also claim RDEC if they are ineligible for R&D tax relief for SMEs.

The reform also allows claimants to apply for RDEC if they have previously claimed SME relief in error and the time threshold for submitting claim amendments has passed.

Because of the territorial conditions introduced, companies that operate in the UK as part of a worldwide group must pay particular attention to the location of subcontracted work and the use of external workers in other jurisdictions since, in most scenarios, the expenditure may not be eligible for R&D tax relief.

Prior to April 2023, overseas R&D costs that were recharged to the claimant UK company qualified for relief, but these changes mean that most R&D activity undertaken in a different country will be excluded.