R&D tax relief: more change is coming for accounting periods beginning on or after 1 April 2024. Preparation is key.
The Spring Budget confirmed the changes to the Research and Development reliefs, which restricts the extent to which payments to contractors for R&D, and payments for externally provided workers (EPWs) can qualify for R&D relief, where the R&D activity takes place overseas.
Under the existing rules for the SME and RDEC schemes, companies can claim tax relief on R&D activity that is conducted overseas. While claimants under the RDEC scheme are restricted on certain subcontracted costs, the location of where the work is performed on both schemes is irrelevant.
Whilst these rules have been legislated, HMRC are yet to publish full guidance on these changes. The consultation outcome published earlier this year contains in excess of 30 examples to explain these simplified rules.
The New Rules
There are various reasons why companies choose to outsource R&D activity, not least because labour overseas is often more cost effective. For such companies claiming R&D, it is critical they are aware of the upcoming changes and the impact these will have on their R&D tax relief claim. Broadly, where companies subcontract R&D activity to a third party, in future they will only be able to claim relief for that expenditure where the third party performs the work here in the UK. Where companies incur expenditure on payments for externally provided workers (EPWs), they will only be able to claim relief on such expenditure where those workers are subject to UK PAYE/NICs.
Overseas expenditure on contracted out R&D, and on payments for EPWs who are not subject to UK PAYE/NICs, may still qualify if the following 3 criteria are met:
- The conditions necessary for the R&D are not present in the UK;
- The conditions necessary for the R&D are present in the location where the R&D is undertaken;
- It would be wholly unreasonable for the company to replicate the conditions in the UK.
To the extent that the condition is partially met, with some activity taking place in the UK, and some not, the contractor payment could be apportioned to the UK element of the activity on a just and reasonable basis. This will depend on the company’s circumstances and evidence may be required to support the arrival at this apportionment.
Timing
The new rules apply to accounting periods beginning on or after 1 April 2024 and affect both the additional support for R&D intensive loss-making SMEs and the new merged R&D Expenditure Credit (RDEC).
For example, if you have a client with a 30 September year end, the new overseas restrictions will only apply for their year ended 30 September 2025, onwards. To be absolutely clear, only the overseas labour costs that are spent after 1 October 2024 are restricted.
Planning
If a significant amount of your R&D labour is undertaken overseas you must be mindful of the impact this will have on your claim. With the reduced rates of relief for SMEs, from 1 April 2023, coupled with the restrictions to overseas expenditure, the value of claims may well experience a substantial downturn and a much-reduced benefit. Claimant’s therefore must forecast accurately to anticipate adjusted cashflows to accommodate the changes being introduced to the R&D tax legislation. It may be that claimants will consider employing UK based labour given the R&D tax incentive is available on those staff members engaged to undertake R&D activities here in the UK.
Conclusion
Overall, this is a pretty significant departure from the old rules and the above 3 criteria are not always clear. This will have a considerable impact for a number of claimant companies who will need to rethink their R&D strategy. Now is the best time to consider your individual circumstances, and plan ahead to ensure you are not missing out on potential future R&D claims.
Please get in touch to discuss this further.
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