Unlike recent fiscal events, this Autumn Statement largely focused on those on lower incomes, with an absence of measures specifically aimed at higher and additional rate…
Virtually every single Budget or similar government statement over the last three years has included something on R&D – and yet despite this the system is still in a state of dramatic flux and uncertainty, particularly for small and medium-sized enterprises (SMEs).
On a structural level it does now appear that the likely way forwards is reasonably clear – the level of benefit for SMEs is to be reduced and the SME scheme broadly folded into an improved large company scheme (RDEC), likely from 1 April 2024. The net result is that large companies and SMEs will likely be treated the same, and that the company doing the R&D activity, regardless of the contractual arrangements with a customer or third party, will not need to be considered – if the rules for this can be written well this should be an improvement.
R&D tax credits for small and medium-sized businesses
However, following various representations made to HM Treasury by the life sciences and pharmaceuticals industry in particular, it does now seem that a limited SME scheme will remain. Such eligible loss making companies who incur R&D expenditure equal to at least 40% of their overall annual cost base will be eligible for a credit equal to £27 for every £100 of qualifying expenditure. This is something of a borrowed concept from the Enterprise Incentive Scheme (EIS) regime, of which I have considerable experience.
The Knowledge Intensive Company (KIC) rules within EIS can be complex and incredibly subjective, so the likelihood is that this R&D intensive SME regime will continue to have a lot of grey areas within it, again creating uncertainty for the taxpayer. EIS has an advanced assurance facility whereby taxpayers can obtain agreement with HMRC in advance of submission that there is a qualifying claim – whilst there is an advance assurance facility for R&D, only those companies turning over less than £2m and employing fewer than 50 people are eligible. Many R&D intensive companies will not be below these thresholds and it’s not clear how comfort could be obtained in advance that the expenditure threshold is met at a later date.
Current issues with the R&D tax credits system
On an operational level, the R&D tax credit system is in total disarray. HMRC has introduced a central compliance check team which appears to have very little R&D or enquiry training, underlining the negative impact of disbanding the previously well-established specialist R&D units several years back. This team is opening up enquiries into claims at the lower end of the spectrum, often without appearing to have reviewed any of the information supplied with the return. The enquiry processes are generally conducted rapidly, with little time taken to digest the information re-supplied, dismissing any requests from the taxpayer or their advisers to meet or speak to explain the R&D projects in more detail, and with a decision letter issued concluding there is no R&D present. There are even reports of HMRC imposing penalties for companies failing to agree their R&D claim in advance, even though (as outlined above) most companies cannot actually do this. The House of Lords has recently expressed concern about the approach being used by HMRC and suggested there is a risk that HMRC is breaching its own Charter. Taxpayers and their advisers are making formal complaints to HMRC and the outcome of these complaints is awaited.
HMRC also appears to be changing its view on areas that most advisers and taxpayers thought were well understood and well explained in HMRC’s own internal manuals – most notably around ‘customer funded R&D’. HMRC has now changed those manuals and despite a well written technical argument being submitted by the Chartered Institute of Taxation to HMRC and HM Treasury, disappointingly there appears to be no resolution to this impasse of views.
HMRC’s longstanding published target was that it aimed to review all R&D claims and process successful claims within 28 days or open an enquiry within 30 days. Notwithstanding the 28/30-day deadline, it has always been the case that the normal enquiry windows still applied, albeit some R&D practitioners relied heavily on these published targets. In one of the recent R&D consultation documents released by HM Treasury, there was an admission that HMRC was unable to robustly review the claims within the 28 days and in reality only had time to process the claim – that has left the system completely broken. Claimant companies now don’t know whether their claim is accepted or not, and have to deal with uncertainty around the length of time that HMRC can go back and challenge the claim – that means the financial benefit of the claim is not ploughed back into new R&D or product development but left in the company bank account in case HMRC asks for it back.
In the interim many companies that believe that they have undertaken genuine R&D in previous years are now not making claims, fearful of becoming embroiled in a dispute of one nature or another with HMRC. This would appear contrary to the intention of Parliament. The irony is that having heavily encouraged companies to claim between 2000 and around 2010, and then having closed the specialist R&D units in around 2016 such that there has been exceptionally little enquiry activity until mid-2022, HMRC has effectively ushered the horses into the stable and then bolted the door behind them.
Changes from April 2023
In addition to the above, changes to the submission system for R&D claims come into force from 1 April 2023. We are told these changes are designed to improve the quality of R&D claims submitted in general and include the submission of an online form notifying HMRC of an intention to make a new R&D claim. One imagined that HMRC would adopt a system similar to the one used for EIS and EMI share options, which helped HMRC gather appropriate information necessary to allow them to determine whether the company qualified for those reliefs – but this does not appear to be the case.
A recent demonstration of the new HMRC system was disappointing – the questions within the online R&D form appeared to be very basic and would not give an HMRC caseworker anywhere near enough information to even begin to risk assess the claim – and thus HMRC freely admit that a full R&D claim of the type currently submitted by most R&D practitioners will continue to be necessary. One therefore needs to ask what the purpose of the form therefore is and whether there is sufficient connection between the questions being raised by HMRC during their enquiries and those responsible for developing the online form.
Whilst the retention of some form of R&D intensive SME regime is welcomed in the round, there are many more issues that Government should be tackling both structurally and operationally to the R&D tax credit system – and that doesn’t appear to have happened today. The wait continues.
Read more analysis in our Spring Budget hub.