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Research and development tax relief, HMRC data requirements, promoters of tax avoidance and sentencing for tax fraud Contents

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Chapter 2: Government Review of Research and Development Tax Relief

Background

9.Research and development tax relief (R&D relief) was first introduced in 2000 in response to evidence that the UK’s R&D spend was falling behind that of its competitors.3 Its purpose was to incentivise companies to undertake innovative R&D—R&D that seeks to advance overall knowledge or capability in a field of science or technology4—by providing further tax relief, over and above the normal corporation tax relief available for business expenses.

10.Initially only available to small and medium sized enterprises (SMEs),5 the Government extended R&D relief to larger companies in 2002, providing relief on the same basis, albeit at a lower rate.6 Since then, there have been a number of changes to R&D relief, particularly in relation to the rate at which relief is granted for qualifying R&D.7 However, one of the more significant changes was the replacement of the large company scheme by the RDEC scheme in 2013. Under RDEC, large companies obtained relief by way of an ‘above the line’8 credit instead of through additional tax relief.9

11.The effectiveness of R&D was not considered during this year’s inquiry. However, last year’s Finance Bill Sub-Committee report, published in January 202310, concluded that R&D relief is perceived by business as important for supporting and promoting R&D activity in the UK. The report also concluded that data from HMRC indicates that the reliefs do promote spending on R&D, but that the return on the SME relief was disappointing.

The Research & Development Review

12.In March 2021, the Government announced it was carrying out a review of R&D relief, the first in the history of R&D relief.11 It said it wanted to: “consider all elements of the two R&D tax relief schemes, with the objective of ensuring that the UK remains a competitive location for cutting edge research, that the reliefs continue to be fit for purpose and that taxpayer money is effectively targeted”.12

13.The Government launched a consultation seeking views on the efficacy of the two R&D relief schemes and on possible changes to the regime.13 The consultation said that the UK was: “unusual internationally in having two different schemes” and questioned whether there was a case for consolidating the SME and RDEC schemes. It also asked how the availability of R&D relief impacted investment decisions and what could be done to improve the claims process.14

14.The Government noted that: “the rate of relief provided by the SME scheme is significantly more generous than that provided by RDEC” and wanted to understand why, despite this, recent evaluations of the two schemes suggested that RDEC was more successful in promoting additional R&D investment than the SME scheme.15

15.At the time of the review, the additional tax relief under the SME scheme was provided at a rate of 130 per cent. As R&D tax relief is an additional relief, the SME first deducts 100 per cent of its qualifying R&D expenditure from its income under normal corporation tax rules and then claims an additional deduction/payable tax credit under the SME scheme. For an SME spending £1,000 on qualifying R&D, this would mean a deduction of £1,300 which, when combined with the normal tax relief for that expenditure, would translate into total relief of £2,300—230 per cent. This had the effect of reducing the SME’s overall taxable profits, resulting in a lower corporation tax bill. Under the SME scheme, SMEs who carried out R&D but made a loss in the relevant year could claim a payable tax credit worth (in broad terms) 14.5 per cent of the surrenderable loss.16

16.In contrast, under RDEC, R&D tax relief is provided to larger companies by way of a (taxable) credit which, at the time of the review, was set at 13 per cent of qualifying R&D spend—referred to as above the line credit17. This means that, in addition to the tax relief for that R&D expenditure under normal corporation tax rules, the company’s R&D expenditure of £1,000 would result in a credit of £130. A company that receives RDEC credit will generally use it to offset its tax bill, reducing the amount of corporation tax it would otherwise pay but, in some circumstances, such as where the company makes a loss, the credit can be paid in cash.18

Initial reforms—Finance (No 2) Act 2023

17.In November 2021, HM Treasury published the R&D Tax Reliefs Report which set out the Government’s proposals for specific changes to R&D relief.19 These included a number of compliance-related changes primarily designed to help counter error and fraud, and a proposed restriction on R&D relief for certain overseas R&D expenditure.20 These proposals, which the Government said were: “initial reforms”21, were examined by last year’s Finance Bill Sub-Committee.22 Other than the proposals relating to R&D relief for overseas expenditure, these proposals were legislated for in Finance (No 2) Act 2023.23

“Rebalancing the reliefs”

18.In the Spring Statement on 23 March 2022, the Government said that it was continuing its review of R&D relief and that it was considering a possible increase to the rate of relief under RDEC to: “rebalance the schemes and make RDEC more internationally competitive”.24 In the Autumn Statement on 17 November 2022 (Autumn Statement 2022), the Government confirmed that the rate of relief under RDEC would increase from 13 per cent to 20 per cent from 1 April 2024, while the SME deduction rate would be reduced from 130 per cent to 86 per cent, and the rate of the SME payable credit which could be claimed for surrenderable losses would be decreased from 14.5 per cent to 10 per cent.25

19.The Government described this rebalancing of the reliefs as bringing: “the generosity of the two schemes closer together” and as: “a step towards a simplified, single RDEC-like scheme for all”, about which it would be launching a consultation. It also committed to work with industry ahead of the 2023 Spring Budget: “to understand whether and how to provide further support to R&D intensive SMEs.26

20.Less than two months later, on 13 January 2023, the promised consultation on the design of a single R&D relief scheme was launched.27 Although the Government maintained that no final decision to merge the schemes had been made, it stated that, if the ultimate decision was indeed to merge the schemes, this new merged scheme would be introduced on 1 April 2024.28

Budget 2023—a new R&D intensive scheme

21.As the consultation period expired two days before the 2023 Spring Budget, no announcement about whether the two schemes would be merged was made at that stage. The Government did say, however, that it would publish draft legislation on a merged scheme in July 2023 for consultation: “to keep open the option of implementing … [a merged scheme] … from April 2024”.29 It also confirmed that the restriction on R&D relief for overseas expenditure would come into effect from April 2024, a year later than originally proposed, to allow time to assess this restriction’s interaction with any merged scheme.30

22.The Government made an additional announcement that, with effect from 1 April 2023, it would introduce a new scheme for loss-making SMEs that invested heavily in R&D—companies it referred to as ‘R&D intensive SMEs’. Under this scheme, qualifying SMEs would be able to continue to claim tax credit under the SME scheme at the previous rate of 14.5 per cent instead of the new lower 10 per cent rate that would otherwise apply.31

Autumn Statement 2023—the end of the review

23.In the Autumn Statement on 22 November 2023 (Autumn Statement 2023), the Government confirmed that it would be proceeding with the merger of the two existing R&D schemes into a single scheme broadly based on the existing RDEC scheme, and that this would come into effect for accounting periods beginning on or after 1 April 2024.32 This announcement marked the conclusion of the R&D Review started in March 2021.33

24.At the same time, the Government announced some changes to the new R&D intensive scheme, to take effect from the start of the claimant company’s first accounting period beginning on or after 1 April 2024. These changes included amendments to the test for R&D intensity—which we discuss in Chapter 3—as well as changes to ensure greater consistency between the rules in the existing SME scheme (under which R&D intensive relief is given) and the proposed merged scheme, in certain areas.34 The Government also said that it would be continuing to work with industry on developing this particular relief.

25.Legislation to implement the merger and to enact the R&D intensive scheme was subsequently published as part of Finance Bill 2023–2024.35 We consider the R&D intensive scheme in Chapter 3 of this report, and the merged scheme in Chapters 4 and 5.

General reaction to the R&D reforms

26.Our witnesses generally supported the Government in its efforts to simplify R&D tax relief. Ela8 Limited (ela8) said that, overall, it welcomed: “any move to simplify the R&D tax relief regime as it is clear that the complexity of the current arrangements is causing difficulties for claimants, R&D practitioners and HMRC alike”.36

27.This general support for the reforms notwithstanding, several of our witnesses expressed concerns about the number and scale of the changes to R&D relief in recent years.37 Ayming UK Limited (Ayming) told us: “R&D schemes are most effective when there is stability and predictability, because businesses can factor that into their decision-making processes … [but] … companies … cannot take R&D relief into account when it is in such a state of flux”.38 ForrestBrown Limited (ForrestBrown) agreed, saying that: “the current extended reform period … has been piecemeal in nature, leading to uncertainties that have undermined the effectiveness of the incentive as a driver of R&D investment.”39

28.Referring to the reduction in the rate of relief under the SME scheme announced at Autumn Statement 2022, Michael Moore of British Venture Capital Association (BVCA) told us that: “the scale of the prospective change was a shock”.40 Nonetheless, he was: “pleased about how some of the thinking has evolved”.41 However, Dr Roger Barker of the Institute of Directors (IoD) said the last year: “had not been a productive way forward” with both new proposed regimes creating: “a lot of uncertainty and disruption”.42

29.There was also a sense that the current proposals—the introduction of an R&D intensive scheme and the possible merger—were being: “rushed”43. Mace said that the timeline: “risks the R&D tax scheme being no longer considered as a stable and reliable incentive for future R&D investment decisions”.44

30.The Financial Secretary, Nigel Huddleston MP, told us that the changes to R&D relief now being taken forward—namely, the R&D intensive scheme and the merger—would: “obviously be beneficial overall” and, in particular, meant there was: “more money going into investing and encouraging investment in R&D”.45 He also told us that the changes were: “the measures that we have been hearing industries say they want, and on the government side we do not want to drag our feet in any way.” He reiterated the Government’s view that R&D relief was: “an important element” of its: “overall push for growth”.46

31.Matt Henty, Deputy Director, Enterprise and Property Tax, at HM Treasury acknowledged that companies would need to adjust to the new R&D relief rules but considered that the changes overall were: “very worthwhile”, resulting in an increase in the support the Government would be providing to R&D activity.47

32.While it is right for the Government to keep the R&D relief scheme under review to ensure that it meets the needs of a modern economy and provides value for money for the taxpayer, too much change over too short a period can create uncertainty. We are concerned that the number of significant R&D changes made in the last 5 years has led to a perception of instability in the UK’s R&D tax relief regime and undermined the intended incentive effect of the relief.

33.The Government’s postponement of a final decision on creating a single merged scheme of R&D relief added to the uncertainty around R&D relief. Businesses can only start to prepare in earnest once a change is confirmed. The Government’s announcement of a prospective commencement date of an unconfirmed measure did not give businesses sufficient certainty to be able to plan effectively.

34.We welcome the announcement at Autumn Statement 2023 that the R&D review is now complete. Businesses need time to adjust to all the recent changes to R&D relief. We recommend that, over the medium term, the Government does not make further changes to R&D tax relief, other than to simplify the relief as set out in this report.

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