Chapter 4: A new merged Research & Development tax relief scheme
Background
79.The Government first raised the possibility of merging the two existing R&D tax relief schemes in its consultation, R&D tax reliefs, published in March 2021.122 The summary of responses to that consultation noted the differing views about the proposed merger.123 Then, at Autumn Statement 2022, the Government announced that it would be consulting on the design of a single R&D tax relief scheme.124 Although that announcement—and the consultation itself125—came too late to be considered as part of last year’s Finance Bill Sub-Committee inquiry into Finance Bill 2022–23, witnesses submitted mixed evidence about the putative concept of merging the two schemes.126
80.Given the lack of consensus among stakeholders, the report by last year’s Finance Bill Sub-Committee reflected disappointment that the consultation on the design of a merged scheme, launched in January 2023, was limited to the design and implementation of the new scheme rather than whether the merger of the two schemes was desirable.127
81.The Government published a summary of responses to this consultation in July 2023, together with draft legislation implementing a merger: “to keep open the option of implementing a merged scheme from April 2024”.128 While the Government said that it had not yet decided whether to go ahead with the merger, it noted that they would do so at the next fiscal event.
82.The next fiscal event was Autumn Statement 2023: the Government announced that it had decided to proceed with merging the SME and RDEC schemes and that, as trailed, the merger would take effect from 1 April 2024.129 Revised legislation was published as part of Finance Bill 2023–2024.130 This meant that, at the time our witnesses gave their evidence, they still did not know whether the merged scheme would be introduced, and it is important to take this into account when reading their evidence.
83.The merged scheme is broadly based on RDEC, with relief provided by way of an above the line131 credit which the Government said made: “the benefit more visible … and easier to factor into R&D investment decisions”.132 However, it also has certain elements—such as in relation to subcontracted R&D, which we discuss in Chapter 5—that are based on the SME scheme, as well as some new features. As Richard Jones of ICAEW told us, this means that both larger companies and SMEs: “will be used to some of [the merged scheme] because it is based … partly on their [current] scheme[s].”133 Mr Henty told us that: “this is taking the best of both schemes into the merged design”.134 Some of our witnesses disagreed. In particular, Benjamin Craig of Ayming felt that many of the: “complexities and challenges of having two schemes are still there. 135
84.We recognise that the Government has sought to engage with stakeholders on merging the two existing R&D tax relief schemes since January 2023. However, given the significance of this change, the consultation in January 2023 should not have been limited to the design and implementation of the scheme; it should also have considered the fundamental question of whether a single scheme was desirable.
A simplification of R&D tax relief?
85.Throughout the consultation process, the Government presented the merger of the two schemes as a means of simplifying R&D tax relief.136 Mr Hailey welcomed this simplification: “if you are not R&D intensive, you have one set of rules for every project”.137 NCUB agreed that a merged scheme: “removes the intricacies of choosing between two differing schemes” for SMEs.138
86.Both Evelyn Partners LLP (Evelyn Partners) and Ayming welcomed the decision to provide relief by way of an above the line credit.139 Evelyn Partners said that an RDEC-like credit would be: “simpler and more predictable than the current SME relief (where the benefit can vary dependent on final tax position)”.140 Ayming told us that an above the line credit makes it: “much easier to calculate” how much relief is available. It added that: “for the majority of SME claimants, the merger will represent a simplification to the existing [SME and large company] schemes.”141
87.ForrestBrown agreed that a single scheme would present: “an important opportunity to … offer SMEs access to … a more consistent effective rate of relief, making forecasting easier, more visibility to decision makers and other stakeholders.”142 Evelyn Partners told us that another benefit was that the merged scheme means: “there will be less of a requirement to ascertain whether or not a business … meets the current SME thresholds.”143
88.On a less positive note, ATT told us that, while: “a single R&D scheme would be a simplification … new rules to define R&D intensive SMEs and the possibility of companies moving in and out of the two regimes … will result in an overall increase in the complexity of the R&D relief regime, rather than simplification.”144 Many of our witnesses shared ATT’s view.145 Mr Hailey pointed to the introduction of the R&D intensive scheme, meaning that there would still be two schemes and: “In that sense, this is not a simplification.”146
89.For CIOT, the Government’s proposals represented: “a huge, missed opportunity” as, by retaining the SME scheme for R&D intensive companies: “most of the benefits of a simplification that would come from having a single scheme in the UK will not be realised”.147 Ela8 agreed: it generally welcomed the move to simplify R&D tax relief by merging the schemes, but retaining:
“the SME scheme for … [R&D intensive] businesses means that the current complexities of these arrangements (including the definition of an SME itself) are retained and there is potential confusion for claimants not fully understanding the differences or when to claim under each regime.”148
90.For Ayming, the fact that there will continue to be two distinct schemes means that the Government has not introduced a complete merger:”[it] just changes the balance of the number of claimants between schemes. There will remain the differentiation for R&D intensive loss-making SMEs and therefore the complexity of the [SME] scheme will remain.”149 In this regard, ATT did not see why enhanced relief for SMEs: “could not be delivered as part of the proposed, merged scheme”.150
91.CIOT accepted the need for the SME scheme to be used to deliver relief under the R&D intensive scheme in 2023/24, but remarked that:
“this does not seem to preclude the additional relief from being amalgamated into a single scheme when the relief being given to SMEs more generally changes, with a different (higher) rate being available to R&D intensive SMEs. Although having different rates would add some complexity into the new scheme, in our view it would be less complicated overall than continuing to have two schemes.”151
92.Bringing relief for R&D intensive businesses into the merged scheme would mean a change in the mechanism by which relief is provided to R&D intensive SMEs—namely by way of above the line credit, rather than additional tax relief. However, both Ayming and ForrestBrown told us this would have been their recommendation in any event.152 Ayming said that, by continuing to provide relief under the SME scheme model, the R&D intensive scheme retained: “a critical flaw” of the SME scheme: “as the amount by which an SME can benefit [under the SME scheme]… is dependent on the wider tax position of the company, and not merely on the level of R&D it undertakes”153 and so varies depending on the SME’s profitability.154 ForrestBrown considered that, by continuing with the SME model for R&D intensive relief, R&D intensive companies were being denied access to: “the benefits of RDEC—a more consistent effective rate of relief.”155
93.Mr Henty told us that the: “vast majority of businesses now have just one scheme to think about … [so] it is definitively simpler than it was before.”156 He told us that the Government had sought to align the schemes in relation to subcontracting and certain other aspects of the relief: “the rules of the game would be very similar but the mechanism [for relief under the two new schemes] would still be different, so there is potentially an option to simplify in the future”.157
94.We welcome the Government’s acknowledgement that having one scheme, instead of the proposed two, would be simpler and its apparent willingness to consider further simplification in the future.
95.We agree that providing relief under the merged scheme by way of an above the line credit to all companies, whatever their size, is the right decision.
96.We acknowledge that, for those companies that are not R&D intensive, having just one scheme for R&D tax relief will be a simplification. However, we agree with many of our witnesses that retaining the existing SME scheme for R&D intensive businesses is a missed opportunity in terms of the Government’s tax simplification agenda.
97.We recommend that the Government consult in the near term on bringing the R&D intensive scheme within the new merged scheme to create a fully merged and simplified scheme.
Timetable for merged scheme
98.The Government confirmed in July 2023 when it published the draft legislation that, if the merger took place, it still intended that the merged scheme would take effect from 1 April 2024.158 This was despite only a third of respondents to the consultation being in favour of that date.159 ICAS told us that this was not: “a realistic timetable. … Until the legislation is enacted, it is impossible for businesses to prepare”.160 ForrestBrown said that: “it is important to allow companies sufficient preparation time” but that the proposed timetable meant that the time available for preparation was: “negligible”.161 BVCA agreed—in its view April 2024 was: “overly ambitious … Businesses will need more time to prepare.”162
99.In addition to the impact on the ability of businesses to prepare for the merger, there was also concern about the lack of time for effective consultation, scrutiny, and revision of the proposed scheme. Ayming saw it as: “unnecessarily hasty to push for implementation this rapidly, since it gives relatively little time to effectively scrutinise and revise the proposals to ensure their effectiveness”.163 ICAEW felt that: “further consultation is required to ensure that any difficulties or complexities involved in merging the two schemes are considered properly”164 and ForrestBrown told us that a rushed implementation: “leading to further piecemeal changes to address unintended consequences”, risked eroding business confidence in the new scheme.165
100.BIA considered that the Government should: “just get on with [the merger]” as otherwise: “we are just prolonging the uncertainty”166 but there was otherwise general consensus that the start date should be deferred until at least until 1 April 2025.167 Kevin Hart of Business Application Software Developers Association (BASDA) told us that April 2025 was achievable—in terms of making the relevant changes to tax software—but only: “on the basis that sufficient information is declared early … [in 2024]”.168
101.Some witnesses suggested that a delay of 2–3 years was needed.169 These included Chartered Accountants Ireland, which said that deferring the start date would: “enable the changes taking effect from 1 April 2023 to bed down and their impact … to be assessed before future changes are considered for introduction.”170
102.At Autumn Statement 2023, the Government announced a change to the proposed start date. Rather than applying to R&D spending on or after 1 April 2024 as originally proposed, the merged regime would instead apply to a company from the first accounting period to start on or after that date. This meant that, for a company whose accounting year ends with the calendar year, the merged scheme will not apply to R&D expenditure until 1 January 2025.171
103.The Financial Secretary hoped that: “the accounting period element will provide some assurance to most businesses. Many of them will have an accounting period that will be late 2024 or 2025, so they have until then to work practically on this.”172 Mr Henty said that he had received feedback that this change to the commencement date for the new regime had made: “a big difference to the big companies that are facing the most change through the merged scheme because of the subcontracting rules”.173
104.We acknowledge that the change to the start date announced at Autumn Statement 2023 will mean that the merged scheme may not apply to some businesses until 1 January 2025. For some companies, however, it will be much earlier.
105.We remain concerned that, even with the latest possible start date under the revised timetable, businesses will not have enough time to prepare for the new scheme.
106.We recommend that the start date for the new scheme be delayed until a company’s first accounting period to start on or after 1 April 2025.
Awareness of the changes to R&D relief
107.A pressing concern raised by witnesses to our inquiry was the lack of awareness about the changes. Ayming said that awareness of the changes was: “poor”174—Mr Craig told us:
“Virtually every business that I have spoken to, with very few exceptions, had not heard about changes until we spoke to them about it. … It is potentially quite concerning that changes are going through and there is a real risk that businesses, through no fault of their own, will get things wrong simply because they do not know that changes are happening.”175
By way of illustration, he told us that his firm had recently hosted a roundtable for clients, including 8 of the UK’s top 12 construction companies and: “not one of them had heard of these changes until we reached out to them”.176
108.Mark Davis of ela8 said that awareness of the merged scheme among businesses tended to be linked to whether the business had a professional adviser. Without an adviser: “there is a very strong chance that [the business] will not know that any of this is happening or understand the consequences … ”.177
109.The Financial Secretary promised that there was: “a plan to communicate” and that HMRC had a: “small paid-for marketing budget” of £20,000 allocated specifically for R&D.178 He also told us that: “many of the industry bodies and groups have done a very good job of publicising [the changes] themselves.” Mr Henty added that:
“Industry bodies, business representation groups, agents, accountants, accountancy bodies, and many businesses have been actively engaged throughout the process … All want to make sure that the information gets out so that people know what they are doing. A large number of people are involved in making that happen rather than it just being an exercise from the agency or the Treasury.”179
110.Given the significance of these changes, it is critical that businesses that could be affected know that they are happening sooner rather than later. We welcome the work of representative bodies and advisers in raising awareness of the changes among the business community. However, the primary responsibility for informing taxpayers of changes to tax regimes lies with the Government. We welcome the Minister’s confirmation that there is a communication plan and a specific budget allocated to HMRC for this purpose.
111.We recommend that, as a priority, HMRC should implement an education campaign about what the merged scheme will mean for businesses investing in R&D.
Adjusting to the merged scheme
112.The decision by the Government to incorporate elements of both RDEC and the SME scheme into the merged scheme means that both SMEs and larger businesses will need to adjust. ForrestBrown noted that: “the proposals potentially disrupt both SMEs and large companies”.180 For large companies, the most significant change, as compared to RDEC, is likely to be the treatment of subcontracting arrangements under the merged scheme181—we discuss this in Chapter 5.
113.In relation to SMEs, Dr Barker told us that while: “in principle the single scheme is more straightforward … the fact that it is new and will be set up on a completely different basis will create uncertainty for SMEs”.182 The main change for many SMEs will be the move to an above the line183 credit. CIOT pointed out that, in addition to the new tax rules, SMEs would need to get to grips with the accounting treatment of the R&D credit as: “accounting for RDEC is more complex” than is the case for relief under the SME scheme.184
114.Ela8 contrasted the proposed: “overnight move to a different regime”, with the situation in 2013, when: “the transition to the RDEC scheme for large companies was phased.”185 The rapid introduction of the merged scheme led ATT to question whether HMRC would be able to provide the: “significant amounts of education, guidance and support ahead of any new scheme launching”.186 Witnesses emphasised that the guidance needed to be clear and contain relevant examples of common scenarios.187 In this regard, ela8 stressed the need for HMRC: “helplines where claimants/potential claimants could access real-time technical support”.188
115.Some witnesses were also concerned that the changes—in particular the reduction in the rate of relief available under the merged scheme (at 20 per cent) when compared with that previously available under the SME scheme—could reduce the willingness of SMEs to claim R&D relief.189 Mr Davis told us:
“The benefit levels have been cut once, and this proposal [for a merged scheme] would cut them again. There is a potential risk of firms in the UK, particularly SMEs, looking at this and starting to debate whether, in the context of the benefit available, … along with a fear of the compliance environment, they want to make a claim for relief”.190
116.Similarly, CIOT told us that:
“It seems likely that the effect of the merged scheme will be to reduce the number of claims overall, … with mid-sized businesses in particular being less likely to be able to claim relief … We recognise that this might be an intentional policy outcome, as the reduction in rate to the relief available to SMEs will cause many SMEs to have to re-evaluate the economic viability of their businesses and R&D projects. … [If] the government wishes to focus R&D tax relief more on larger companies, it should be more open and transparent about these policy aims.”191
117.Dr Barker said that, for IoD members: “the key fact behind whether the new regime will be successful will not be the format of the scheme but how generous the final scheme is in incentivising R&D expenditure”.192 In a survey of IoD members, 47 per cent of those who responded said that they thought the merged scheme: “could result in them spending less on R&D than in the past.”193
118.The Federation of Small Businesses (FSB) suggested that if the merged scheme goes ahead: “a higher rate of relief could be set for SMEs”.194 ForrestBrown told us that providing a higher rate of relief for SMEs was justified as: “access to finance for risky endeavours such as R&D is more limited [for SMEs] than for larger businesses.”195
119.The Financial Secretary told us that, overall, the changes—both the merged scheme and the relief for R&D intensive businesses—were: “adding hundreds of millions more into the R&D system”:
“The reality is that we have fallen behind in overall investment in business and R&D compared to many other countries around the world. … We need to focus on growth and to enhance our productivity … R&D benefits the UK economy. There is a lot of economic analysis looking at the previous systems and seeing what worked and what did not work. We are very confident that this will lead to positive outcomes”.196
120.In addition, HMRC said that it will be monitoring the measure through information collected from claims and that, after 5 years of monitoring in this way: “Consideration will be given to evaluating the policy”.197
121.We are doubtful that final guidance of the quality needed to support businesses as they adjust to the merged scheme can be put in place by 1 April 2024. Without final detailed guidance, well in advance of the start date, it is not sensible or appropriate to bring the merged scheme into effect.
122.We are concerned that the introduction of the merged scheme will impact investment in R&D by SMEs, and subsequently impact UK productivity and growth. We note the concerns raised by witnesses that the reduction in the rate of the relief may deter SMEs from submitting future claims. If it is the Government’s intention to reduce the number of claims from SMEs and focus the relief on larger companies, then it should make this clear.
123.We recommend that the Government commits now to evaluating the effectiveness of the merged scheme in incentivising investment in R&D by large and small businesses in three years’ time.
124.We ask the Government to provide evidence of the economic impact of the merged scheme and the R&D intensive scheme and, in particular of the additional monies they have injected into the UK’s R&D systems.
Costs
125.The Government first produced an estimate of the costs for business of adapting to the new R&D scheme when it announced its decision to proceed with the merger at Autumn Statement 2023. One-off costs for businesses were estimated at a total of £7 million and on-going costs at £300,000—with the Government saying it expected approximately 87,000 businesses to be impacted by the change.198 Mr Henty told us that this was: “based on established methodology for business-customer costs”. He said that that one-off costs were expected to be about: “familiarising yourself with new rules” and were therefore: “a forecast based on a set of assumptions about the time taken to look at the rules of the new scheme”.199
126.Our witnesses provided their evidence before the Government published its costings.200 ICAEW said it was: “unacceptable” that potential costings had not been provided earlier as businesses: “need time to assess the final design and the likely cost impact to advise the government on whether the scheme is good value for money.”201 ATT agreed: it described the Government’s failure to quantify these costs in July as: “disappointing”, leading ATT to conclude that: “the cost to business will not be considered as part of the final policy decision.”202
127.Ela8 told us that, although the costs of adjusting: “should be manageable for most businesses with a realistic timetable and appropriate support”, SMEs could face particular issues as: “sourcing quality, professional support at reasonable cost is becoming difficult for SMEs due to rising complexity and compliance costs”.203
128.Mr Henty told us that the new scheme would give additional support to businesses and that the Government therefore judged the one-off transition costs to be: “very worthwhile”.204
129.The cost to taxpayers of implementing new tax rules is an important consideration when developing new policies. While not confirming whether the merged scheme would go ahead, the Government has been clear since January 2023 that, if it did, it would take effect from April 2024. Changing the way in which R&D relief is given is a major change and we see no reason why indicative cost estimates could not have been provided in July 2023. By only publishing its costings in late November 2023, the Government left it too late for stakeholders to engage on whether its estimates accurately capture those costs.
130.Where the Government is proposing a major change to how businesses are taxed, we recommend that costs are modelled at an earlier stage in the consultation process to allow for stakeholder engagement, even where some details have not yet been finalised.
122 HM Treasury and HMRC, ‘R&D Tax Reliefs: consultation’ (3 March 2021): https://www.gov.uk/government/consultations/rd-tax-reliefs-consultation [accessed 4 January 2024]
123 HM Treasury, ‘R&D Tax Reliefs Report’ (30 November 2021): https://www.gov.uk/government/publications/rd-tax-reliefs-report [accessed 4 January 2024]
124 HMRC, ‘Reforms to R&D tax reliefs’ (21 November 2022): https://www.gov.uk/government/publications/research-and-development-rd-tax-reliefs-reform/reforms-to-rd-tax-reliefs [accessed 4 January 2024]
125 HM Treasury, ‘R&D Tax Reliefs Review: Consultation on a single scheme’ (13 January 2023): https://www.gov.uk/government/consultations/rd-tax-reliefs-review-consultation-on-a-single-scheme [accessed 04 January 2024]. Our call for evidence had expired on 2 November 2022.
126 Economic Affairs Committee, Research and development tax relief and expenditure credit (3rd Report, Session 2022–23, HL Paper 137)
127 Economic Affairs Committee, Research and development tax relief and expenditure credit (3rd Report, Session 2022–23, HL Paper 137), p 61, para 260
128 HMRC and HM Treasury: ‘Consultation on draft legislation published for Finance Bill 2023–24’ (18 July 2023) https://www.gov.uk/government/collections/finance-bill-2023–24 and HM Treasury, ‘R&D Tax Reliefs Review: Consultation on a single scheme—summary of responses’ (18 July 2023): https://www.gov.uk/government/consultations/rd-tax-reliefs-review-consultation-on-a-single-scheme [both accessed 4 January 2024].
129 HMRC, ‘Research & Development (R&D) tax relief reforms’ (22 November 2023): https://www.gov.uk/government/publications/research-development-rd-tax-relief-reforms [accessed 4 January 2024]
130 HMRC, ‘Research & Development (R&D) tax relief reforms’ (22 November 2023): https://www.gov.uk/government/publications/research-development-rd-tax-relief-reforms [accessed 4 January 2024]
131 See Box 1.
132 HM Treasury, R&D Tax Reliefs Review: Consultation on a single scheme—summary of responses (18 July 2023), p 17: https://assets.publishing.service.gov.uk/media/64b65ec90ea2cb001315e470/Summary_of_Responses_-_RD.pdf [accessed 4 January 2024]
135 Q 39 (Mark Davies, Benjamin Craig) and also see Chapter 5 in which we discuss the concerns of witnesses about the adoption of the SME scheme model for subcontracting within the merged scheme.
136 HM Treasury, ‘R&D Tax Reliefs Review: Consultation on a single scheme’ (13 January 2023): https://www.gov.uk/government/consultations/rd-tax-reliefs-review-consultation-on-a-single-scheme. [accessed 4 January 2024]
137 Q 47 (Colin Hailey), written evidence from BIA (DFH0013). We note that Mr Hailey caveated his view saying his welcome was dependent on relief being available under the merged scheme for subsidised expenditure—which following Autumn Statement 2023 will be the case: we discuss the treatment of subsidised expenditure in Chapter 5.
139 See Box 1.
145 Written evidence from Ayming UK (DFH0014), BVCA (DFH0017) CAI (DFH0001), CIOT (DFH0006), ela8 limited (DFH00015), ICAEW (DFH0005) and ICAS (DFH0018), Q 38 (Mark Davis, Justin Arnesen), Q 6 (Susan Cattell).
148 Written evidence from ela8 limited (DFH0015). This is because the R&D intensive scheme follows the SME model (while RDEC is the model for how relief is given under the merged scheme). Written evidence from Ayming UK (DFH0014)
150 Written evidence from ATT (DFH0002), Q 6 (Susan Cattell) and written evidence from ela8 limited (DFH0015).
153 Written evidence from Ayming UK (DFH0014), which includes an example explaining the impact of profitability on R&D relief under the SME scheme.
154 Written evidence from Ayming UK (DFH0014), which includes an example explaining the impact of profitability on R&D relief under the SME scheme.
158 HMRC and HM Treasury: ‘Consultation on draft legislation published for Finance Bill 2023–24’ (18 July 2023): https://www.gov.uk/government/collections/finance-bill-2023–24 [accessed 4 January 2024]
159 HM Treasury, ‘R&D Tax Reliefs Review: Consultation on a single scheme–Summary of Responses’ (18 July 2023): https://www.gov.uk/government/consultations/rd-tax-reliefs-review-consultation-on-a-single-scheme [accessed 4 January 2024]. In contrast, 0 per cent of respondents were against 1 April 2024 as start date and 30 per cent neutral.
164 Written evidence from ICAEW (DFH0005) and Forest Brown (DFH0016), Q 16 (Dr Emma Rawson) and written evidence from CIOT (DFH0006)
167 Q 9 (Susan Cattell), Q 15 (Andrew Harding, Dr Emma Rawson), written evidence from CIMA (DFH0008), ela8 limited (DFH0015), Evelyn Partners (DFH0012), ForrestBrown (DFH0016) and Skanska (DFH0010)
171 Finance Bill, Schedule 1 [Bill 14 (2023–24)]. The Finance Bill does not contain a specific commencement date but instead provides for a day to be appointed by regulations.
178 Q 88 (Nigel Huddleston MP, FST) and written evidence from HMRC (DFH0020), letters from Nigel Huddleston MP Financial Secretary to the Treasury to Lord Leigh of Hurley Chair of the Economic Affairs Finance Bill Sub Committee (7 December 2023 and 12 December 2023): committees.parliament.uk/publications/42723/documents/212469/default/ and committees.parliament.uk/publications/42711/documents/212323/default/
183 See Box 1.
186 Written evidence from ATT (DFH0002)
187 Written evidence from ela8 limited (DFH0015), Evelyn Partners (DFH0012), and ForrestBrown (DFH0016)
197 HMRC, ‘Policy paper, Research and Development reform—Consultation on a single scheme’ (18 July 2023: https://www.gov.uk/government/publications/research-and-development-reform-additional-tax-relief-and-potential-merger/research-and-development-reform-consultation-on-a-single-scheme [accessed 4 January 2024]
198 HMRC, ‘Merger of current small or medium enterprise (SME) and Research and Development Expenditure Credit (RDEC) schemes’ (23 November 2023): https://www.gov.uk/government/publications/research-development-rd-tax-relief-reforms [accessed 4 January 2024]
200 Written evidence from ICAS (DFH00018)