The Government has published a consultation document which sets out some proposed changes to the UK research and development (R & D) regime. The proposed changes are intended to ensure that the R & D regime supports innovation for large and small companies. Response to the consultation is due by 2 September.
Key Business Impact
- For larger businesses, the consultation document heralds some major changes to the existing R & D regime, notably a proposal to change the format of R & D tax credit from an enhanced deduction to a credit against the company’s corporation tax bill (see point 1 below for more detail on the Government's proposals).
The possible switch to an 'above the line' credit will be both a major change in the R & D regime but also a very welcome one. It is likely to show R & D as a core element of pharma, technology and biotech business and one which simultaneously contributes to the company's growth but also legitimately reduces its corporation tax bill.
- Under current law, companies must spend at least £10,000 on qualifying R & D activities to be eligible to claim the credit. This restriction will be repealed.
- Changes are also proposed to the way that relief is given for subcontracting expenses. Companies who engage subcontractors should carefully review their arrangements. It may be that the activities undertaken by the subcontractor will soon be eligible for an R & D claim by the company and the company needs to (i) reserve its right to make that claim and (ii) ensure the documentation enables the company to request the relevant paper work from the subcontractor.
A link to the consultation document can be found here.
Readers may also be interested in the Government's proposals (also recently announced) for the patent box tax. A link to the Herbert Smith briefing can be found here.
The changes are part of the Government's plan to demonstrate that the UK has a competitive tax system and to encourage investment and growth in the UK by incentivising companies to locate high-value jobs and activity associated with the development of and investment in innovative activity in the UK. The new proposals are aimed at removing barriers to companies claiming the relief.
Areas of reform highlighted in the consultation document
The key areas of reform affecting larger businesses are as follows:
- Introduction of a corporation tax credit in place of enhanced deduction:
The Government is contemplating reformulating the R & D tax credit so that it becomes a credit against the company’s corporation tax bill rather than an enhanced deduction which reduces its taxable profits– referred to as 'an ‘above the line’ tax credit'.
Taxpayers have argued for this change on the basis that it delivers a better incentive effect for little additional cost.
For those companies that do not have sufficient corporation tax liabilities to offset against the 'above the line' credit, the Government will consider providing for either an offset against other taxes or an ability to ‘cash in’ the credit for a payable sum. A payable credit would therefore potentially deliver relief faster for some loss making companies.
By contrast, under the current system which provides a 'super deduction' of up to 135% of qualifying expenditure, large companies which do not have enough profits to immediately make use of the 'super deduction', may carry it forward as a corporation tax loss which will be relieved when the company has sufficient taxable profits.
- Proposal to allow 'employers' / clients to claim R & D relief for subcontracting expenses in some circumstances:
The inability to include the cost of some subcontracting expenses within eligible R & D expenditure has been controversial because of lack of clarity.
Under current rules applying to large companies (and to small companies doing subcontract work for large companies), it is the subcontractor who claims R & D relief. The controversy arises because it is not always clear whether the work done is R & D for the subcontractor and if it is not, relief is denied.
The Government is considering changing the rules to allow the 'employer' company to claim the relief in circumstances where the subcontractor makes clear that the work it is doing is for its 'employer' and that that work is qualifying R & D. Both parties need to be able to support this position in the event of HMRC enquiry. As expected, HMRC is keen to ensure that relief should be given only once in respect of the same expenditure.
- Possible extension of rules to allow relief for externally provided workers:
Under current rules, expenditure on externally provided workers is allowable if certain conditions are satisfied, notably that the workers are engaged to work alongside the company’s own employees and are, for day-to-day purposes, treated as though they were actual employees, they must be engaged to meet a particular need and must remain employed by the agency rather than the company.
The Government accepts that the 'current rules are over restrictive and will bring forward draft legislation in the Autumn retaining the essential features of the test for relief under the current rules (ie that the worker is for day to day purposes performing similar functions to, and is subject to the same degree of control as, an employee) but allowing a wider range of circumstances to qualify.'
- Rejection of request to amend the definition of R & D:
Many in the sector had asked HMRC to revise the definition of what qualified as R & D. The Government has declined to do so.
However, it will, as requested, issue revised guidance on what 'production' means for R & D purposes. The Business, Innovation and Skills guidelines exclude the “production and distribution of goods and services” from being R & D.
The Government has confirmed that R & D takes place when a project seeks to achieve an advance in science or technology, and that activities which directly contribute to the advance, by resolving scientific or technological uncertainty, are R & D. HMRC will develop improved guidance setting out this “uncertainty” principle and will illustrate how it may be applied in a number of different situations. This draft guidance will be published shortly.
- Government to encourage greater use of specialist R & D teams at HMRC:
The Government has also agreed to encourage companies to use the specialist HMRC R & D teams who are able to assist taxpayers to ascertain when and if they have qualifying expenditure, help with claims and assist with record keeping requirements.
The Government will consult in the Autumn on draft legislation to implement further changes to the R&D scheme. Prior to that date, it welcomes views on the issues raised above.