Key Changes to the UK R&D Tax Incentives

21st July 2022

Key Changes to R&D Tax Incentives

Draft legislation has just been published setting out the details of key changes to the UK’s R&D tax incentive regimes. These will all take effect for accounting periods beginning on or after 1 April 2023.

Restriction on overseas R&D

Background

Following consultation, HM Treasury released their initial report on R&D Tax Reliefs in November 2021. A key component of this report was their desire to refocus the R&D tax credit reliefs to support innovation in the UK. Under the current rules for both the SME and R&D Expenditure Credit (‘RDEC’) schemes, companies can claim relief on R&D activity that is conducted overseas.

Their stated intention was to amend the rules such that:

“Where companies subcontract R&D activity to a third party, they will in future only be able to claim relief for that expenditure where that third party performs the work within the UK. The rules for subcontracting will not otherwise change. This will apply to the SME scheme, and a similar principle will apply in RDEC, where subcontracting occurs and where a company claims for contributions it makes for independent R&D to a qualifying body.
Under both schemes, 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 paid through a UK payroll.”

HM Treasury clarified that companies will still be able to claim R&D tax reliefs on the costs of software (including data and cloud computing), consumables and payments for clinical trials volunteers sourced overseas, as these are considered inputs to activity in the UK.

The responses to this proposal, including representations made by FTI Consulting, made clear the circumstances where a company in the life sciences sector may be required out of necessity to undertake R&D overseas.

The BIA supported by FTI Consulting have played a key role in providing support to HM Treasury and HM Revenue & Customs (‘HMRC’) to help design an exemption to accommodate for this.

Draft legislation

The draft legislation sets out that qualifying overseas R&D expenditure may be included in certain circumstances. These circumstances are that the conditions necessary for the R&D:

are not present in the UK;
are present in the location in which the R&D is undertaken, and
it would be wholly unreasonable for the company to replicate those conditions in the UK.

‘Conditions’ includes:

geographical, environmental or social conditions,
legal or regulatory requirements as a result of which R&D may not be undertaken in the UK,

but does not include conditions relating to:

cost; or
the availability of workers to carry out the R&D.

FTI Consulting Comment

Companies undertaking pre-clinical and clinical development are likely to be undertaking significant elements of R&D outside the UK and so these new measures could have a material impact on their potential eligible expenditure.

We are pleased that HM Treasury and HMRC understood the need for an exemption, given the potential impact on companies in the life sciences sector.

The exemption, as drafted, should help to mitigate the impact of these new measures although HMRC regard this as having a ‘narrow’ application. Companies will have to identify R&D undertaken overseas, provide evidence that it is not ‘wholly unreasonable’ for the same activity to have been carried out in the UK and reference the relevant ‘conditions’.

Additional qualifying expenditure: Data, Cloud Computing and the HSCL

The scope of qualifying expenditure will be extended to include the costs of datasets and cloud computing. There will be restrictions where rights are given to exploit these directly for commercial purposes.

For the calculation of staff costs, the health and social care levy can also be included alongside national insurance contributions.

Tackling abuse

All claims to the R&D reliefs will in future have to be made digitally and claimants will have to break the costs down across qualifying categories and provide a brief description of the R&D. Each claim will need to be endorsed by a named senior officer of the company.

Where companies have not claimed in the previous three years, they will need to inform HMRC their intention to make a claim within 6 months of the end of the period.

Claims will also need to include details of any agent who has advised the company on compiling the claim.

Next steps

HMRC are seeking feedback on the draft legislation before its inclusion in Finance Bill 2022-23. The rules will become effective for accounting periods starting on or after 1 April 2023.

Companies should assess their expected position before the rules come into force and consider which exemption may apply when entering new arrangements. This could impact arrangements in contracts that are being drawn up now where the work will fall into the scope of these new rules.

FTI Consulting have developed a cost tracking application identifying when R&D is undertaken overseas and providing appropriate supporting evidence for expenditure potentially falling within this exemption.

If you have any questions or would like to view the tracking application please do not hesitate to contact Richard Turner or Oli Pumfrey.

FTI Consulting Life Sciences Tax Team

The views expressed in the commentary are those of the author(s) and not necessarily the views of FTI Consulting,

its management, its subsidiaries, its affiliates, or its other professionals.

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