Key points of new R&D merged scheme

Overview

The government’s initial intention was to create a single scheme going forward. However, at the last minute it was announced that there would continue to be different rules for certain small and medium enterprises (SMEs) that are “R&D intensive”. Despite this, the main scheme is referred to as the “merged scheme”. This replaces both the old SME scheme and the Research and Development Expenditure Credit (RDEC), though is largely based on the latter.

Changes 

If you previously claimed under the SME scheme, claims going forward will be significantly different. The SME scheme involved an enhancement to qualifying expenditure, i.e. an additional deduction from income. The merged scheme operates in broadly the same way as the RDEC, so involves introducing an above the line taxable credit, before deducting the same amount from the corporation tax liability.

The way relief is given follows a strict order, which is especially important if the deduction exceeds the corporation tax liability for the current year.

Timing

The merged scheme applies to accounting periods beginning on or after 1 April 2024. This means that the old rules will still be relevant for some time yet. For example, a company with a 31 December year end will still use RDEC or the SME scheme for qualifying expenditure incurred this year.

To complicate matters, recall that the rates of relief changed for accounting periods beginning on or after 1 April 2023. The previous rates will apply to companies with, for example, a year end of 31 December 2023.

The deadline for claiming is two years from the end of the relevant accounting period, so the old rules (and the old old rates!) will have a long tail-off period. For clarity, the appropriate rates are summarised below:

Accounting period start date	SME scheme	RDEC	Merged scheme
Pre-1 April 2023	130%	13%	N/A
1 April 2023-31 March 2024	86%	20%	N/A
Post-1 April 2024	N/A	N/A	20%

 

The table shows what are called the “headline” rates. These do not correspond directly to the amount of net relief, which will depend on the applicable corporation tax rate.

Example. Acom Ltd incurred £100,000 of qualifying R&D expenditure in its year ending 31 March 2023. It claims an enhancement of £130,000, i.e. £230,000 in total, on its corporation tax return. The corporation tax rate for that year was 19%, so the maximum relief is £230,000 x 19% = £43,700, or 43.7%.

The merged scheme credit rate is 20%.

Contracted workers etc.

A big change under the new rules is the treatment of costs attributable to payments made to contractors and externally provided workers (EPWs). Generally, payments to an EPW, e.g. someone provided by an agency, are now only qualifying if the worker is subject to UK PAYE and Class 1 NI. Where the supplier of the EPW is not connected to your company the deduction is restricted to 65%. If the supplier is connected, the deduction is 100% of the lower of the:

• relevant costs paid to the staff supplier; or
• relevant costs incurred by the staff supplier.

Pro advice.Directors of the claimant company cannot be classed as EPWs and any payments made to them must be excluded.

With contractors, relief can only be given to the extent that the R&D activity physically takes place in the UK. This restriction, along with the similar one for EPWs discussed above, is part of a strategy of ensuring relief is targeted at UK-based work. However, there is a limited exception to these geographical restrictions. Relief will still be available if all three of the following apply:

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

HMRC gives the example of deep ocean research.

Entitlement to claim

A further change in relation to contractor payments is a move away from the commercial and financial risk test when deciding where the entitlement to claim relief lies in a chain of contractors and further subcontractors. For accounting periods starting on or after 1 April 2024, you need to consider the nature of the agreement between your company and the contractors. Generally, the right to claim R&D relief will fall to the custome (i.e. your company). However, this right will move to the contractor where they are engaged to carry out work, but it would not be “reasonable” to assume that the customer “intended or contemplated” that any R&D activity would be required. The test is really looking at who is making the decision to initiate the R&D.

It is important that “intended or contemplated” requires a relatively advanced appreciation of what R&D will be undertaken. A mere awareness or vague knowledge that some kind of R&D activity would be needed would not be enough.

Enhanced scheme

If your company is an SME and is R&D “intensive”, it may be able to utilise the enhanced R&D intensive support (ERIS). To be considered intensive, at least 30% of total relevant expenditure (plus that of any connected companies) must be relevant R&D expenditure. A one-year period of grace applies where the condition was previously met. ERIS is a continuation of the old scheme for SMEs, i.e. using the enhanced deduction rate of 86%, and credit rate of 14.5% where a loss is surrendered for a payable credit.

Note. Only loss-making SMEs can use ERIS.

Ordering of relief

Under the merged scheme, relief is offset in a similar way to RDEC, following a seven-step process:

1. Deduct from the corporation tax bill for the same accounting period as the claim.
2. Compare the unused amount from Step 1 to the “net amount of expenditure credit” (see below) and carry the lower figure to Step 3.
3. Compare the amount from Step 2 to the PAYE cap, i.e. 300% of the PAYE and NI costs for the claim period plus £20,000. Any amount up to the cap is carried to Step 4, any excess is carried forward as an R&D credit for the next period.
4. Offset the amount from Step 3 against any other outstanding corporation tax for other periods.
5. Any unused amount after Step 4 can be (but does not have to be) surrendered to offset the corporation tax liability of any other group company.
6. Any amount remaining is applied against any other company tax liabilities, e.g. VAT, employers’ NI etc.
7. Anything still not used can be claimed as a repayment, as long as the company is a going concern.

The “net amount of expenditure credit” is the amount claimed at Step 1, minus notional corporation tax at the company’s applicable rate. However, this will be 19% or 25% - you do not deduct marginal relief here.