Advance Planning Pays Dividends in Claiming UK R&D Tax Relief

It’s been more than 20 years since the UK government introduced research and development tax relief. Throughout that time, engagement with the relief by businesses has been almost entirely retrospective. From a policy level, this isn’t coherent—designed to influence and drive behavior, a relief looked at retrospectively is a paradox.

Now that retrospective approach is set to change. The newly merged scheme R&D expenditure credit, along with guidance from the UK tax authority, HM Revenue & Customs, in its Guidelines for Compliance 3, GfC3, means that businesses must think before they act.

Businesses that fail to adapt face increasing risk of seeing their claims reviewed and rejected, whether on a technicality or for failing to meet evidential requirements, with all the attendant risk of penalties and, in extreme cases, discovery (the powers that enable HMRC to look back up to 20 years) to follow.

The stakes are particularly high when it comes to supply chain relationships. Under the merged scheme, HMRC will monitor this issue across all commercial chains for large companies and small and medium-sized entities, or SMEs, with some large companies potentially seeing major adjustments in the long-term value of their R&D tax relief.

The merged scheme applies for accounting periods beginning on or after April 1, so there’s still time to adjust if businesses act now.

New Premium on Evidence

Before introducing the merged scheme, HMRC published guidance for claimants, GfC3, which responds to calls for examples that clearly illustrate key R&D tax relief concepts.

The introduction in 2023 of a mandatory Additional Information Form to be submitted in advance of all claims nudged businesses toward contemporaneous record-keeping. GfC3 reinforces this. While R&D can be identified retrospectively, GfC3 encourages businesses to identify R&D projects during planning to gather detailed information to identify qualifying activities and costs.

Intensity Matters

The merged scheme brings together two of the UK’s R&D tax relief incentives. For the majority of businesses it replaces either the SME scheme or the R&D expenditure credit. However, a small portion of businesses will remain beyond its boundaries.

Loss-making SMEs that meet a threshold for “R&D intensity”—40% of total business expenditure, coming down to 30%—qualify for enhanced R&D intensive support, or ERIS. Eligible businesses not only enjoy the most generous rate of relief of all companies (up to 27%) they also benefit from the removal of restrictions on claiming for expenditure subsidized by grants or similar sources.

Establishing eligibility for ERIS could make a material difference to the finances of a business, and businesses must factor in the potential return from the relief when planning investment.

Supply Chain Impacts

The merged scheme’s most significant changes relate to contracting out R&D. These changes apply to R&D activity involving two or more parties and seek to define which entity can claim tax relief.

Under the merged scheme, the definition of “contracted out R&D” places the right to claim relief with the R&D decision-maker. Put simply, if a company is carrying out R&D to deliver goods or a service to a customer, this shouldn’t affect its right to claim—unless the customer has specified that R&D be carried out. If the company then wants to claim for R&D activities it has contracted out itself, it will need to make sure this is clearly evidenced in the contract.

The main takeaway is that there will be winners and losers. Large businesses have never had to navigate this minefield in the past, and could see swings in the value of their R&D claims both upward (where downstream subcontractors are now included in their claims) and downward (where the right to claim relief sits with their client).

Companies must identify where the right to claim R&D tax relief sits in their supply chain. In sectors such as defense, where prime contractors are often used, it’s particularly important to understand where the right to claim R&D tax relief sits.

Risks and Opportunities

The risks and opportunities are multiplied for those working across portfolios of companies, including private equity and venture capital investors. Both contracted out R&D and the new rate for loss-making R&D-intensive SMEs are relevant here; visibility and analysis across a portfolio will be key in a world where one size no longer fits all.

As HMRC intensifies scrutiny (one in five claims are now subject to a compliance check), portfolio managers can use trends in claim value and inquiry rate to inform their investment strategy based on risk appetite.

The double whammy of increased compliance checks and decreased rates of relief (excluding ERIS) could push more businesses toward incentives such as direct grant funding. Additional submission deadlines, payment points, and reporting requirements add further complexity. Tracking these variables will help businesses protect and manage their investment in R&D.

What to Consider

Businesses will be impacted by these changes in different ways, depending on size, sector, and supply chain relationships. However, there are three themes that all should consider:

Visibility is key. Whether upstream or downstream in the supply chain relationship, understand where R&D is taking place, who is in a position to claim for it, the impact of rate changes, and any other variables.

Protection is undervalued. In a more complex regime, companies shouldn’t be afraid to make a claim, but they need to take action to protect themselves from risk. This starts with understanding where that risk lies and the values involved.

Integration is needed. Innovation incentives are made available to companies for a reason and should be made to work harder. An integrated strategy across the spectrum of incentives available to businesses will support access to the right funding at the right time, with the potential benefit of cash flow outside the tax return cycle.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

James Dudbridge is a director and leads the tax advisory practice with ForrestBrown.

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