What you need to know about how R&D tax relief is updating

The two most significant changes are:

• upcoming restrictions for businesses conducting R&D activities overseas, and
• the new inclusion of cloud computing and data costs in qualifying R&D expenditure.

Businesses will need to assess the potential implications of these changes to understand how they might impact their ability to claim R&D tax credits in the future and to ensure they remain compliant under the new rules.

Changes to R&D tax credits for overseas activities

We anticipate that R&D tax relief will only apply to activities carried out in the UK as of 1 April 2023. The current regulations allow for relief for overseas R&D expenses recharged to a UK claimant company. To be eligible for cost inclusion, R&D activity must be physically located in the UK starting with the 2023–24 tax year. UK companies that currently include R&D costs paid to overseas group companies or third parties, for instance, may no longer be able to do so.

In the tech and media industries, there are numerous instances of international R&D hubs where numerous businesses make use of R&D facilities in Asia, the Americas, and portions of Europe. Software development and engineering resource costs are then charged back to the UK company and in many cases form a significant portion of the qualifying costs in the R&D claim. The impact of this change will largely depend on the size of your business and the amount of R&D taking place outside the UK.

What can businesses do to help preserve their R&D tax benefits where it makes commercial sense?

Businesses that continue to conduct all or a portion of their R&D overseas must revaluate their potential R&D claims. They must weigh the financial, logistical, and practical effects of onshoring to the UK versus maintaining their current organisational structure.

Example 1: Keeping your R&D activities overseas

The obvious advantage of keeping your R&D activities where they are is that they can focus on meeting business needs, requirements, and expertise. Depending on your situation, this might also be the most economical choice. Your deliverables are optimised, you have the right people in place, your infrastructure and processes are already in place. Why alter an unbroken system?

The sacrifice is clear: starting on April 1, 2023, currently qualifying overseas R&D will no longer qualify. Whether your claim is submitted under the more lucrative SME Scheme or the RDEC Scheme will determine how this will affect you and how much of your claim’s overseas R&D expenditure is at risk (or Large Company Scheme). If your business is heavily invested in R&D and the majority of your costs are currently incurred through activities conducted abroad, you should anticipate a significant decrease in your claims for R&D tax relief and may want to think about moving these operations to the UK in order to maintain your eligibility for the relief.

Example 2: Relocating your R&D activities to the UK

For each business, moving your R&D operations will look different. Some people might only need to look for new suppliers in the UK to solve this problem. Naturally, this will depend on whether the necessary skill sets are accessible and affordable (taking into consideration savings made through inclusion of future UK supplier costs in your R&D claim).

Some companies may have access to foreign R&D resources that are linked to the UK claimant company (e.g. employees of a group company). Businesses will need to take into consideration a plethora of other non-R&D related issues in addition to the obvious cost/benefit implications of moving to a UK R&D hub. These could include restructuring, new hires, staff relocation, training and support – along with all the associated legal and tax considerations for both the company and any employees relocating.

Claims for cloud and data expenditure

Costs associated with cloud computing and data cannot currently be claimed as R&D tax relief expenses. But starting on April 1, 2023, these expenses will be included in the list of qualifying costing categories. This change will be welcomed by many, especially in the tech and media sectors, and it may help to offset any losses brought on by the limitations on foreign R&D expenditures.

In light of this new development, companies that, for instance, pay licence fees to rent cloud computing space or incur data costs for R&D, will now be able to include these costs in their claims.

Tackling abuse and compliance – the HMRC crack-down

A hundred more inspectors were recently hired by HMRC in order to provide more thorough and reliable reviews of R&D submitted claims. As a result, there has been a discernible increase in the volume of inquiries about R&D.

In addition, the results of recent Tribunal cases have both informed and created some uncertainty around the following topics:

1. Attributes of a “competent professional” and the evidence needed to qualify a project and its activities as R&D.
2. The link between customer payments and the underlying R&D costs to inform subsidised R&D considerations.
3. Ownership of R&D tax relief in the context of the independence of the R&D performer for customer-driven R&D projects.
4. A re-write of HMRC’s R&D guidance on the interpretation of subcontracted R&D in the context of which party is entitled to claim relief.

It is likely that HMRC will keep an eye on these areas and that we will see more challenges from HMRC regarding R&D costs that were outsourced and subsidised.

Businesses should always make sure that their claims are correct, strong, and have enough supporting documentation to withstand HMRC scrutiny. HMRC is also paying close attention to claims of portfolio companies backed by private equity investment.

Need help calculating your tax credits?

The new restrictions to overseas costs and the inclusion of cloud computing and data costs will affect businesses in different ways and it is important understand how the changes will affect your business.

We encourage you go get in touch with our expert team to assess the potential implications of these changes and how they might impact your ability to claim R&D tax credits in the future and also to ensure you remain compliant under the new rules.