R&D tax credits changes – Spring Budget 2023

Rate change for innovative Small and Medium Size (SME) businesses

There were real concerns about the negative impact that slashing the SME cashback rate would have on R&D investment plans. The R&D tax credit cash is a key element to cashflow planning for innovative businesses burning through cash to create the next generation of products and services. Thankful these concerns have been listened to and addressed in the Spring Budget. 

Prior to November 2022, the SME cashback sat at a healthy 33% of qualifying expenses. To combat fraud in the programme, the November budget reduced this to just under 19%, which shocked many SMEs. On the back of the 2023 Spring Budget announcement, the cashback is up to 27% for firms that invest heavily in R&D. 

But the devil is in the detail. The new higher cashback rate applies to business who spend more than 40% of their total expenditure on R&D. How will this fraction be calculated? HMRC is using the R&D claim value as a proxy for R&D spend within the business and dividing this by the total expenditure within the business to derive an R&D fraction. But this total expenditure will cover all linked entities and the qualifying spend will retain the subcontracted restriction for claims under the RDEC scheme. We expect that some R&D intensive businesses might find themselves stuck in the lower rate bracket due to the quirks of this calculation, these would include:

• SME claims that sit alongside grant-funded work claimed under the large company RDEC scheme
• SMEs backed by PE funding where the claimant might be linked to all other businesses within the PE house
• Innovative businesses making heavy use of contractors or subcontractors to undertake the R&D work

It seems peculiar that HMRC did not use a modified version of the patent box nexus fraction to calculate this R&D percentage. This approach has been applied for a number of years and overcomes some of the ambiguities of the current R&D fraction proposal. 

But the biggest confusion comes with how this scheme will be implemented. This increased rate is not available until the current finance bill is approved and only at this point will companies be able to submit claims to receive the 27% credit. In the meantime companies will have to claim under the revised cash back rate of 10% which is less than ideal.

Not everything is changing as expected on 1 April 2023

Many businesses have been planning for a raft of changes pencilled in for 1 April 2023. Some of the changes are still going ahead, such as expanding the definition of qualifying expenditure to include hosting and cloud computing costs as well as covering mathematics as a qualifying activity. Also, it will be mandatory to submit claims via the HMRC portal from this point onwards.

But there are delays to other changes. Pre-notification and the requirement to complete HMRC’s digital information form will become mandatory from August 2023. Advisers have seen a draft of these new forms, but the Spring Budget leaves companies in limbo until the final details of requisite secondary legislation is introduced into parliament. Hopefully, these forms will be released in August, but any further delay will cause real issues for companies looking to access the R&D intensive cashback rate. 

Finally, a big surprise. This Spring Budget includes one utterly unexpected change: a postponement of the overseas restriction on qualifying spend until 1 April 2024. We could complain that this modification came fairly late in the game. Yet, many SME enterprises will be grateful that this restriction has been postponed since they would have had difficulty locating high-calibre personnel by April 2023 due to a tight UK labour market.

HMRC has made its intention clear to align the creative reliefs to the R&D scheme and remove the ability to include EEA spend  . Therefore, the video game tax credit will become a UK-focused programme as of 1 April 2025. Moving forward, there will be a single 34% credit for audio-visual development activities that will operate similarly to the R&D RDEC scheme. The audio-visual expenditure credit will likely be updated to reflect any significant modifications to the R&D scheme's overseas expenditure restriction in order to keep the two programmes in sync.

Therefore, we expect that the R&D scheme will move onto a UK only footing in the near future. But with an election looming next year, it wouldn’t be surprising if this change is further delayed.

What’s next?

The final R&D tax related piece of news is that a merged SME and RDEC scheme will not be implemented before 1 April 2024, and the Chancellor left the door open to push this decision back even further and let it fall under the remit of the next Parliament. We really feel that Treasury need to embed the current raft of changes to assess their impact before embarking upon another set of changes. Companies really need a bit of certainty for a while to adjust to the lower rates for SMEs and new filing requirements.

What do you need to do following the Spring Budget?

The R&D scheme is clearly here to stay with a welcome increase in the cashback rate for R&D intensive SMEs. But the scheme is becoming more and more complex with new requirements to be able to access the tax credit scheme and having the SME credit split in two depending on the spend profile of your business. The key thing businesses need to be doing is planning for these changes and understanding what is required of them to avoid any costly mistake.  

Your business will need to be on top of the R&D claim preparation process going forward, and model investments or growth plans to understand how the credit they receive might change. We can help your business get on the front foot with these changes and feel confident that you can plan the R&D credit into your business plans.

If you would like to speak to one of our R&D experts to find out more about how we can help, please get in touch via the form below.