Research and Development (R&D) tax relief plays a crucial role in supporting innovation and driving business growth in the UK. However, the scheme has been the target of frequent criticism in recent years, prompting a raft of changes.
The last of these were introduced at the start of the current tax year in April 2023. But following a public consultation that concluded before these changes were implemented, the government has now published draft legislation proposing an even more radical overhaul – the headline measure being the merger of the separate systems for SMEs and larger businesses into one scheme.
Why the rush for reform?
HMRC has made no bones of the fact that it views the current system, and specifically the SME relief scheme, as open to abuse. Moreover, it points to the fact that an eye-watering percentage of incorrect filings are causing long delays in claims being processed.
In a notable recent report into how it handles R&D relief applications, HMRC reported that around half of all claims exhibited some level of non-compliance, although indications of fraud were found in fewer than 10%. These results apply to SME applications only, and come from the introduction of a mandatory random enquiry programme (MREP) in 2020 which has allowed HMRC to gather in-depth data on compliance.
While the number of R&D relief claims from SMEs doubled between 2015 and 2020, HMRC found that levels of error and fraud were almost five times higher than previously thought, adding more than £1bn to a scheme that costs the exchequer £6.6bn anyway.
So the agenda isn’t difficult to understand. Against the backdrop of a bloated, unwieldy system that is costing the public purse huge sums in administration costs, errors and abuse, the government is now looking at ripping things up and starting again with a much more streamlined, slimmed-down one-tier system.
What is unusual is that these latest proposals come barely four months after relief rates were cut and the reporting and compliance rules were tightened in a bid to reduce errors at source. The figures relating to the SME scheme just published by HMRC are for three tax years prior to these reforms. There doesn’t seem to be much appetite to let this year’s reforms bed in and assess their impact. It’s almost as if the government has already made up its mind – and the standalone SME scheme is in its sights.
What are the new proposals?
The draft legislation outlines how the currently separate Research and Development Expenditure Credit (RDEC) and the Small- and Medium-Enterprise (SME) relief schemes would be merged into one. This would be an expenditure credit scheme, meaning all companies would claim back a proportion of their R&D investments as a tax credit. This would do away with the more generous SME scheme, which currently allows small firms to reduce their taxable profits by 186% of qualifying R&D investment costs.
While the government talks about ‘tax simplification’ in its policy objectives, it’s clear it also has an eye on scaling back the cost of the R&D scheme.
Another interesting proposal is that the draft legislation suggests keeping the subcontractor rules from the current SME scheme, which currently allows small firms to claim for payments made to subcontractors as part of an R&D project. This would open up the same benefit to larger firms.
In draft form, the legislation would still have to make its way through Parliament before being implemented by the proposed date of April 2024. With a general election looming next year, there’s a high chance of it being kicked into the proverbial political long grass. Watch this space.
