In the Autumn Statement, the government announced R&D tax relief rate changes for both SME and RDEC schemes. Some of these rates were modified and updated in the Spring Budget 2023. Below we are discussing the most up-to-date (as of March 2023) changes that are scheduled to come into effect from 1 April 2023 and will also affect expenditures incurred on or after the same date.
The year 2023 is seeing a significant overhaul of the R&D tax relief scheme, which was instigated by a mixture of HMRC aiming to combat fraudulent activity and ‘to ensure public money is spent effectively and best supports innovation’. With the rates due to change, businesses claiming under the SME R&D tax relief scheme will feel the greatest impact as their enhanced deduction will decrease from 130% to 86% and the credit rate will decrease from 14.5% to 10%. On the other hand, the RDEC enhanced deduction rate will increase from 13% to 20%, making the larger company scheme more generous in proportion.
The table above highlights the financial impact the tax relief cut will have for innovative SMEs. Additionally, it paints an unsettling picture for SMEs within the industries that require a significant amount of upfront cost, sometimes for years on end before turning a profit, such as biotechnology and pharmaceutical businesses. This realisation led many businesses operating within R&D-intensive spheres to urge the government to reconsider.
The UK BioIndustry Association in response to the change in rates highlighted that ‘the R&D tax relief rate was fundamental to leveraging private capital into high-risk businesses’ and with lower rates, the investors will consider the investment as too risky without the cushioning effect a government incentive provides. Likewise, the lack of R&D funding could mean that it takes longer for a product to go to market and makes viability a lot harder.
Taking the feedback on board, during the Spring Budget 2023 a new rate was introduced for loss-making SMEs that are heavily involved in R&D, which will be set to 14.5%, instead of the newly legislated 10% starting from April 2023. In order to qualify for this rate, a business would need to incur at least 40% of its ‘total expenditure’ on qualifying R&D activities.
Although the Chancellor framed this new rate as a generous additional relief, it’s important to understand, firstly, that this relief is only available to companies that surrender their losses to HMRC. Secondly, the 14.5% is the same rate loss-making SMEs would have received before the new rules, therefore it can’t be considered an increase. Lastly, whilst not industry-specific, the 40% eligible expenditure requirement will primarily benefit loss-making SMEs within particular industries, such as pharmaceutical and technology startups. Loss-making SMEs within industries such as engineering, architecture and manufacturing rarely reach the 40% spend on R&D, therefore will receive the lower tax credit rate of 10%.
Overall, it’s comforting that the Chancellor has listened to the feedback and has made some adjustments. However, considering that one reason provided for the cut to the SME scheme is to tackle fraud, it is still not clear how this measure will achieve this goal. Is disincentivising fraudsters from the scheme reason enough to make a change that will have major ramifications on growth, jobs and innovation done by SMEs within the UK? Cynically, will this 40% threshold incentivise claims to be artificially elevated to reach this ceiling and therefore benefit from the higher tax credit rate?
Throughout the changes, the Chancellor continued to emphasise that the government aims to support and facilitate innovation within the UK by investing in promoting R&D. This is indicated by the increasing the RDEC scheme despite decreasing the SME scheme. But, would we go as far as to admit that these measures will have ‘no detrimental impact on the level of R&D investment in the economy’ will only be answered in time.