In July this year HM Treasury and HM Revenue & Customs published a discussion document; ‘Supporting growth in innovation: enhancing the R&D tax credit’, which aimed to identify ways in which the tax credit could be simplified and improved with the overall aim of increasing the level of research and development (R&D) expenditure undertaken in the UK. The Government’s proposals in response to the representations from companies, their industry bodies and advisers were announced at the end of last week, pre-empting today’s Pre-Budget Report.
In this special bulletin we look at the details of the new measures and comment on what they will mean to companies claiming R&D tax relief. It should be noted that some of these measures will represent State aid and will therefore require EC approval prior to their becoming law:
The Government’s proposals
A key theme of the discussion document was improving the experience for claimants. This arose largely in response to perceptions of inconsistency of treatment between individual tax districts and even individual inspectors, especially in some difficult areas such as software and engineering.
In response to this the Government intends to:
- Set up dedicated teams of R&D units to handle all R&D tax claims for SMEs. SME companies, which are able, in some cases, to claim a repayable credit of up to 24% of eligible expenditure, have been particularly vocal in pointing out inconsistencies in the scheme. The greatest area of disagreement had been on whether projects in fact met the criteria to be R&D in the first place, and this led many to call for HMRC to employ experts in science and technology. The Government has decided not to go down this route but to build expertise in the R&D tax relief system itself. In view of the cost and complexity that would have been involved in employing science experts the proposal announced seems the more sensible solution. Employing science experts would have raised questions on whether niche areas would have been adequately dealt with, whilst many respondents were concerned about confidentiality. It is hoped that the establishment of R&D specialist units will lead to greater certainty, enabling the value of the tax credit to be built into investment decisions.
- Issue a statement of practice for SMEs giving details of how they can expect their claims to be handled, focussing on speeding up the cash payment of tax credits. Such a statement already exists for companies dealt with by the Large Business Offices and so a similar practice note for SMEs is to be welcomed. The statement of practice will be developed in parallel with the setting up of the R&D units as part of a co-ordinated approach. Recently HMRC published a guidance note on the R&D tax relief system aimed specifically at SMEs and in conjunction with the measures announced this should improve the claim experience for these companies;
- Extend the definition of qualifying costs to include payments to volunteers who take part in clinical trials, providing a welcome increase in the cost base for pharmaceutical and biotech companies;
- Re-align the time limit for claiming the payable credit (for SMEs) and the claim for the enhancement to qualifying expenditure (for both SMEs and large companies), effectively reducing the time limit for claiming the enhanced relief from six years to two. This is a sensible move, since many companies have been confused by the existence of two time limits, whilst the reduction to two years may act as an incentive to submit claims earlier;
- Publish the names of designated overseas universities in relation to whom the costs of subcontracted R&D can be claimed under the large company scheme. At present, whilst any UK higher education establishment will qualify overseas ones have to be designated piecemeal and the list is not published, adding to the uncertainty and compliance burden for companies.
Other measures being considered
- Allowing certain projects that are capital for tax purposes to qualify for relief, particularly those undertaken by SMEs. This would be a major improvement to the R&D tax relief system, removing a disincentive that currently exists for companies where the expenditure is treated as capital for tax purposes. Such companies could include start up companies developing software platforms that are intended to perform a central and long-lasting function as a tool in the business. Whilst the emphasis seems to be on SMEs, there will undoubtedly be calls from large companies to be included too, such as large organisations with their own in-house teams developing software and other assets for internal use. Such companies could include those in the telecommunications, oil and gas, financial services and retail sectors;
- Further training of HMRC staff, particularly in areas where R&D is not so obvious such as of software and engineering. Difficulties in getting software R&D claims in particular agreed with tax inspectors have been widely reported in the press. While any activity aimed at allowing inspectors to more effectively assess projects claimed in this field is therefore to be welcomed, we should sound a note of caution. It is true that there are many principles of theoretical Computer Science that give rise to claims, but the scope of R&D is much wider than this and indeed covers many of the more practical aspects of Information Technology. In other words, while a solution may be theoretically possible, it may not be apparent how to achieve it in practice, and it will therefore give rise to eligible R&D under the meaning developed by the DTI and used for tax purposes. Experimental development of this sort is equally eligible for the R&D credit as pure and applied research but the challenge for HMRC will be in identifying the hallmarks of R&D in this type of work. The rapid pace of change in technology standards and capabilities means that without the practical experience of working in the industry at the time, they will not be able to make this judgement themselves. Any training therefore must be based on practical IT industry experience in the development of software as well as an understanding of Computer Science. Crucially, the current system, whereby the call is (in theory) made by the company's own technical personnel who are competent professionals in their field should remain the cornerstone of the assessment of eligibility. The training programme should not therefore aim to replace this as it can never hope to turn tax inspectors into software engineers - what it should try to achieve is an appreciation of the process whereby advancements are made in the field. Above all, it should not result in a checklist of eligible/ineligible kinds of software work. One of the key flaws in the original R&D Guidelines published in 2000 was the inclusion of specific examples eligible software work, which led many Inspectors to reject claims for projects simply on the basis that they weren't on the list. The critical questions will be: who will design and deliver this training, what will the objective and the content be, and will the training materials be made available to taxpayers so that they can understand where an Inspector might be coming from with his questions? If careful thought is applied by HM Revenue & Customs to answering these questions then it is hoped that the R&D tax credit system will adequately reward companies in this key UK sector;
- Relief for the cost of developing technical standards. HMRC is to work with DTI and standards setting bodies to develop an understanding of the extent that such work should qualify;
- Raising the threshold at which companies become defined as large, in order to make the SME reliefs available more widely. This is a recommendation of the recent Cox Review of Creativity in Business, but as the EU definition of an SME is used the Government acknowledges the need to consider the extent it is permitted to amend the threshold.
A number of further measures were considered but have been rejected for the time being. These include the targeting of incentives to specific industry sectors; the offset of the tax credit against the current year’s PAYE and National Insurance liabilities; and additional incentives for undertaking more R&D than in previous years. The Government has also decided against expanding the eligibility of activities subcontracted by large companies. It feels that doing so would increase the scope for unintended double claiming if such costs were included.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
