What’s happening to UK R&D Claims from 1 January 2025?

Whilst many R&D claimants and advisors were pleased to see no further upheaval of UK R&D relief in the recent autumn budget, there are many key changes coming into effect to be aware of.

The changes apply to a company’s first accounting period starting on or after 1 April 2024. However, as approximately 40% of all UK businesses have a December accounting year end, for many companies the changes will impact R&D expenditure beginning from 1 January 2025.

The New R&D Schemes

Companies will no longer claim tax relief or tax credits for R&D expenditure under the traditional SME or RDEC schemes. Instead, the new “Merged” R&D scheme will apply for most companies.

Ironically, the intention of the Merged scheme was to combine both the old SME and RDEC schemes into a single ‘RDEC-like’ scheme regardless of company size. However, there will still be two R&D schemes to consider as an alternative “Enhanced R&D Intensive Support” (ERIS) will remain available for loss-making ‘R&D-intensive’ SMEs.

Value and Mechanism of R&D Relief

If a company previously claimed under the large company RDEC scheme, the rate of credit remains unchanged in the new Merged scheme.

However, SMEs will experience a reduction in the value of their R&D claims, now receiving 15 pence for every pound spent on R&D. Additionally, the delivery mechanism has shifted from the previous SME ‘enhanced tax deduction’ to an RDEC-like ‘above the line’ credit.

Loss-making SMEs that spend at least 30% of their total annual expenditure on qualifying R&D activities will qualify for the ERIS scheme, which provides a greater tax credit worth up to 27 pence for every pound spent on R&D, via the same enhanced tax deduction and loss surrender mechanisms of the old SME scheme.

Overseas R&D Expenditure

Companies will need consider the incoming general exclusion of overseas R&D expenditure. This was originally announced before the Merged and ERIS schemes but carries the same implementation date. Costs associated with subcontractors or external workers conducting R&D activities outside of the UK will not be eligible to claim, unless unique conditions necessitate overseas work.

These conditions include scenarios where specific geographical or environmental factors make it impossible to conduct the R&D within the UK, but do not include scenarios where a company is unable to find the same pool of technical resource within the UK or where the resource is more expensive in the UK compared to outsourcing overseas.

Contracted-out R&D

Companies will also need to consider a new definition of contracted-out R&D, which has been implemented to avoid instances where multiple parties to a contract might claim on the same R&D activity.

The general rule for this is that the party who takes the decision to undertake the specific R&D activity in question, will be entitled to claim the qualifying R&D expenditure that they have incurred, provided that they are a company with a trade within the charge to UK Corporation Tax.

Companies must be able to justify their reasoning for each R&D project that they claim expenditure for, to show why the business has claim entitlement rather than the other party (or parties) in a contract or contracting chain.

In addition, it won’t be possible to modify contract wordings to reserve the right to the R&D claim on the project, unless a company is eligible in the first instance in accordance with the legislative test.

It’s important to remember that separate forms of R&D can still arise during a contract. So, if a company doesn’t have claim entitlement for the overall R&D project under the general rule, they should consider whether they have carried out R&D activities that are separate from the overall R&D project undertaken as part of the contract.

This is a particularly complex area of the new Merged scheme, and we expect that many claimants will have difficulty in independently assessing their eligibility.

Wider Scope for Subcontractor Costs

Large companies could previously only claim R&D subcontractor costs under RDEC if the subcontractor was an individual, partnership, or qualifying body.

Now, under the new rules, eligible R&D subcontractor costs include expenditure incurred on corporate-entity contractors, provided the ‘Overseas’ and ‘Contracted out R&D’ conditions (discussed above) are met. This change is expected to significantly benefit industries like construction, where corporate entity contractors are commonly used during R&D projects.

Subsidised R&D Projects

Another significant improvement is the removal of restrictions on subsidised R&D projects.

Previously, claims by SME companies were restricted for subsidised projects, such as, where a project was grant funded. The new schemes (both Merged and ERIS) eliminate this restriction.

Additional Compliance

Beyond these changes, companies should not forget the other recently implemented compliance measures:

• All R&D claimants must complete and file an R&D Additional Information Form (AIF) before submitting the Corporation Tax return, whilst

• Some claimants (new claimants or those that haven’t claimed in broadly the last three years) must also pre-notify HMRC of their R&D claims within six months from the end of their accounting period.

Failure to meet these requirements will result in R&D claims being invalid and automatically rejected.

In conclusion, challenges such as stricter rules on overseas expenditure and the complexities of contracted-out R&D activities mean that seeking expert advice will remain crucial to navigating the intricacies and leveraging the opportunities within the new Merged and ERIS schemes.