Original content provided by BDO UK.
Three significant changes to the UK’s tax reliefs for research and development (R&D) will take effect from April 2023. The core legislative changes (in Finance Bill 2021/22) are working their way through Parliament, but there is much work still to be done to interpret those changes and build effective HMRC guidance on how the new rules will be applied. BDO is taking an active part in that process, and the government has confirmed it expects to make further adjustments to the legislation in Finance Bill 2022/23.
R&D outsourced overseas
The main thrust of this new rule is to focus R&D tax relief on work carried out in the UK: broadly, costs of overseas workers will not qualify for UK R&D relief where incurred after April 2023. Of course, “broadly” covers a very large range of areas where there may be uncertainty, unfairness and, therefore, some need to soften the rule to make it practical.
We understand that the government does not want to create a rule that unfairly discriminates against businesses that cannot practically carry out research in the UK. For example, if you are developing products for extreme environments (such as deserts or the Arctic), it is quite difficult to carry out sensible testing in the UK. Equally, there may be some situations where the testing equipment or machinery required is just not available in the UK and may only be available in one or two labs worldwide, or where testing in a market jurisdiction is required if a product is to be sold there.
Therefore, work is ongoing to consider the creation of some “narrow exemptions” from the future ban on claiming overseas workers costs, including for:
- Environmental/geographical reasons
- Legal or regulatory reasons (eg local testing of drugs in the USA)
- Specialist skills (ie using world-leading experts in their field who are based outside the UK).
There are also many issues to consider when it comes to the international structures of businesses carrying out R&D. For example, a UK group may have a branch in another company where work on UK R&D projects is undertaken. If all the IP from the project is retained in the UK and profits from the overseas branch are taxed in the UK, are the costs of the ‘overseas’ work still not to be allowed for UK R&D relief purposes? Conversely, if an overseas company owned by a UK parent, seconds a worker to the UK to carry out a UK research project, but the worker is paid by the overseas company (recharged to the UK parent at a mark-up), will those salary costs qualify for UK R&D relief just because the work is carried out in the UK on a temporary basis?
Data and cloud computing costs
While allowing the costs of purchasing data for R&D projects will be helpful, there are some issues to consider around usage and residual values that it will be helpful for HMRC to clarify in guidance.
There are rather more areas of uncertainty around qualifying costs for cloud computing costs. For example, we understand that the costs of “data storage” will not be allowed – although if you are running tests you need to capture the data somewhere for the short term at least, to be able to assess success or failure of a project. So perhaps short term or “active” storage costs should qualify.
There are also likely to be many practical issues around identifying cloud costs that relate to an R&D project where perhaps bundled services and composite billing are used. BDO has encouraged the government to allow HMRC to engage directly with the main cloud computing providers to work at identifying costs that can qualify, with the aim of producing guidance for claimants.
Anti-abuse action
The review also proposes some initial measures to deter the ‘abuse’ of R&D tax relief that the government perceives is taking place. Alongside potential new powers and enforcement action against rogue R&D advisers, the report suggests a number of new compliance procedures to deter speculative R&D claims. This includes requiring:
- All claims to be made digitally
- More details to be submitted with all claims
- Each claim to be endorsed by a named senior officer of the company
- Details of any agent who has advised the company on compiling the claim
- Companies to notify HMRC, in advance, that they plan to make a claim.
The notification requirement stems from the fact that the government sees all retrospective claims as potentially speculative. While this may be true in some situations, in our experience, many companies fail to recognise when they are carrying out an R&D project for which tax relief may be available. BDO has pointed out to HM Treasury that it seems contrary to the public policy of encouraging businesses to undertake R&D for such businesses to be disadvantaged simply because they have not notified their intention to claim in advance. Such a requirement may also lead to many businesses making notifications just to protect their position in case R&D is undertaken during the relevant accounting period.
Whatever new compliance procedures are introduced, it also clear that HMRC will be undertaking much more risk profiling and scrutiny of R&D claims in the future – more enquiries on poorly prepared claims seem inevitable. In April 2022, there will be a BDO webinar on the risk and mechanics of dealing with R&D enquiries.
More reforms in the pipeline
HM Treasury’s latest report makes clear that “The government continues to consider other areas for reform as part of the ongoing review.”
In response to the report, BDO has suggested that where there are negative impacts on the attractiveness of the UK’s R&D regime, such as the overseas costs restriction, the government should seek to balance these by making the regime more attractive in other ways – such as increasing the rate of relief. The government may also revisit the idea of regional variations in R&D relief within the UK as part of its wider levelling up agenda.
Help with planning ahead
Clearly, there are many issues that remain to be resolved, and BDO has urged the government to publish updated guidance well before April 2023. If you have concerns about how the reforms discussed above will affect your R&D claims in the future, please get in touch with Cathy Kelly.