Research and development tax relief – understanding the changing landscape

November 5, 2021

With a recent tribunal looking set to change the nature of the Government’s research and development tax relief, Jonathan Scott, tax partner at North East-based accountancy and business advisory firm Haines Watts, tells Steven Hugill what businesses need to do to continue claiming the finance they need to stay innovative in the marketplace.

From the birth of railways to lightbulb creator Joseph Swan, hydraulics forerunner William Armstrong and even windscreen wiper designer Gladstone Adams, the North East has a rich pioneering history.

Our modern-day region is no different, of course, with companies maintaining the innovative ethos of yesteryear through ground-breaking advances across sectors including manufacturing, healthcare, energy and technology.

Yet while their collective inventive philosophy remains unchanged, something is altering – specifically the rules around claiming financial support through the Government’s research and development tax credit schemes.

Divided into two components – wherein an SME element supports businesses with less than 500 staff and turnover lower than €100 million, and a research and development expenditure credit (RDEC) model applies to larger organisations – they incentivise new products and ideas through corporation tax relief and associated cash reimbursements.

But while latest HM Revenue and Customs (HMRC) figures show the estimated number of tax credit claims for the year ending March 2020 had risen 16 per cent to 85,900, the nature of what constitutes a claim is dramatically evolving.

The catalyst for change stems from a tribunal earlier this year, where HMRC challenged an application made by Sheffield’s Hadee Engineering.

The business, as it had done previously, sought to claim research and development support through the Government’s SME scheme.

However, HMRC disputed its application on the grounds that the precision engineer was working as a subcontractor.

Arguing SME research and development claims must not relate to outsourced activities, the HMRC case was ultimately successful.

And, says Jonathan Scott, tax partner at Haines Watts, the outcome is of great significance for North East companies.

He says: “Historically, it was standard practice for firms to claim SME relief for the kind of work Hadee Engineering was doing, but HMRC took the claim out of principle to set a new mould.

“And what it means now is that anyone being paid to do subcontracting work should claim RDEC relief.

“Effectively, what HMRC is saying is that if, as a business, you are being paid to do something, you cannot claim SME relief, if so this is therefore an incorrect use of taxpayers’ money.”

This sea change, says Jonathan, requires organisations of all sizes to readdress their tax relief strategies.

He says: “Post the tribunal, it is about starting afresh, undertaking a review of your claims and looking at the evidence – because HMRC are asking for more evidence.

“The worst thing you could do is stick your head in the sand and do nothing because you will factor claims into your cashflow, and if it’s not there, how do you cope?

“Taking appropriate action follows the same principle as when you get a number of quotes for building work on your property.

“Get expert advice – from firms that are part of a professional tax body – to find out what claims you should be making.

“It is also vitally important to scrutinise contracts before signing them. Doing that allows you to clearly understand what relief you can claim.

“This is imperative because it is your company’s risk on the table; if a business submits an incorrect claim, HMRC has the ability to charge a hefty penalty.”

One option to ensure organisations are making a correct claim, says Jonathan, is a hybrid submission, which combines SME and RDEC relief.

He says: “A lot of clients are switching from SME to RDEC, which means they are facing a gap in terms of tax or cashflow.

“But a hybrid claim can help mitigate this – and firms can have SME and RDEC support in a single year.

“For example, a manufacturer might have five orders from five different customers, for which they would be able to claim RDEC as a subcontractor.

“However, it might be carrying out other elements for itself too, such as developing new tooling or machinery to make processes environmentally friendlier.

“That is research and development, at the manufacturer’s own risk, and falls into the SME category, which means the firm can take a hybrid approach.”

As well as the hybrid model, Jonathan says the Government’s Patent Box scheme can play an equally important role in helping organisations.

Designed to encourage companies to retain and commercialise intellectual property in the UK, Patent Box allows them to apply a lower, ten per cent rate of corporation tax to profits earned from patented inventions.

Jonathan says: “Patent Box is one of the largest underutilised reliefs in the UK.

“It is often assumed you can’t have it with the other claim schemes, but they can work together in tandem across any sector. We have businesses in IT, manufacturing, telecoms and the creative sector using it, for example.

“People expect patents to be hundreds of thousands of pounds, but you can get them for between £5000 and £6000 if it’s a UK-only patent, and that cost pales into comparison to the tax relief you’re going to get.”

While looking at potential hybrid and Patent Box options, though, Jonathan says the situation ultimately comes down to clarity, with the Government needing to provide firms with clear direction on SME and RDEC claims.

He says: “SME relief makes up most of the tax relief for the UK economy, and if the Government shifts the focus to RDEC, there is inevitably going to be relief pulled from manufacturing in the North East, which is already one of the lowest claiming regions in the UK.

“And if it is markedly reduced, are those businesses going to continue taking on research and development projects and generate new jobs?

“We need to take a step back to better understand what the Government’s recent statistics show.

“Ultimately, we need to work with HMRC and the Treasury because at present clients are in a kind of limbo, thinking, ‘do I continue claiming SME relief, or do I move to RDEC?’

“Research and development is here to stay – we just need some greater clarity on how it will be supported going forward.”