UK and International Tax news

HMRC Issues Draft Guidance For Consultation On Changes To R&D Tax Relief

Wednesday 21st February 2024

HMRC has issued draft guidance covering changes to Research and Development tax reliefs due to be implemented on 1 April 2024.

In the Autumn Budget 2021, the Chancellor announced reforms to support modern research methods including expanding R&D reliefs to cover data and cloud costs, refocusing support towards innovation in the UK, and changes to target abuse and improve compliance. HMRC published draft guidance on the implementation of these reforms in December 2022.

In the Spring Budget 2023, the government announced that the measures to refocus R&D relief on innovation in the UK would come into effect from 1 April 2024 instead of 1 April 2023. This allowed the government to consider the interaction between this and the design of a potential merged R&D relief.

In last year’s Autumn Statement, the government confirmed changes to the way contracted out R&D activities would be treated from 1 April 2024, including the overseas rules.

HMRC has now published new draft guidance on contracted out R&D activities and updated draft guidance on the overseas rules for consultation which takes into account comments received in response to the December 2022 draft.

The draft legislation proposes to restrict the extent to which contractor payments for R&D and payments for externally provided workers can qualify for R&D relief where the R&D activity takes place overseas, and introduces new rules for contracted-out R&D.

For contractor payments, the restriction in the legislation applies through the location of the activity. For EPWs, it applies through a requirement that the EPW’s earnings are subject to PAYE and NICs. For both contractor payments and EPW payments, there are exceptions where the R&D activity meets certain conditions, in particular that the activity necessarily takes place abroad.

Overseas expenditure on contracted out R&D, and on payments for EPWs who are not subject to UK PAYE/NIC, however may still qualify for relief if certain circumstances are met.  These are that conditions necessary for the R&D are not present in the UK, the conditions are present in the location where the R&D is undertaken, and it would be wholly unreasonable for the company to replicate the conditions in the UK.

Guidance on the new rules relating to contracting out R&D addresses issues around activity involving two or more parties and how to determine which party, if any, can claim the relief. The simplest situation is where a customer commissions some work and a contractor undertakes it.

Where R&D is carried out under a contract, the new R&D expenditure credit and the enhanced support for lossmaking R&D intensive SMEs from April 2024, will give the right to claim for contracted-out R&D to the customer, subject to certain exceptions.

R&D is defined as contracted out where it is reasonable to assume that the customer intended or contemplated this sort of R&D would be done. Such a contract might cover an entire commercial project (including R&D and other activities), an entire R&D project or aspects of an R&D project. The rules will apply equally to all three cases. The legislation also generally excludes claims for expenditure by the contractor, but with important exceptions.

Where a company is contracted to do work for a customer, and the company does related R&D but it is not reasonable to assume that the customer intended or contemplated R&D of the sort carried out should be done then, subject to meeting the other rules of the relief, the contractor can claim. This is not R&D contracted to the company under the new rules, because the decision to initiate R&D will have been taken by the contractor. The contractor has been engaged to carry on specified work for the customer, not contracted to carry out R&D, so the R&D is initiated of its own volition.

HMRC’s guidance includes a number of examples which are intended to clarify the operation of the new rules.

Responses to the consultation have been requested by 1 March 2024.

For further information on the above, please contact Keith Rushen on 0207 486 2378.

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