The heightened administrative burden placed on SMEs as a result of proposed changes to the UK’s research and development (R&D) tax regime will be outweighed by plans to extend the scope of relief, according to Ben Conry, R&D tax lead at advisory firm SeedLegals.
In draft legislation on R&D relief changes published in July, HMRC proposed an expansion of qualifying expenditure on software and consumables to include data licenses and cloud services, in addition to extending the scope of relief to cover mathematical advances.
Being able to claim tax relief on the hundreds of hours spent on these activities every year will have a profound impact on many businesses, according to Conry.
“This has been quite a significant restriction in the past, particularly with data-heavy companies that haven’t been able to leverage those costs and turn them into cash,” he says.
“The changes to the legislation are going to help those companies no end.”
Explaining why SMEs in particular stand to benefit from the proposed changes, Conry points out that a great deal of the activity within scope of the new legislation is becoming increasingly popular among smaller entities.
“Access to AI and other advanced technologies is easier than it’s ever been, and what we’re seeing is a lot of start-ups using this technology.
“It doesn’t really matter what industry they’re in – AI and data science is phenomenally helpful in getting these businesses off the ground.”
To qualify for R&D tax credits under the SME scheme, companies must have a staff headcount below 500 and a balance sheet total below €86m.
These businesses can deduct 230% of their qualifying costs from their annual profit – the normal 100%, plus an additional 130%.
“Being an SME and being able to claim this kind of cash injection is a phenomenal way to extend your runway,” Conry says.
Groundwork needed for SMEs
However, alongside the widened scope, HMRC has proposed adding a number of administrative steps to the process of filing a relief claim, with a view to limiting fraudulent and erroneous activity.
The draft legislation also includes measures to withdraw relief for subcontracted activity taking place outside of the UK, unless the activity is deemed to be “unavoidable”.
The industry has levelled criticism at these proposals, arguing that increased red tape and restrictions will pose a further drain on the resources of already struggling business.
Mark Joyner, director at R&D advisory specialists RDS, says SMEs must thoroughly review their activity in order to determine the most profitable scenario.
“We appreciate that often development work is subcontracted abroad due to lower labour costs. However, due to the new legislation, we would recommend all companies to weigh up the cost of foreign labour versus what could be reclaimed as tax relief.”
Joyner also stressed the importance of businesses seeking further assurance as to the quality of their records and the details of their claims.
Conry agrees, arguing that SMEs will “unlock” the benefits of the R&D scheme if they take a prudent approach to the administrative side.
“The first thing businesses need to grasp is good record-keeping, which is going to become more and more important going forward.
“One of the key changes HMRC are proposing is more information being provided by businesses. So if we can get companies to actually put in place recording mechanisms for projects, that will benefit them hugely.”
Commenting on the new overseas subcontractor rules, Conry argues that factors such as the affordability and availability of skills may determine the best course of action for SMEs.
“It isn’t always as straightforward as saying, ‘okay, we’re bringing our R&D work into the UK’ – there are wider considerations.”
The subcontractor category for R&D tax relief is capped at 65%, suggesting that the removal of this cap could act as a greater incentive, adds Conry.
A vital boost to the economy
Above all, says Conry, the reforms to the UK’s R&D tax regime will see a clamp down on fraudulent activity and stimulate the economy by encouraging businesses to use the scheme as it was intended.
“The changes are really intended to clamp down on fraud and the opportunistic advisers in the market,” he says. “In theory, it will reward SMEs for actually doing the R&D work rather than those who aren’t.”
According to research published by national accountancy group UHY Hacker Young earlier this year, it is estimated £725m in R&D tax relief was underpaid in the 2020-21 tax year. This represents a 16% increase on the £623m suspected to have been underpaid the previous tax year.
In its 2019 to 2020 annual report, HMRC officially estimated the amount overspent on R&D relief to sit at £311m.
But perhaps equally important to the nation’s economic growth is awareness around the R&D scheme, Conry adds, arguing that many advisers view claims as a “flash in the pan moment”.
“It’s an ongoing process – R&D should form part of your tax submission process every single year.”
According to the latest HMRC figures, just 5% of SMEs that could be using R&D tax credits are doing so, leaving millions of pounds unclaimed.
This emphasises the need to R&D advisers to support in the education of business when it comes to the R&D regime and the reliefs that are potentially available, says Conry.
“If we can raise awareness and try and get that percentage higher, that’s going to boost the economy.”