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How R&D Tax Credit Restrictions are Impacting Your R&D Claims?

5 September 2023

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Research and Development (R&D) tax relief has played a pivotal role in fostering the spirit of innovation by incentivising businesses to invest in cutting-edge research and technological advancements. However, recent shifts in R&D tax credit restrictions have cast a shadow of uncertainty over the landscape, leaving businesses grappling with the implications for their R&D claims. Understanding these restrictions can redirect efforts and help businesses make informed decisions while filing their claims to maximise outcomes.

7 R&D tax credit restrictions in 2023

The rules and regulations around R&D are continuously evolving, as seen with the 2023 budget changesThis article outlines the intricate web of R&D tax credit restrictions and explores how these changes are resonating across industries, reshaping priorities, and posing significant challenges to businesses both large and small-medium sized companies. The purpose of this article is to equip you with the information you need to prevent any surprises when completing your R&D claim. It’s helpful to have these restrictions in mind as you carry out your research and development projects, so you can gauge what R&D tax credits you can receive. 

Here are 7 main restrictions of R&D tax credits in 2023 you need to be aware of while putting forward your R&D tax claim.

1. R&D PAYE Cap

Staff costs are qualifying costs for R&D, however, there is a cap in place for how much you can claim back. Small and medium-sized enterprises (SMEs) have the option to receive a refundable tax credit, which is limited to a maximum of 300% of their combined payments for Pay As You Earn (PAYE) and National Insurance Contributions (NIC) obligations. There is an additional allowance of £20,000 provided as a buffer. So the cap means your R&D claim won’t exceed £20,000 + 3 times the amount you pay for PAYE and National Insurance.

Who does this impact?

  • Small teams – For SME businesses who have low payroll expenditure, the PAYE/ NI cap will impact how much they receive from the R&D tax credit incentive as they can only claim up to three times whatever they spend on staff.
  • Loss-making SMEs – This cap prevents loss-making companies from receiving the tax credits they would have been able to claim in previous tax years.
  • Subcontracting R&D work – If you rely on lots of subcontracting work, you will be impacted by the cap. Without costs on staff members, you can only rely on the £20,000 buffer.

When are you exempt from the R&D PAYE Cap?

When the workforce is engaged in generating, preparing for the creation of, or overseeing Intellectual Property (IP), and the company is spending on subcontracted Research and Development (R&D) with affiliated entities, or on externally provided workers (EPWs) from related parties, does not exceed 15% of its eligible R&D spending.

2. Notifying HMRC to be able to make an R&D tax claim

HMRC will not accept your first-time R&D claim if you don’t notify them of your intention to put forward a claim. So, this rule is for claiming R&D tax credits for either RDEC or the SME scheme for the first time from the tax year commencing in April 2023, or if you haven’t claimed for the previous 3 accounting years.  

To notify HMRC, there is an online form which needs to be submitted. The form must be finalised within six months from the conclusion of the accounting period in which you plan to file a claim. If you have already made a claim in the preceding three accounting periods, then you’re not obliged to let HMRC know.

3. Providing additional information to HMRC

Another restriction that could get in the way of you receiving the R&D tax credits you’re eligible for is failure to complete the additional information form for HMRC. 

This was introduced on August 8, 2023. All businesses, for both SME and RDEC schemes,  are obligated to provide an extra information form to accompany all requests for R&D tax relief. The supplementary details must be submitted before your Corporation Tax return, as HMRC will be unable to handle the claim without them.

The form will request the following information:

  • Your unique Taxpayer Reference (UTR)
  • The employer PAYE reference number
  • VAT registration number
  • The business type

4. R&D qualifying activities

Not all research and development activities are eligible for tax credits. Generally, the activities must involve technological innovation, scientific research, or the development of new or improved products, processes, or services. Routine activities, distribution of goods, market research, and certain business administrative tasks may not qualify because they do not directly contribute to the resolution of scientific or technological uncertainty. It is therefore crucial to analyse the qualifying activities for R&D in order to make a risk-free claim.

5. Qualifying expenditure for R&D

R&D tax credits often cover both direct and indirect costs related to qualifying activities. Direct costs are usually easier to identify and include items like employee wages directly involved in R&D, materials, and certain equipment. Indirect costs include more restrictions and often surprise R&D claimants. Some of the costs that don’t qualify for R&D are:

Marketing and commercialising your product, solution, or process

You’ll receive tax credits from the research and development part of your process but not for the costs involved in actually producing the product and promoting it through marketing efforts.

Ordinary tasks and visual enhancements for aesthetic purposes

Engaging in routine tasks or duplicating existing products, devices, materials, or procedures will not qualify for R&D tax credits. Similarly, activities focused solely on altering the appearance of a product or device are also ineligible. If you use new technology to make the visual changes, then this will qualify for the credits. 

However, it’s important to note that the creation of new technology aimed at implementing aesthetic changes will qualify for the credits.

Capital expenditures

Capital investments such as rent, land, and patent creation are essential for business operations; however, they fall outside the scope of R&D tax credit eligibility due to their nature as long-term asset expenses, rather than immediate operational expenses required to carry out iterative experimentation.

Learn more about R&D qualifying cost calculations here.

6. Substantiation of eligibility

Businesses are required to provide detailed documentation and evidence to substantiate their R&D activities. This includes project plans, technical documentation, test results, evidence of costs, and other supporting materials. This is why maintaining accurate and comprehensive records of R&D activities and related costs is essential. Insufficient documentation could lead to either propel enquiries from HMRC or the denial of tax credit claims upon audit. Relying on a specialist R&D tax advisor, such as Alexander Clifford, means your technical narrative and all documentation needed are developed for you, and aligned with HMRC’s standards.

7. Overseas R&D activity and expenditure

At present, R&D expenses accrued abroad by a UK-based claiming company are eligible for R&D tax benefits in the UK. New regulations for overseas R&D expenditure come into action from the 1st of April 2024. The main change will be that subcontracted R&D tasks and the expenses related to externally provided workers (EPWs) will be confined to activities conducted within the UK. However, certain exceptions will be recognised as eligible overseas expenditures. HMRC outlines 3-part criteria for gauging whether overseas research and development are eligible for tax credits:

  1. The conditions necessary for R&D are not present in the UK. So, if you’re unable to conduct R&D in the UK. These necessary conditions could relate to geography, environment, and social factors.
  2. The conditions are present in the location where the R&D is undertaken
  3. If it would be wholly unreasonable to replicate the conditions in the UK

What is the purpose of R&D tax credit restrictions?

The reason why HMRC has R & D tax credit restrictions is to focus on genuine innovation and high-impact research, pushing the boundaries of technology and science. With various caps and compulsory documentation, HMRC is preventing the R&D incentive from being abused by increasing the transparency of projects.

Final thoughts

The key to a successful R&D claim that meets HMRC’s requirements is having as much knowledge of R&D as possible. Being aware of the R&D tax credit restrictions helps to guide your decision-making. You can allocate resources strategically, knowing what you can claim back for, helping to create an efficient allocation of funds, and helping you increase the potential of your innovation.

How can we support you?

Our expertise can provide invaluable assistance in navigating the complexities of R&D tax credit restrictions while supporting your R&D tax claim application. We’re always at the forefront of changes to R&D tax relief, and by leveraging this knowledge, we can meticulously guide you through the intricate details of these restrictions, ensuring that your R&D claim is precisely aligned with the latest guidelines. Contact us today to create a robust claim for you with confidence.

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