Guide to SME R&D tax relief changes

From April 2023, a broad range of reforms to the SME R&D tax relief scheme took effect.

To combat fraud and error and modernise the SME R&D tax relief scheme to support innovators and the technology sector moving forward, the government has implemented its most significant reform to the scheme in over two decades.

To ensure you understand the full implications of these changes on your company, we’ve provided a complete overview of the reforms and what they could mean for your future claim.

The SME scheme’s enhancement rate decreased from 130% to 86% in April 2023, and the SME tax credit rate reduced from 14.5% to 10%.

The SME scheme’s enhancement rate decreased from 130% to 86%

For accounting periods prior to April 2023, companies claiming through the SME R&D tax relief scheme can increase the value of their R&D costs by 130% to enhance the tax credits they receive. However, from 1 April 2023, this changed; the R&D enhanced expenditure rate or, in tax law, the ‘additional deduction’  decreased from 130% to 86%.

The SME tax credit rate will reduce from 14.5% to 10%

Once enhanced, the cash benefit of an SME R&D tax relief claim varies depending on whether you’re breaking even, loss-making or profit-making.

When your company breaks even, your R&D enhanced expenditure will now have a 10% tax relief applied instead of 14.5%, resulting in an 8.6% relief rate available instead of the 18.85% that was in effect before April 2023.

Breaking even calculation

Total qualifying R&D Expenditure (TQE): £1,000,000

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

R&D enhanced expenditure x New SME tax credit rate = Tax Credit Claim Value

£860,000 x 10% = £86,000

Tax Relief Value = £86,000 (8.6% of relief)

HMRC calculates your R&D tax credit when you’re a loss-making company by combining the enhanced R&D expenditure and trading loss. The new 10% tax credit rate is applied instead of 14.5%, resulting in an 18.6% relief rate available instead of the old 33.35% before April 2023.

Loss-making calculation

Total qualifying R&D Expenditure (TQE): £1,000,000

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

Maximum surrenderable loss (186%)

(£1,000,000 + £860,000) x 10% = £186,000

Tax Relief Value: £186,000 (18.6% of relief)

To calculate the R&D tax relief as a profit-making company, first, deduct your increased R&D expenditure from your taxable profits. Then multiply that figure by the corporation tax rate to get your revised corporation tax bill. The money you save is calculated by subtracting the reduced corporate taxes bill from what it would typically be without the deduction. See the calculation below.

Financial position

Total Qualifying R&D Expenditure (TQE): £1,000,000

Profit: £1,500,000

New Corporation Tax = Profit x 25%

1,500,000 x 25% = £375,000

R&D credit calculation

TQE x New Enhancement Rate = R&D enhanced expenditure

£1,000,000 x 86% = £860,000

New taxable profit = Profit – R&D enhanced expenditure

£1,500,000 – £860,000 = £640,000

New corporation tax = New taxable profit x 25%

£640,000 x 25% = £160,000

Tax savings

Corporation tax – Reduced corporation tax

Total tax saving: £375,000 – £160,000

Total tax saving: £215,000 (21.5% of relief)

 

Note: Starting from 1 April, companies generating over £250,000 in profits will pay 25% corporation tax. Businesses seeing profits between £50,000 and £250,000 will be subject to a graduated rate ranging from the current 19% up to the new 25%.

A profit-making company can receive a relief rate ranging from 16.34% to 21.5%. The company’s profit margin determines the rate, which determines its corresponding corporation tax band.

What if the R&D enhanced expenditure is higher than your taxable profit?

If the R&D enhanced expenditure is higher than your taxable profit, the R&D enhanced expenditure becomes a trading loss, and a loss-making calculation applies. However, the new 10% tax credit rate must be applied instead of the old 14.5%.

If your year-end date is not 31 March, you will need to do a split period calculation for R&D costs to apply the rates of relief correctly.

For instance, if your accounting period starts on 1 October 22′ and ends on 30 September ’23, you will need to apply the old rates to the first half of the year (182 days up to 31 March) and then the new rate to the second half of the year (183 days up to 30 September).

To see detailed examples of split calculations with old and new rates for the SME scheme, download our quick reference guide below.

While the SME scheme became less generous from April 2023, there is a silver lining for R&D-intensive SMEs. In the Spring Budget, the government announced that a higher rate of relief for R&D-intensive SMEs would be introduced.

What is an R&D-intensive SME?

An R&D-intensive SME is a company with qualifying R&D expenditure that is at least 40% of its total expenditure.

How much will an R&D-intensive SME receive?

An R&D-intensive SME will be able to claim a higher payable R&D tax credit rate of 14.5% (rather than the reduced 10%).

This means that loss-making R&D-intensive SMEs will receive a cash credit of £27 for every £100 spent on R&D expenditure instead of the reduced rate of £18.60 available to non-R&D-intensive SMEs.

How will this be delivered?

As part of the existing SME scheme, companies will be able to indicate if they are claiming as R&D-intensive using a new digital ‘Additional Information’ form. The introduction of this form is set to take effect on or after 1 August 2023.

From 1 April 2023, cloud computing services and data count as qualifying R&D expenditures for the SME R&D tax relief scheme, and the government is amending the Guidelines on the meaning of research and development for tax purposes to include pure mathematics in the definition of qualifying R&D activities.

Like all qualifying R&D expenditures, the costs must contribute to resolving scientific or technological uncertainty.

For data costs or cloud services utilised for various purposes, not just R&D, HMRC will accept a fair split of the expenses. A good example would be to calculate based on factors such as staff hours employed, number of licences acquired and proportionate storage allocated to R&D versus non-R&D activities.

All claimants must submit additional information from the accounting period starting on or after 1 August 2023. Recently published draft guidance detailed exactly what this additional information is. It includes:

• VAT number.
• Contact details of the main internal R&D contact at the company.
• Contact details of any agent working on the claim.
• Qualifying expenditure under the following categories:

1. Employee costs.
2. Externally provided workers.
3. Contracted out R&D.
4. Software.
5. Consumable Items.
6. Payments to participants of a clinical trial.
7. Data licence (for accounting periods starting on or after 1 April 2023).
8. Cloud computing services (for accounting periods starting on or after 1 April 2023).
9. Contributions to independent R&D costs (RDEC only).

• Show the amount of the above that is qualifying indirect activities (QIAs).
• Show the number of projects claimed for.
• Descriptions of the projects under 5 headings:

1. What is the main field of science or technology?
2. What was the baseline level of science or technology that you planned to advance?
3. What advance in that scientific or technical knowledge did you aim to achieve?
4. What scientific or technological uncertainties did you face?
5. How did your project seek to overcome these uncertainties?

• For 1 to 3 projects, the company will need to describe all projects, covering 100% of the qualifying expenditure.
• For 4 to 10 projects, it will need to describe projects that account for 50% of the total expenditure, with a minimum of 3 projects described.
• Show the number of EPWs who worked on the above projects.
• PAYE scheme reference for those EPWs (suggesting that HMRC expects to see a linked PAYE reference for any costs to be accepted as EPW costs).

This will have to be submitted digitally through a government web form known as the Additional Information Form, which is set to go live in April 2023 on HMRC’s website.

From 1 August 2023, some companies must submit a claim notification to ensure their R&D tax credit claim is valid. Only some companies are required to submit a notification. HMRC has proposed that it should be mandatory for:

• Companies planning to submit R&D tax claims for the first time.
• Companies that have not submitted a claim for 3 years or more.

Claim notification forms must also be submitted through a g-form, set to go live on 1 April 2023 on the gov website.

To learn more, read our quick, easy guide that covers every question you may have about the claim notification.