Changes to UK R&D SME tax credits
Among the changes announced in the Chancellor's Autumn Statement on 17 November 2022 were significant and largely unfavourable proposed changes to the UK Research and Development ("R&D") tax relief scheme for small and medium-sized enterprises ("SMEs"). These were announced without warning or prior consultation.
The R&D changes have now been debated in the House of Commons. Although the relevant Treasury Minister has committed to holding a roundtable discussion with members of the life sciences industry to negotiate how companies in the sector can continue to be properly supported by the R&D tax relief scheme, it seems at the moment as though these changes will be enacted as law.
This note considers the broad impact these changes may have on the sector if there are no further changes or additional support.
What R&D reliefs are currently available?
Relief for R&D is based on how much a company spends on eligible R&D. To work out what relief is available, a company must first identify its qualifying expenditure.
In broad terms, a company can then claim relief in respect of its qualifying R&D expenditure either by way of:
- A corporation tax reduction for profit-making companies (larger companies and SMEs have different rates), or
- In the case of loss-making SMEs (which will be the case with most biotech companies), a cash tax credit from HMRC
Currently the credit is calculated using 230% of the qualifying expenditure and then applying a tax credit rate of 14.5% which means a credit of approximately 33% (230% x 14.5%) of the expenditure is paid. The cash payment is made to companies by HMRC after they have submitted their tax return for the year, and is welcome cash flow. (This is very much a summary of the position as there are a number of other detailed conditions, including a cap on the repayment amount by reference to the amount of PAYE paid over from a company's payroll.)
Companies are categorised as SMEs, and will therefore qualify for the R&D tax credit, if they have:
- Fewer than 500 staff; and
- A turnover of under €100 million and/or a balance sheet total under €86 million.
What are the changes?
The changes affect R&D expenditure on or after 1 April 2023. Although there may be devil in the detail, expenditure before that date is unaffected and so companies will no doubt be thinking about accelerating expenditure so that it is incurred before that date.
For expenditure after this date by SMEs, only 186% of the qualifying expenditure will qualify and the credit rate will fall to 10% (meaning an overall tax credit of 186% x 10% =18.6%).
The BIA summarises the SME change as follows:
"In practice this means that, under the current proposals, businesses who have made their investment plans based on the SME R&D tax relief providing 33p for every £1 the company itself invests in R&D will instead receive 18.6p for each £1 of in-house R&D they perform and as little as 12p for each £1 of R&D they outsource to universities, hospitals or other companies."
This is an over 40% cut in the amount of cash rebate received.
These changes are being made ahead of other changes which had already been announced, including the extension of the scope of qualifying expenditure but also the restriction on overseas R&D costs, and follow other implemented changes in recent years, including the SME PAYE cap.
While SMEs fare badly, it is worth noting that the R&D expenditure credit rate for larger companies (i.e. companies who are not SMEs) will at the same time increase from 13% to 20%, but that is not normally of benefit to any but the larger life sciences companies.
Indeed, the targeting of this benefit at larger companies is deliberate as one of the main reasons given for reducing the SME rate was that fraud has become endemic among smaller companies and the Government have said that, balancing the two changes, their commitment to the sector overall remains constant. There is also the prospect of a combined regime for relieving R&D costs for all size of companies.
What are the likely consequences?
Given it is less than three weeks since the changes were announced, companies are still working through the impact of the changes to the SME regime.
- For many companies in this sector, future cashflows will be significantly affected.
- Companies which were counting on a level of cash being retained in the business will now need to rewrite business plans as they will see cash leave the business quicker unless they make changes to their plans.
- They will have to think of how this cash outflow is replaced or cut back and/or delay expenditure (or possibly source it overseas under other more favourable regimes).
- Funding options, including further funding from investors and grants, will need to be considered. At a time of depressed investment activity, investor appetite may not be sufficient and M&A or other activity may also rise.
Alternative proposals have been put forward, including restricting relievable R&D to high knowledge areas with further measures to combat fraud in this area, but so far those do not seem to have been taken up by the Government.
While we may see further cooperation and consultation with key players in the sector over the coming months, SMEs should prepare themselves as the tax reforms are likely to go ahead as planned in April 2023.
For more information, please speak to your usual Stephenson Harwood contact or any of the key contacts listed.