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Proposals for a single R&D tax regime: a death knell for the SME regime?

Last week, HM Treasury released its Summary of Responses document to the consultation published earlier this year seeking views on the design of a single research and development (R&D) tax relief regime – or, in other words, the collapsing of the independent R&D tax relief regimes for small and medium enterprises (SMEs) and large companies into a single regime.

The key takeaway is that the UK Government is yet to make a final decision on whether to press ahead with a single R&D tax relief regime, but it was noted that the option of implementing a merged regime from April 2024 is being kept open. That being said, draft legislation for the Finance Bill 2023-24 was also released last week which contains the UK Government’s proposal for what a single R&D tax relief regime would look like – that drafting is largely based on the existing research and development expenditure credit (RDEC) regime for large companies.

A final decision though will come at the next fiscal event. That will likely be the fiscal event taking place in Autumn 2023. If the UK Government decides to trigger an early general election in Spring 2024, that will make the Autumn 2023 fiscal event either the final or penultimate one for the current government.

With that headline in mind, there are some other interesting points coming out of this Summary of Responses.

Stakeholder Views

Perhaps unsurprisingly, the idea of merging the R&D tax relief regimes into a single regime modelled on the RDEC had broad support from large companies. The key proposal on the table is for the merged scheme to operate as an ‘above the line’ credit so, in principle, nothing material should be changing for large companies. Indeed, the large companies responding to the consultation noted that the proposed changes would “not have a significant impact on the way they conduct R&D”.

The response from SMEs does seem quite different. In general, SMEs were nervous about the changes. Understandably, it was specifically flagged that most SMEs are loss-making in their early years and so the “greater support” under the regime for SMEs is preferable.

The point here seems to be framed as an issue related to the headline rates of relief. That is interesting because, typically, SMEs are fond of the cash element which is payable under the R&D tax relief regime for SMEs (where a loss-making SME may ‘surrender’ the additional deduction available under the SME regime in return for a cash payment from HMRC). However, the responses (or at least HM Treasury’s summary of the responses) do not refer to this. That may suggest SMEs are not particularly worried about the loss of the cash element available under the SME regime (perhaps because a cash payment is possible under the current RDEC rules albeit only in very specific circumstances). Even if that is the case, I do wonder why this was not specifically raised by respondents en masse because the UK Government’s proposal of next steps specifically mentions a “small decrease in the immediate cash benefit for SME loss makers”. It may be possible that SMEs are hoping that the seven-step process which currently exists under the RDEC rules will be simplified such that the cash element becomes easier to obtain under a new single regime (this simplification of the seven-step process was also something which large companies called for in their responses).

Error and Fraud 

The UK Government has, for some time, considered error and fraud (particularly in respect of SMEs) as a key pressure point in respect of the R&D tax relief regimes. I have written about this previously here and here.

The consultation published earlier this year stated that the estimated level of error and fraud in respect of R&D tax reliefs for 2021 to 2022 was £469m (£430m in respect of the SME regime, and £39m in respect of the RDEC scheme). HMRC’s Annual Report and Accounts published on 17 July 2023 indicated that this will likely turn out to have been an underestimate, given that, in respect of 2020 to 2021, it includes an upwards correction of the error and fraud estimate to the tune of £794m (a total of £1.13bn - with £1.04bn attributable to the SME regime and £90m to the RDEC scheme - as opposed to the earlier estimate of £336m).

In practice, this is likely to result in (even further) scrutiny by HMRC on R&D tax relief claims by SMEs. The repeated identification of error and fraud as a growing issue is also likely to encourage HMRC to be “confrontational” with companies (an approach the House of Lords Economic Affairs Select Committee specifically noted it was concerned about with regards to HMRC’s treatment of SMEs making R&D tax relief claims).

New Rules

Another key concern with the proposal of moving to a single R&D tax relief regime, largely from SMEs, was that they would need to familiarise themselves with an entirely new set of rules, possibly without any dedicated HMRC support.

Putting aside whether HMRC would set up a “dedicated helpline” (the chances of which one might reasonably regard as slim in light of the three-month closure of the self-assessment helpline this summer) or otherwise provide sufficient education and guidance for SMEs, becoming familiar with a new set of rules may indeed prove to be a mammoth task. Not only, for SMEs, will the nature of the relief change but the consultation requested views on ancillary features of the R&D tax relief regimes. There was a wide range of responses, covering, for example, the treatment of subcontracting costs, whether relief should extend to capital expenditure, the expansion of relief to include social sciences and humanities, varying rates of relief for certain areas of R&D and the operation of caps on relief.

It therefore seems that, rather than simply collapsing the R&D regimes into one and exporting existing rules, the UK Government may take the opportunity to make wide-ranging and fundamental changes to the R&D tax relief landscape. Large companies, in some respects, may have an easier time as, rather than having to become familiar with an alteration in the nature of the relief offered (and the impact that may have on business operations), the task will be to monitor the differences in the technical aspects. In any case, large companies are likely to be better resourced than SMEs to monitor this and may be able to rely on advisers – something which SMEs mentioned in their responses that they would not be able to do quite as easily.

Final Thoughts

Overall, the design of a single R&D regime marks a turning point in the UK’s offering of tax incentives for R&D and ends over two decades of tailored incentives for SMEs in respect of their R&D activities. Whether it was the correct policy decision in the first instance to have two separate R&D tax relief regimes, it seems that the existence of a R&D tax relief regime solely for SMEs lived on borrowed time from the moment the rates of error and fraud became part of the discourse around the UK’s broader innovation strategy.

In terms of what can be expected next, as mentioned above, draft legislation on what a merged R&D tax relief regime might look like was released last week – although it does not yet include provisions to alter some of the more technical aspects of the relief offered that were mentioned in the consultation response.

I suspect, at least from the UK Government’s perspective, it will be a larger headache to build in those changes now as part of a transition to a single regime. The simpler approach would be to wait for the newly designed regime to be in place. Once stakeholders are familiar with the rules and best practice (and guidance) has developed, the UK Government (perhaps led a new Prime Minister and supported by a new Chancellor) will be at liberty to tweak the new R&D tax relief regime much like it has been doing for the past two years.


slaughterandmay, uk tax, research and development, r&d, rdec, smes