A Reformed Incentives Regime for the UK—The Autumn Budget 2022

Autumn Budget 2022—Key Announcements on Research & Development Tax Regimes

Introduction:

On 17 November 2022, the UK Chancellor, Jeremy Hunt, delivered his 2022 Autumn Budget to Parliament, espousing the government’s strategy to make the UK’s R&D tax relief regimes more impactful and cost effective. The extent of the change is remarkable, with it having a real impact on a large contingent of UK companies undertaking qualifying R&D activities on or after 1 April 2023—for instance, in the case of RDEC, the Chancellor’s announcements are set to increase the tax benefit rate for large company claimants by as much as 50% where expenditure is incurred on or after 1 April 2023.

The announcement follows a series of industry consultations, starting in Spring 2021, as well as draft legislation published in Summer 2022, to ensure that key industry stakeholders had the opportunity to offer feedback and guidance on the proposed legislative reforms.

The reforms outlined in the Autumn Budget will be legislated for in the New Year, via the Finance Bill 2023, and will be effective for claims made in respect of accounting period that end on or after 1 April 2023.

Updates to the Scope of Qualifying Expenditure:

It was confirmed, as announced at Autumn Budget 2021, that the R&D tax reliefs will be reformed to include an expanded definition of qualifying expenditure. Claimants will soon be able to include ‘data and cloud computing’ costs that are used as part of the R&D process, providing that such costs are incurred on or after 1 April 2023—the date from which the legislative changes are brought into force.

The inclusion of data and cloud computing costs chimes well with the government’s overarching strategy to foster the UK’s digital economy, as well as their declared ambition to retain and augment the UK’s position as a leader in AI, Quantum Computing, and associated technologies.

A refocusing of the regimes on UK based activities was also largely expected. This was affected by confirming that subcontracted R&D and activities of Externally Provided Workers (EPWs) must be located within the UK to be included within an R&D claim. The criterion for UK-based activities is largely focused on geography, namely, that the activities taking place fall within UK borders, but also that, in the case of EPWs, the relevant individuals are subject to UK PAYE.

The refocusing of R&D on UK-based activities featured heavily in industry discussions during the consultation and the draft legislation process. There was extensive debate about how such changes might impact certain sectors, particularly software and technology, which have significant technical workforce sitting in foreign locations (e.g., India, Malta, etc.).

The Autumn Budget has done little to address this fact pattern, but it does seem that the Chancellor has retained the concept of allowing certain overseas costs via a new cost category called ‘qualifying overseas expenditure.’ The circumstances in which overseas expenditure might qualify are as follows:

• Where it is ‘wholly unreasonable’ to carry out the R&D activities within the UK for geographical, environmental, or social factors (e.g., subsea research, etc.); or
• Where legal or regulatory requirements specify that the activities must take place in specific territories (e.g., clinical trials).

Note that the Chancellor made clear, as did the draft legislation, that ‘cost’ or ‘workforce availability’ are not reasons for overseas expenditure to qualify for inclusion within a claim.

Changes to the Research & Development Expenditure Credit (RDEC):

The Chancellor reiterated the government’s ambition to increase R&D spending to approximately £20 billion per annum by the tax year 2024/25. Such a target will require a significant increase in the government support for commercial R&D efforts, perhaps up to a c.40% increase in Treasury spending commitments.

Part of this planned spending uplift can be accounted for by the Chancellor’s announcement that the RDEC rate is set to increase from 13% to 20%, a not insignificant c.50% increase.

The change in the RDEC rate is welcome news to large companies. The increase goes beyond compensating for the increase in corporation tax to 25%, which would otherwise reduce the benefit received by claimants net of tax, and goes someway to offsetting the impact of some of the non-UK spend restrictions. The net benefit to claimants (i.e., the RDEC rate after tax due) will increase from 10.53% to 15%. For example, a claimant who incurs £1 million of qualifying R&D expenditure on or after 1 April 2023 will receive a tax credit of £150,000, compared to £105,300 under the current rates.

It is hardly unsurprising that the government has taken measures to bolster the support offered to large companies through RDEC. In the Spring Statement, it was cited that the multiplier effect of the RDEC—i.e., the amount of additional private R&D expenditure incurred for each £1 of relief offered—was significantly greater than under the SME regime. In particular, the econometric models published by HMRC in October 2020 indicate that the RDEC stimulates approximately £2.40 to £2.70 of additional spend for each £1 of RDEC relief, compared to £0.68 to £1.28 for each £1 under the SME regime.

Changes to the Small- and Medium-sized Enterprise Regime:

Unlike the Chancellor’s announcement on the RDEC rate, the Autumn Budget has set out a plan to legislate reduced rates for the SME scheme. The enhancement rate for SMEs from 1 April 2023 will reduce from 130% to 86%, and the credit rate will fall from 14.5% to 10%. With corporation tax set to rise from 1 April 2023, where tax is paid at 25%, the net benefit of the deduction reduces from 24.7% to 21.5% and the cash back rate reduces from 33.35% to 18.6%.

This is not welcome news for existing or potential SME claimants who will now receive less benefit for each £1 of qualifying R&D spend incurred on or after 1 April 2023. This announcement largely reflects the government’s understanding on the multiplier effect of the SME regime in comparison to the RDEC regime (i.e., the latter regime being more effective at encouraging private R&D spend), as well as a perception that the SME has historically been more susceptible to abuse as a result of its more generous tax and cash benefit.

Potential Future Changes:

The changes to the SME regime, combined with the increase to the Research and Development expenditure credit (RDEC) rate, will narrow the gap between the benefit received under the two regimes. The Autumn Statement also set out the government’s intention to consult on a simplified and unified regime, as well as working with industry to determine whether further support is necessary for R&D intensive SMEs provided it doesn’t significantly change the cost of supporting R&D to the Treasury. No further details have yet been released on either of these matters.

Autumn Budget 2022—Key Announcements on the UK Patent Box Regime

The Impact on the UK Patent Box:

No new amendments were announced in respect of Patent Box, and as such, with the corporation tax rise to 25% from 1 April 2023, this means the benefit will increase to 15% compared to the current 9%.

The changes in the scope of qualifying costs for R&D claims necessarily has implications for the Patent Box regime, which generally follows the definition of R&D and qualifying spend implicit within the R&D legislation. As such, the definition of qualifying R&D costs for Patent Box purposes has been extended in line with the expansion of the definition of qualifying R&D costs to include data licences and cloud computing costs.

The Autumn Budget has also made no changes to the provisions announced in the draft legislation to allow Nexus to ignore the restrictions on overseas expenditure in respect of Externally Provided Workers. Indeed, for Patent Box purposes only, the definitions that applied to EPWs on 31 March 2023 (i.e., the day before the new legislation comes in force via the Finance Bill 2022/23) will continue to apply for Nexus calculation purposes only.

Autumn Budget 2022—Key Announcements on the UK Capital Allowances Regime

An Update on Capital Allowances:

It has been reaffirmed by the Chancellor that the government intends, as expressed in the Mini Budget 2022, to keep the Annual Investment Allowance (AIA) at £1 million, and that the super-deduction rules—i.e., the 130% and 50% enhanced first year allowances for main pool and special rate pool assets, respectively—will no longer apply for expenditure incurred on or after 1 April 2023, as originally stated. The closing of the superdeduction window as initially stated, along with the decision to reinstate the rise in corporation tax to 25%, means that the technical amendments to the super-deduction legislation, which were announced as part of the Mini Budget 2022, have now been abandoned. The super-deduction legislation will remain in force as initially enacted.

The Autumn Budget speech also briefly highlighted that the proposed introduction of new investment zones will now be limited to a smaller group of locations than initially thought. The reduced list of locations will be properly announced in the coming months, upon which we will be able to better appreciate the impact of the new zones on regional business and economic growth.

Finally, the Chancellor also announced that the first-year allowances for electric vehicle charge points will be extended to 31 March 2025 to help incentivise investment in the UK’s EV charging infrastructure.

HMRC Draft Guidance—Key Takeaways

On 20 December 2022, His Majesty Revenue & Customs (“HMRC”) published their draft guidance on the recently announced R&D reforms. This document sets out HMRC’s interpretation of the reformed R&D legislation and how they might intend to apply it once the legislation takes effect on 1 April 2023. The draft guidance can be found here.

The draft guidance has been published by HMRC for feedback purposes only (i.e., it might be subject to change in the future). Responses to the guidance should be provided to HMRC on or before 28 February 2023.

Deloitte is currently compiling its own response to HMRC’s draft guidance. Should you wish to discuss this or would like to know more about the UK’s R&D regimes and the changes currently taking place, please reach out to us.