The UK government announced updates to a number of tax policy measures on November 30th as part of the “Tax Administration and Maintenance Day”, in an attempt to modernise the UK’s tax system and combat non-compliance.
The substantive policy changes included:
- The inclusion of data and cloud computing costs as an eligible qualifying expenditure category
- The clampdown on overseas R&D activities, with emphasis instead placed on incentivising domestic R&D activities
- The improvement of compliance within the industry as a whole
In addition to the above, HMRC also made reference to some further policy updates at the Research & Development Communication Forum (RDCF) which was held in early December. After attending the forum and reading through the above policy changes in detail, we have summarised our initial thoughts below.
Data and cloud computing costs
We have spoken at length in another post about the proposed changes to the data and cloud computing costs and what it will mean for businesses so we will only briefly summarise them. If you want to learn more, read our blog post about it here.
Following the changes, businesses will be able to claim R&D tax relief on expenditure that is linked to buying datasets that are directly used for qualifying R&D. However, companies will not be able to claim relief on costs on datasets where the information will be resold or have lasting value to the business beyond the duration of the R&D project. Whilst this definition is made in a similar manner to consumable costs, how this is interpreted in practice is yet to be seen. Data is often consumed during the training of an algorithm and, assuming the project is successful, will have a lasting value within the business if that algorithm is then used commercially.
Staff costs in relation to datasets
Businesses will be able to claim relief on staff-related expenditure for the purpose of collecting, cleansing and analysing data. Although you were already able to claim relief on staff expenditure that is directly tied to the R&D project, the government wants to make their position on this clear in relation to the guidance.
Cloud computing and software
Raw data is often required to be further analysed and modified in order for it to be available for interpretation. The government will now allow businesses to claim relief on the cost of cloud computing services and software used directly for R&D if they are used for computation, data processing and analytics.
Caution needs to be taken though that some software performs more than one function, such as analytics and storage. The scheme specifies that storage does not qualify for relief. The reason that costs relating to servers and data storage are not included is because they are seen as overhead costs, akin to rental costs, which are not considered a qualifying expense for R&D tax relief.
In practice this means that if you use software that incorporates multiple functions such as AWS DynamoDb, which can act both as a storage and analytics tool, the costs need to be apportioned as the business will only be able to claim for the analytics costs. However, for other software, such as AWS Lambda, which is fully used for data processing and analytics, the business will be able to claim the full amount.
Overall, compared to other proposed changes, it appeared that this area had the least debate and questions surrounding it. Most questions focused on two things. Firstly, the practicality of being able to apportion costs of software programmes. Secondly, whether it is reasonable to expect data not to be reused for other purposes and projects. At the RDCF HMRC confirmed that the details are still being finalised which unfortunately didn’t shed any further light on this subject for now.
Overseas R&D relief
This proposed change was one of the two that raised the most follow up questions and concerns. Currently, under the SME R&D tax relief scheme and RDEC, businesses are able to claim relief on R&D activity that is conducted overseas.
However, in an effort to refocus R&D investment and innovation domestically, the government is proposing to limit the relief to R&D activity that has only been undertaken in the UK. This relates to all qualified expenses, such as staff costs, subcontractor costs and EPWs, the only exceptions to costs outsourced overseas were for data, cloud, software, clinical trial volunteers and consumable costs. In addition, if you hire a subcontractor and they rely on overseas staff, relief will only be available on expenditure that has been performed within the UK.
This presents a number of challenges that can be broken down into three questions:
- What if R&D must take place overseas, for example, due to regulatory issues in the UK?
- How does a company ensure an unconnected subcontractor or staff provider doesn’t engage with overseas workers in delivering their service?
- What does this mean for companies that have international subsidiaries?
From the discussions at the RDCF, it appears that HMRC have a rather rigid opinion that most expertise required for R&D work in the UK can also be found in the UK. Whilst this could be true for certain industries such as software development, this isn’t clear cut for others. At the RDCF, an attendee raised the point that sometimes overseas R&D expenditure is required, for example studying climate change that requires staff to be posted abroad near glaciers, or relying on clinical trials to be conducted abroad, much like the case with AstraZeneca and developing the COVID vaccine, where the trials took place in Brazil and South Africa which allowed them to gather more data.
Moreover, in both these cases time and urgency appears to be a factor, which makes one wonder whether taking R&D abroad to expedite the project would qualify for relief. HMRC representatives appeared to respond favourably to these examples although no definitive answer was provided.
During the forum, we tried to ascertain how HMRC suggests companies ensure that the work is carried out by subcontractors whose staff is based within the UK was left unanswered. It will be interesting to see how this works in practice, as it seems unlikely that businesses will be privy to this sort of information from their subcontractors, unless they are connected parties.
Likewise, HMRC confirmed that if the policy changes are implemented as currently planned, this restriction will also impact connected parties or companies that have overseas subsidiaries. Considering that the reason for this change is to ensure that the R&D relief is reinvested back into the UK, not allowing connected companies or companies part of international groups that are owned by a UK tax paying entity to claim relief on overseas expenses may seem counterintuitive to stimulating R&D taking place in the first instance.
Overall, it is still unclear whether this will go into effect and there is scope for this to change as the government is interested in hearing stakeholders’ views and suggestions. If the stakeholders are able to justify overseas expenditure without detracting from the focus on encouraging UK innovation and promoting UK industries, this point may be reconsidered.
There have been some concerns over abuse in relation to the R&D tax relief claims over the past years. Some of the proposed changes to mitigate these issues is to require more information and make all claims digital.
In terms of adding more detail about each R&D project it is hard to tell what effect it will have on the claim process. In practice, it is very difficult to prescribe a set format for the ‘Technical Narrative’ which outlines qualifying work, given R&D could be undertaken in vastly different industries. As of now, the legislation does not require the submission of supporting documentation for an R&D claim. In essence, this means that a claim can be submitted without providing a ‘Technical Narrative’ and instead, the one number is included on the company’s Corporation Tax Return. The government may look to change this in the future and legislate for supporting documentation, though how this is achieved in practice is somewhat speculative at the moment.
Likewise, when asked to clarify what HMRC meant by digital, they said ‘submitted by COTAX or IXBRL’, which could mean that HMRC is aiming to standardise how it is receiving all the information about R&D tax relief and will stop receiving claims through post or email. In the past, HMRC’s willingness to accept CT600 amendments by email has led to delays. It, therefore, seems that the move towards digitalisation will help ensure claims are processed in a timely manner.
In addition to the above-proposed changes, the claims will need to be endorsed by a named senior officer of the business and include the details of any agent who advised in compiling the claim. Ultimately the company is responsible for any R&D claim made by the business, though as it stands no one individual needs to put their weight or credentials against the claim. Again, this is already captured already through the inclusion of ‘Competent Professionals’ on the narratives, though in practice this can sometimes be hard to implement, given that one individual may leave the business.
Similarly, in cases where companies may use a third party R&D consultant to do their claim but their accountants input the R&D figures to a CT return, who would be held responsible? What would accountability actually mean in the eyes of HMRC and where would the line be drawn in terms of responsibility, liability or penalties?
Probably the most divisive change that HMRC proposed was the requirement for companies to notify them in advance if they are planning to make an R&D tax relief claim as it appears to contradict the concept of an uncertainty, hinder startups and is overall incompatible with a company’s statutory right to amend their return. To properly unpack all these concepts, we decided to dedicate a separate blog post to it, which you can read here.
What are the next steps?
The government is encouraging stakeholders to share their views on the proposed changes. They will then publish a draft legislation in the summer of 2022. The draft legislation will then be subject to further debate, before the final changes are included in the 2022-23 Finance Bill. Any eventual changes to the R&D Tax Relief scheme will therefore take effect from April 2023.