Legislation Day: Changes to the R&D scheme

What we received instead was far more significant: confirmation of enhanced support for R&D intensive companies and, unexpectedly, the first draft legislation for a single merged R&D tax relief scheme. These developments could reshape how thousands of UK companies access innovation funding. Below, we break down what has been announced, what remains uncertain and what it means for businesses preparing claims in the months ahead.

‍Updates to support R&D intensive SMEs

The first announcement was expected. In the Autumn Budget 2022, the Government reduced the generosity of the SME R&D scheme by cutting the enhanced deduction from 130 per cent to 86 per cent and reducing the credit rate from 14.5 per cent to 10 per cent. These changes were widely criticised for disproportionately affecting loss-making SMEs who invest heavily in innovation.

Following industry feedback, the Government agreed to protect the most research intensive SMEs. The new policy paper confirms that loss-making companies investing at least 40 per cent of their total expenditure into qualifying R&D can access a higher 14.5 per cent credit rate. In real terms, this equates to an effective benefit of around 27 per cent of qualifying expenditure. While still below the previous level of support, this is a far better position than originally feared.

The unexpected development: plans to merge the SME and RDEC schemes

The second announcement was more surprising. HMRC released draft legislation for a merged R&D scheme due to take effect from 1 April 2024. The Government had previously suggested alignment between SME relief and RDEC, but the publication of draft legislation marks a significant move towards a single unified system.

The proposed merged scheme would operate as an above-the-line credit. This would bring several potential advantages for businesses.

• A simpler, more streamlined R&D tax system
• Clearer visibility of the benefit for financial forecasting and cashflow planning
• A more consistent claim experience across company sizes

However, there are concerns that designing one scheme to serve all UK businesses may overlook the very different needs and risk profiles of start ups, SMEs and large companies. This could lead to uneven outcomes and weaken incentives for smaller, innovation heavy firms.

There are promising signs for R&D intensive SMEs, but a single scheme risks being too broad to deliver fair and targeted support for the businesses driving much of the UK’s scientific and technological progress.

Insights from HMRC’s public consultation

Earlier this year, HMRC launched a public consultation on merging the SME and RDEC schemes. Today’s summary of responses provides valuable insight into sector sentiment.

Most of the 149 respondents agreed that merging the schemes could simplify the system, reduce administrative burden and offer clearer guidance for claimants. However, there were two major reservations.

• The pace of reform, especially alongside widespread changes already announced
• The risk of reduced benefit rates for SMEs, many of whom depend on R&D relief for cashflow stability

The introduction of the enhanced rate for R&D intensive SMEs does ease concerns, but many advisers remain cautious while the details of the merged scheme are finalised.

The consultation also explored several technical issues, including how subcontracted R&D should be treated. Under the current RDEC scheme, subcontracted costs are excluded. Under the SME scheme, they may be included, but HMRC’s interpretation of who “owns” the R&D has led to disputes and multiple First Tier Tribunal cases.

Most respondents argued that R&D relief should continue to reward the company taking the financial risk. This principle will be central to any workable merged scheme.

Other technical themes included the PAYE and NIC cap, Qualifying Indirect Activities and discussions around potential minimum spending thresholds.

What the draft legislation clarifies so far

The draft legislation contains some notable updates.

• The proposed rate for the merged scheme is 20 per cent of qualifying expenditure
• Overseas externally provided worker costs will be excluded
• Domestic externally provided worker costs will be allowed only where PAYE applies
• The more generous SME PAYE and NIC cap will be retained
• Subcontracted R&D will be included, unlike in the current RDEC scheme

This could allow larger companies to claim relief on a wider range of activities, potentially increasing uptake among major UK innovators.

However, several points remain unclear.

• How the merged scheme will treat subcontracted R&D versus contract research
• Whether a subsidised expenditure clause will remain
• The definition and treatment of Qualifying Indirect Activities
• Whether a minimum expenditure threshold will be introduced

These areas have caused long-standing uncertainty for SMEs, and the absence of clarity is likely to generate further debate.

What happens next

The policy paper confirms that the Government has opened a technical consultation on the draft legislation. This is a crucial opportunity for advisers, businesses and industry bodies to provide feedback and ensure that the final design delivers a fair and effective incentive.

Kene will continue to contribute actively to this consultation and support companies navigating the most substantial period of change the R&D tax relief landscape has seen in more than a decade.

For businesses preparing claims, early planning has never been more important. Whether you are an SME, an R&D intensive innovator or a large company working at scale, understanding how these reforms affect your claim is essential.

If you would like support interpreting the latest changes or preparing a robust R&D claim, our specialist advisers are here to help.