The 2007 budget trailed the introduction of changes to the R&D tax relief and Vaccine Research Relief (VRR) that were confirmed in the budget on 12 March and published as draft legislation in the Finance Bill published on 27 March 2008.
The 2008 Finance Bill both consolidates previously announced positions and introduces restrictions on the ability for SMEs to claim, inevitably introducing more complexity to the legislation. At the heart of most of the measures announced in the 2008 budget and the Finance Bill is the influence of the EC. The SME scheme and the VRR scheme are both classified by the European Union as State aids and consequently, any changes to them must be notified to and agreed by the European Commission (EC). At the date of publication of the Finance Bill (27 March 2008) EC approval had not been obtained and so the entry into force of the changes to the SME and VRR regimes will not be until a day appointed by Treasury Order. It is possible that the EC will require further changes to the legislation before approval is given.
The draft legislation contained in the Finance Bill in essence falls into two parts. Firstly there are the measures that have been announced in previous PBR’s and Budgets and that will be ‘switched on’ following EC approval. Secondly there are the proposed new measures which act to restrict the SME & VRR regimes in ways that are likely to be unwelcome, potentially affecting those companies most in need of the relief.
Previously announced measures
Extension of the SME definition | Changes in rates of R&D relief
Proposed new measures restricting R&D and VRR claims by SME’s
Companies in difficulty | A cap to ensure that R&D aid given per project does not exceed €7.5m | VRR declaration for large companies
Our view
Previously announced measures
Extension of the SME definition
The long awaited extension of the SME definition for R&D relief doubling the criteria for qualification as an SME to 500 employees and turnover not exceeding €100m or an annual balance sheet total not exceeding €86m is still awaiting EC approval. It is now unlikely to be effective before 1 April 2008.
The extension will be good news for those companies that did not previously fall within the definition of an SME but that will meet the new criteria, particularly if they are loss making as the large company R&D regime does not provide any cash payment option for loss makers. It is important however that companies that were previously claiming under the large company scheme take account of the numerous and fundamental differences between the SME and Large company regimes when making their claims if this change affects them.
To make a valid claim under the SME regime, companies must be able to demonstrate that any IP resulting from the R&D vests with them and they must exclude any expenditure covered by grants or subsidies. Also, claims cannot be made under the SME regime in relation to work that was contracted to them by a third party or for a project in respect of which another form of notified state aid has been received. Companies that are SMEs can however still make claims under the less generous Large company regime in respect of contracted work and expenditure covered by grants, subsidies or notified state aid so, whilst the changes should always be positive, there may well be companies for whom the apparently generous extension may not bring such large additional benefits.
On the positive side, companies can include 65% of payments made to subcontractors in an SME claim, a cost category not available to large companies.
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Changes in rates of R&D relief
The rates for the enhanced R&D deductions will increase to 130% for the large company regime and 175% for the SME regime. The increase for large companies will take effect from 1 April 2008 whilst the SME increase will be effective from a date to be appointed by Treasury Order as EC approval is still outstanding. The overall value of the payable R&D tax credit will increase slightly as a result of the proposed legislation. The value of the cash credit available to SMEs will be calculated as 14% of the surrenderable loss which, combined with the increase in rate of relief proposed, gives a slightly larger cash credit amount of up to 24.5% (subject to the PAYE/NI cap) compared to 24% currently.
For the very small number of companies currently claiming the VRR relief there will no doubt be disappointment as the relief will be reduced from an additional 50% currently to 40%; again from a date yet to be announced.
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Proposed new measures restricting R&D and VRR claims by SME’s
Companies in difficulty
Schedule 9 sets out the proposed rules which act to prevent an SME from making a claim under Schedule 20 FA 2000 (R&D) or Sch 13 FA 2002 (VRR) for enhanced deductions, the alternative treatment for pre trading expenditure and perhaps most importantly, for the R&D tax credit, if it is not a going concern.
Where a company has made a claim for a tax credit under either scheme and then ceases to be a going concern it shall be treated as if it had never made the claim. The draft legislation defines a company as being a going concern if its latest accounts are published on a going concern basis and that nothing in those accounts indicates that they were only prepared on that basis because of an expectation that the company would receive tax relief or credits under either scheme.
However the draft legislation states that if the credit has been wholly or partially paid, or the relief applied, before the company ceases to be a going concern then the claim is still treated as made to that extent and the company can keep the benefit.
There are a few practical points that need to be considered as a result of these proposed changes. There would now appear to be a real benefit for those companies that might be affected by this change to prepare and file claims as early as possible so as to trigger payment of tax credits before any subsequent accounts are published. Clearly the better these claims are prepared and the more robustly they can be presented to HMRC or defended then the more chance there is a obtaining and retaining any cash tax credit. The second point is that this restriction will undoubtedly lead to some interesting discussions with the company’s auditors if there is likely to be a going concern issue! Lastly, there are no provisions announced that would enable the company to claim under the Large company scheme instead, although this would potentially be of little value if the company was in a loss making position and unable to utilise the additional tax deductions available.
This change would have effect in relation to claims and elections made, and amounts paid or applied, on or after a day yet to be announced following EC approval of the details. HM Treasury expect the number of companies affected to be small, although with the expected extension of the definition of an SME and with the effects of any downturn in the economy to factor in, this may be an issue which exercises the minds of company directors and their auditors in future.
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A cap to ensure that R&D aid given per project does not exceed €7.5m
This will work by limiting the maximum R&D aid per project under the SME and VRR schemes to €7.5 million per project with effect from a date yet to be announced by Treasury Order. Any expenditure beyond this cap will only attract relief under the large company scheme subject to a further restriction that the expenditure is not incurred by the SME on R&D contracted out to it by large companies etc as set out in Para 10B (c) of FA2002 Schedule 12 .
The legislation ensures that the total R&D aid received is not over and above that which could have been available under the large company scheme on the project expenditure. This will add an additional layer of complexity for companies as they will need to track and calculate the benefit project by project and will have to calculate that benefit under both the SME/VRR scheme and the large company rules as well.
HM Treasury do no expect this to affect any more than 25 companies. However, with the extension of the SME regime to larger companies this is a restriction that could bite in due course and companies will need to consider and then perhaps perform the calculations irrespective of their effect if only to be able to demonstrate that they have not exceeded the threshold, and this may consequently affect more companies than estimated.
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VRR declaration for large companies
Finally, the Finance Bill introduces a condition for large companies to declare when making a VRR claim that the availability of the relief has resulted in an increase in the amount, scope or speed of the R&D undertaken, or to increase the amount of their R&D expenditure. This change was required by the EC to evidence the incentive effect of large companies receiving VRR as well as a necessary condition to ensure that the SME companies continue to meet the requirements of the EC’s State aid Framework. With perhaps only five large companies currently claiming VRR this is unlikely to be either an onerous or widespread change.
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Our view
The increase in the rates of relief and the proposed extension of the relief are welcomed. However we believe that removal of the SME relief for companies in financial difficulty strikes at the heart of the need to incentivise UK companies to perform R&D with certainty. The introduction of a cap for aid given by project will introduce additional costs of compliance into the process and further add to the complexity of the regime.
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