Maximise your R&D relief claim by changing the year end

R&D tax relief rules have seen numerous alterations and changes in recent years.

The issue

Examples of some of the recent changes to the rules are:

1) For accounting periods beginning on or after 1 April 2024 the SME and RDEC (large company) R&D tax relief schemes will be replaced by a single ‘merged scheme’ that provides an above the line tax credit of 20% of qualifying expenditure.

For profitable companies paying the main rate of corporation tax (25%), the existing SME scheme provides a net benefit of 21.5p for every £1 of qualifying expenditure. The new merged scheme provides a 20% tax credit for qualifying expenditure. However, the tax credit is itself subject to corporation tax.

This means that, with a 25% tax rate, the net benefit is 15p for every £1 of qualifying expenditure (75% of 20%). The new scheme is therefore much less generous (6.5p for every £1 of expenditure).

2) For accounting periods beginning on or after 1 April 2024 expenditure on overseas third-party costs will no longer be eligible for R&D tax relief.

The above changes to the legislation apply to accounting periods starting on or after 1 April 2024. Helpfully, where companies have an accounting period which straddles this date, HMRC have not sought to apply the changes mid-way through the period. This makes it simpler for tax advisors preparing R&D claims. However, it means that a company’s choice of accounting period can now significantly impact the value of an R&D claim.

Example

To illustrate this issue, let’s look at A Ltd, which is a profitable company with a 31 March year end, currently filing R&D claims under the SME scheme.

A Ltd incurs £600,000 of qualifying UK R&D expenditure in the year to 31 March 2025. It also incurs expenditure on overseas subcontractors of £120,000. As the accounting period started on 1 April 2024 the overseas subcontractor costs - of which 65% currently qualify for relief - no longer qualify under the new R&D rules.

The claim also falls under the new merged R&D scheme rules which provides a reduced net benefit of 15% for profitable companies.

A Ltd’s net benefit from the claim, if it keeps a March year end, is therefore £90,000 (£600,000 x 20% tax credit less 25% CT arising on the tax credit).

However, if A Ltd were to shorten its previous year end to 29 February 2024 (say), its next accounting period would be from 1 March 2024 to 28 February 2025. Assuming that costs are incurred proportionately over time, a large amount of the overseas subcontractor expenditure that is incurred after 1 April 2024 will still be qualifying expenditure for R&D purposes.

In this case, £71,500 (i.e. 65% of the £110,000 of costs incurred between 1 April 2024 and 28 February 2025) of overseas subcontractor costs and £550,000 of UK qualifying expenditure (£600,000 x 11/12) can be included within the current claim. This increases the total qualifying R&D expenditure to £621,500 with the additional £50,000 of UK R&D expenditure falling into the next financial year’s claim (YE 28 February 2026).

The current claim also falls under the existing SME R&D scheme, as the accounting period started before 1 April 2024. A Ltd’s net benefit under these rules is 21.5p for every £1 of expenditure, rather than 15p. Therefore, the claim results in additional tax relief at 6.5% for the £550,000 of UK R&D expenditure and 21.5% for the £71,500 of overseas costs which now qualify for relief by shortening the year end.

The effect of changing the year end is therefore an additional R&D benefit of £51,123.

Hamilton Rose's view

With R&D tax relief for SME claims set to become less generous for accounting periods starting on or after 1 April 2024, all companies which currently submit R&D claims ought to be reviewing their accounting period end dates, to ensure that they remain within the ‘old regime’ for as long as possible.

However, the answer to this issue is more complex because of other recent changes to the R&D rules. For example, for accounting periods starting on or after 1 April 2023 the scope of qualifying R&D expenditure was widened to include cloud computing, data licences and ‘pure mathematics’ which are used within an R&D project. The decision to change a year end to remain within the old SME regime for longer will potentially delay the point at which the company can begin to include these kind of costs within their claim.

The types and amount of expenditure therefore needs to be carefully considered before a conclusion on the optimal year end date can be made. As the solution will generally entail shortening or lengthening a previous year end date, it is important that this issue is considered now while there is still time. Also, this clearly all assumes that HMRC are prepared to accept that there is qualifying R&D in the first place!