REV BN 6: Improvements To Research And Development Tax Credits

Who is likely to be affected?

1. Companies, especially small and medium-sized companies, carrying on research and development (R&D).

General description of the measure

2. R&D tax credits for companies that are small or medium-sized enterprises (SMEs) were introduced in Finance Act 2000. Similar credits for large companies, and a targeted relief aimed at R&D into vaccines and medicines for the killer diseases of the developing world, were introduced in Finance Act 2002.

3. Following a consultation in 2003, proposals to simplify the definition of R&D and to widen the range of qualifying costs were announced at the Pre-Budget Report. These changes are now being brought into effect, representing a further Government investment in R&D of £35 million per year.

Operative date

4. For large companies changes will take effect from 1 April 2004.

5. For SMEs and for vaccines research relief, changes will take effect as soon as State aids approval has been received. They will therefore commence from a date yet to be announced.

Current law and proposed revisions

Definition of R&D

6. R&D is currently defined by legislation which applies the DTI’s guidelines of 28 July 2000. On 5 March 2004 the DTI published new guidelines (available at www.dti.gov.uk/support/rd_guidelines.htm) which make the R&D definition easier to understand and use. The new DTI guidelines were given effect on 11 March 2004 for company accounting periods ending on or after 1 April 2004, although companies may use the new guidelines as an aid to interpretation of the previous guidelines.

7. As well as applying for the purposes of R&D tax credits and vaccines research relief, this new definition of R&D also applies for a number of other purposes including the various investment reliefs and R&D allowances.

Range of qualifying expenditure

8. Broadly, expenditure qualifying for R&D tax credits and vaccines research relief currently includes expenditure on staff costs, consumable stores, externally provided workers and in certain cases expenditure on sub-contracted R&D.

9. As announced in the Pre-Budget Report, these categories of qualifying expenditure are being expanded to include expenditure on software, power, fuel and water. The definition of consumable stores is also being amended so that expenditure on consumable or transformable materials qualifies for relief. These extensions will widen the support given to innovative companies and reduce the real cost of R&D.

10. Comments were invited on whether the range of qualifying expenditure being introduced represents the direct costs of R&D. The general theme of representations was that all costs attributable to R&D should qualify for the tax credit. Implementation of this would entail a cost of around £230 million a year and may increase complexity, particularly for SMEs, by causing companies to undertake detailed allocations of all their overheads.

11. The Government considers that at this time the most appropriate way to support R&D is to give relief for the costs which have the greatest incentive effect on the amount of R&D done. With the extension to software, power, fuel and water the Government considers the qualifying costs now represent those costs which have the greatest incentive effect, and that to extend beyond those costs is not justified at this time.

Other changes

12. Announced separately today in Budget Note 36 are details of changes to the rules for expenditure on staffing costs. These changes correct the inadvertent inclusion of benefits in kind as a qualifying cost.

13. Also detailed separately today in Budget Note 25 are changes to the R&D schemes as a consequence of the introduction of International Accounting Standards in 2005.

14. It was announced at the Pre-Budget Report that the rules for large company sub-contracting would be amended to provide a generic definition for qualifying bodies which will aim to encompass ‘Public Sector Research Establishments’. This proposal will be implemented after the Budget.

15. To support the changes being made in the Budget and to reflect experience of claims made since introduction of the schemes Inland Revenue will produce improved guidance later in the year followed by a programme to improve delivery of the credit. Inland Revenue also plans to issue regular information on R&D tax credits in its publication of National Statistics.

Further advice

16. If you have any questions about this change, please contact your local Inland Revenue tax office.

www.inlandrevenue.gov.uk