The latest overhaul of the UK’s Research and Development (R&D) tax credit system, dubbed the “new R&D Expenditure Credit (RDEC) regime” by HM Revenue and Customs (HMRC), is now in effect, reshaping how businesses can claim relief for qualifying research and development activities.
With significant changes in eligibility, thresholds, and financial impact, the new RDEC scheme represents a seismic shift for claimants, particularly small and medium enterprises (SMEs) transitioning from the legacy SME regime. Here’s a snapshot of what you need to know.
For businesses previously reliant on the SME scheme, the changes are significant, as many will find their claims subject to reduced rates of relief under the new RDEC regime. However, the introduction of an enhanced support mechanism - targeted specifically at R&D-intensive loss-making SMEs - does offer some hope to those whose business’s do meet the required criteria.
For accounting periods beginning on or after 1 April 2024, HMRC’s new RDEC regime replaces the previous SME and RDEC schemes which have been combined into one streamlined approach. While this might sound like old news, this timeframe is crucial - it means that businesses with 12-month accounting periods will begin filing claims under this new regime for periods ending 31 March 2025 onwards. The merger goes someway in simplifying the administrative burden for businesses but does reduce the rates of benefit previously available to many SMEs, who, when also taking into account the significant increase in compliance checks now being carried out by HMRC, will be considering whether a UK R&D claim will still be worthwhile.
Under the new regime, a single RDEC credit rate of 20% applies. This credit is taxable at the main corporation tax rate of 25%, resulting in a net tax benefit of 15% for profitable companies. For loss-making businesses, a notional tax rate of 19% can be applied, increasing the net benefit to 16.2%. While these rates are less generous than the legacy SME scheme, they still provide meaningful on-the-ground relief for British businesses, particularly for companies that integrate R&D into their long-term growth strategies.
Alongside the new RDEC regime, the government has introduced the Enhanced R&D Intensive Support (ERIS) scheme. This secondary regime targets loss-making SMEs whose qualifying R&D expenditure accounts for at least 40% of their total trade and operating expenditure for expenditure incurred on or after 1 April 2023 (decreasing the intensity threshold to 30% for accounting periods beginning on or after 1 April 2024). Designed to cushion the impact of reduced rates of relief, ERIS enables these R&D-intensive businesses to deduct an additional 86% of qualifying expenditure for tax purposes and surrender relevant trade losses that are available at a rate of 14.5% for a repayable cash credit.
However, it’s important to clarify that not all loss-making SMEs will benefit under ERIS. Where companies may miss out due to unexpected fluctuations and comparatively higher total expenditure HMRC has included a “year of grace” provision to account for exceptional spending that might skew a company’s intensity ratio temporarily.
A critical point to emphasise is that the new regime imposes stricter restrictions on relief for overseas expenditure. To qualify, work conducted by externally provided workers (EPWs) or subcontractors must occur strictly within the UK’s borders. While some exemptions exist, this change will likely reduce claim sizes for companies that previously relied on overseas resource.
The rules surrounding subcontracting has been a welcome refinement. Companies subcontracting R&D projects can claim relief if it was reasonable to assume the contracted R&D activities were intended, however, the subcontractors themselves can only claim if the R&D undertaken was of their own volition. This creates a complex dynamic that businesses across all industries, including, for example, areas such as aerospace, automotive and engineering, will need to navigate carefully and take into consideration when planning their rollouts.
Under the new RDEC scheme, eligible staffing costs include for salaries, wages, bonuses, employer NICs and employer pension contributions. Additionally, the PAYE/NIC cap under the new regime uses the more generous formula taken from the legacy SME scheme, offering a cap calculated as £20,000 plus 300% of the claimant’s relevant expenditure on workers.
With employers’ National Insurance contributions (NICs) set to increase from 13.8% to 15% in April 2025, businesses investing in R&D are likely to see an increase in staffing costs identified which may ultimately aid companies who continually invest into long term R&D growth strategies in mitigating some of this increased tax burden.
Under the new RDEC regime, the extension to qualifying cost categories introduced for accounting periods beginning on or after 1 April 2023 - including cloud computing, data, and pure mathematics costs - remain eligible. These changes provide businesses with broader opportunities to align their digital transformation efforts with R&D tax relief claims.
Companies investing in the dedicated R&D space can also leverage the Research and Development Allowances (RDA) to deduct the full cost of qualifying R&D-specific property, machinery, and equipment from their taxable profits, reducing financial strain and hopefully encouraging reinvestment into innovation in the UK.
The transition to the new RDEC regime brings both challenges and opportunities for UK businesses. While many SMEs will face reduced benefits compared to the legacy scheme, the enhanced ERIS program and more generous PAYE/NIC cap offer avenues for strategic cost management. By understanding the nuances of the new regime and aligning R&D investments with the updated criteria, businesses may find opportunity in offsetting rising employment costs and drive innovation in a rapidly evolving economic landscape.
If you’d like to explore how the new RDEC regime could impact your business, reach out to our R&D tax experts today.
