First published in our Biotech Review of the Year publication (Issue 10).
For life sciences companies, the alterations to the UK’s R&D tax regime will be of particular interest. Rishi Sunak had already announced significant changes to the regime in the 2021 Autumn Statement so it came as a surprise to tax advisors and tax payers alike when further substantial modifications were announced in November 2022. We hope this summary helps you prepare for the changes ahead.
Progress on the changes announced in the Autumn Statement 2021
The following changes will be included in the Finance Bill 2023, expected to become law in Spring 2023:
- Territoriality restriction
A territoriality restriction for sub-contracted R&D claims will come into force for accounting periods beginning on or after 1 April 2023. The aim of this measure is to ‘refocus’ the UK’s R&D tax reliefs towards activity that actually takes place in the UK. Understandably, many concerns were voiced following this announcement. In particular, those in the life sciences sector were concerned about the effect this would have on clinical trials taking place outside the UK. Under the existing rules, supporting this overseas activity with the UK tax relief had enabled UK-based life sciences companies to develop life changing medicines and therapies, whilst also attracting investment on an international level.
After successful lobbying, an exemption to the territoriality restriction has been introduced based on a “wholly unreasonable” test. This means that the restriction will not apply in situations where it is wholly unreasonable to expect the activity to be carried out in the UK. Helpfully for life sciences companies, HMRC’s new guidance published on 20 December 2022 specifically notes that the following are both factors that should be taken into account when determining whether the exemption is available:
- medical factors, such as incidence of a disease or availability of volunteers to trial a new medicine or treatment; and
- the requirements and decisions of regulatory bodies (e.g. if testing of a medicine must be done according to a method agreed by a regulatory body and that body decides that activity must take place in a particular country, or imposes requirements that make that necessary).
This means that sub-contracted R&D activity taking place outside the UK as a consequence of either of the above can still qualify for UK R&D relief.
It should be noted that the cost and availability of workers are specifically excluded as relevant factors, so claiming R&D relief will not be possible where a trial is carried out abroad simply in order to keep costs down or use a particular workforce.
Evidence of scenarios that meet the ‘wholly unreasonable’ test will need to be provided by claimants, but HMRC have suggested that it will be sufficient for tax payers to self-assess, rather than obtaining third party reports.
As at the time of writing, there is no clear guidance on whether HMRC consider it ‘wholly unreasonable’ to break a pre-existing legal commitment to complete R&D activity overseas such that any existing arrangements that continue past 1 April 2023 can continue to qualify for relief.
- Cloud computing and data
Another change announced in 2021 was an attempt to ensure that R&D relief reflects the way in which businesses conduct research in the modern world. This involved the expansion of the definition of qualifying expenditure to include the costs of data licences, cloud computing services, and pure mathematics. This was a welcome announcement, as many businesses and industries lobbied hard for this expansion, including the growing number of organisations harnessing the power of healthcare AI.
- Combatting abuse
Further changes were announced to combat abuse of the R&D tax system, including a requirement for all claims to be made digitally and to include a breakdown of costs across the qualifying categories. Claims will also need to be endorsed by a named senior officer of the company and will need to include details of any agents advising on the claim. In addition to these new requirements, an advance notice will need to be made to HMRC before making a claim, although there will be an exemption from this for companies who have made recent claims within the previous three accounting periods.
Practical tips for CRO Agreements
- CRO Agreements should be clear where R&D activity will take place (and ideally why it will take place there).
- Where costs will be incurred partly in relation to UK based activity and partly on overseas activity, the agreement should clearly split out those costs.
- Evidence of specialist resources, expertise, patient populations or facilities and any bespoke regulatory environment requiring research or trial activity to take place in a specific jurisdiction should be collected and kept on file.
Changes announced in the Autumn Statement 2022
These changes were focused on the rates of the reliefs available under both the small or medium sized companies (SMEs) regime and the Research and Development Expenditure Credit (RDEC) scheme (the latter being primarily aimed at larger companies, although it can be useful to SMEs in certain scenarios).
Under the existing SME regime, where the necessary conditions are met, R&D relief is available to SMEs in the form of an effective 230% deduction on qualifying expenditure. It is then up to the SME to choose whether to utilise those losses or surrender the losses in return for a cash repayment (currently capped at 14.5% of the losses that would otherwise be available). There is also a cap by reference to the company’s PAYE and NICs liabilities, which was introduced in 2021. In the Autumn Statement 2022, the Government announced plans to reduce the SME tax credit additional tax deductions rate from 130% to 86% (reducing the effective deduction to 186%) as well as plans to reduce the rate for SME R&D cash claims from 14.5% to 10%. This latter reduction is a particularly key change for many loss making companies who rely heavily on the repayable credit to support their cash flow needs.
The changes to the SME system are clearly very disappointing. Many have expressed concerns as to the effect the reductions will have on the attractiveness of the UK to start and grow a life sciences business, and the potential movement of jobs to the US and the rest of Europe as a result. The purpose of these rate changes remains unclear. Jeremy Hunt stated in his speech that the changes were aimed at combatting reports of abuse and fraud; however, it is difficult to identify a clear ‘avoidance’ rationale for the changes, particularly as the effectiveness of the anti-abuse measures announced in 2021 (which will come into force in April 2023) has not yet been tested.
By contrast, there was better news on the RDEC scheme which should please large pharmaceutical and life sciences companies in the UK undertaking (or planning to undertake) significant R&D activity. The headline rate of the credit will increase from 13% to 20% for qualifying R&D expenditure incurred on or after 1 April 2023. This taxable credit may be used to offset liability to UK corporation tax or claimed as a cash payment. This change was made with a view to “rebalancing the reliefs” as between large companies and SMEs.
These measures have been included in the Autumn Finance Bill 2022.
Potential reform in 2023
And if the 2021 and 2022 announcements weren’t enough, the Government has also announced that it will consult on the potential implementation of a new R&D system. The idea is that this would be a single system rather than two separate systems for SMEs and RDEC – a concept which was considered in the Government’s 2021 consultation but not taken any further (until now). It remains to be seen how a single scheme would work, and the impact that it would have on the life sciences sector, but we are expecting further details to be published in Spring 2023.