Proposed changes to the UK’s R&D Tax Relief will impact Scotland’s engineering and manufacturing sectors

In the Autumn Statement on 3rd December 2014 the Chancellor announced that the Government intended to tighten the UK’s R&D Tax Relief (and R&D Tax Credit) provisions to restrict the benefit of R&D claims in circumstances where the “product” of the R&D project was an item which was then sold to a customer.

The draft legislation, which will be included within Finance Bill 2015, was published in December and confirms that HMRC are seeking to intend to exclude from R&D claims any costs which relate to materials, or items which are consumed, which are included within an item which is then sold to a customer.

The background notes to the draft legislation confirm that HMRC regard these changes as restricting the reliefs to being “targeted on innovative research and development activities, rather than activities related to production”.    The changes are intended to apply to both the SME and Large company R&D tax relief regimes and will apply from 1 April 2015 if the legislation is enacted as drafted.

So who will this affect?

For an SME involved in engineering or manufacturing large, high value, engineered items the financial risks attaching to development of innovative and complex “first in class” items can be substantial.  The path to successful development and commissioning of such high value items is not typically straightforward.   Even when the product is developed, there are typically long periods of testing, “debugging” and potentially financial performance bonds may be required by the customer.

Practical example

The SME R&D scheme provides a financial support mechanism of approximately 33% of the cost of R&D, and currently can include some of the material costs of a first in class item.   This enables many engineering businesses to embark on such high value projects with greater financial security in the event that the investment in R&D required is greater than originally anticipated.

As an example, a company claim in relation to the development of a “first in class” item where the cost of the R&D aspect of development of the item was approximately £1m and the materials content within the R&D was approximately £400,000.

Under the new provisions, the value of the financial support the R&D claim provides in the example above would drop from around £140,000 to approximately £80,000.

What happens next?

The draft legislation was subject to consultation until 4th February 2015 and before the consultation closed it was argued that, rather than excluding the material and consumables costs altogether, companies within the SME R&D scheme should be able to treat the costs as “subsidised” expenditure which could be claimed under the Large R&D scheme which would enable Above-the-Line claims to be made in relation to the materials and consumables costs.

If SMEs were able to claim on the basis that the material costs were “subsidised” rather than excluded, this would restrict the financial benefit for SMEs to 8% (8.8% from April 2015), but would at least continue to provide a measure of financial support to SMEs in relation to the “materials” cost of development of first in class items.

Don’t delay …….

In the meantime we recommend that companies in the engineering sectors ensure that they consider fully the opportunity to make any claims for materials and consumed items included within projects and which are incurred up to 31st March 2015.

If you would like to discuss how these changes could affect your R&D claims, please contact us.