Evolution of the SME/RDEC scheme

Research and Development (R&D) tax relief is a scheme that rewards companies that incur qualifying expenditure during successful or failed attempts to resolve scientific or technical difficulties. Whilst a new scheme has been introduced for financial periods beginning on or after April 1, 2024, companies that wish to claim for accounting periods occurring prior to April 1, 2024, must do so through two distinct schemes: the SME Scheme and the RDEC Scheme. It is essential that those seeking to claim R&D tax relief understand the differences between each scheme so that they can maximise the number of claimable credits. 

What you must first know 

To claim R&D tax relief for accounting periods beginning on or after April 1, 2023, any company must first submit a claim notification form. This must be done if the company is claiming R&D relief for the first time or if the last claim was made more than three years prior to the notification deadline. This form must be submitted within 6 months following the end of the financial year for which the company wishes to claim. 

SME Scheme 

To qualify for the SME scheme, a company must have fewer than 500 employees and either a turnover of less than €100 million or a balance sheet total of less than €86 million, or both. These numbers must include staff, turnover, and balance sheets, as well as those of partners and linked enterprises, to determine whether you can qualify for R&D tax relief under the scheme. 

In this scheme, R&D tax relief allows a company to deduct 86% of qualifying costs from their trading profit for tax purposes in addition to the standard 100% deduction, for a combined total of 186% deduction. In cases where a company is loss-making, a payable tax credit worth up to 10% of the surrenderable losses can be claimed for. This number rises to 14.5% if the company meets the intensity condition for expenditure. 

The intensity condition refers to a company that claims R&D for an accounting period beginning before April 1, 2024, where R&D expenditure incurred on or after April 1, 2023, constitutes at least 40% of the total expenditure for that period. Companies that meet this condition are referred to as R&D-intensive SMEs, which, if loss-making, can claim through an Enhanced R&D Intensive Support Scheme (ERIS). 

It is essential to note that claims beginning prior to April 1, 2023, were subject to a more generous calculation, specifically an additional deduction rate of 130% and a tax credit rate of 14.5%. See the table below for a comparison of the scheme: 

RDEC Scheme 

The RDEC scheme was specifically created for large companies. The scheme applies to companies that have 500 or more employees or meet both financial thresholds: an annual turnover of over €100 million and a balance sheet total of €86 million or more. This scheme differs from the SME scheme in that it rewards RDEC credit as income in a company’s profit and loss account, thereby increasing the overall profit before tax. This is referred to as “above the line” credit, which becomes taxable. Prior to April 1, 2023, the credit percentage for qualifying R&D expenditure was 13%, increasing to 20% for R&D occurring on or after that date. 

Small and medium-sized enterprises can also qualify for the RDEC scheme if the R&D claimed for was subcontracted to them, if they’ve been notified of State Aid for the project, or if the claimable costs have been subsidised, such as in the case of a grant. See the table below for an overview of the updated RDEC scheme: 

The core difference between the two schemes 

Before April 1, 2024, the SME scheme offered greater benefits compared to the RDEC scheme due to one primary difference: taxable income. As previously mentioned, the RDEC relief is included in a company’s profit and loss account. This means that to calculate the total benefit, one must subtract the amount of tax owed on the credit to arrive at the final figure. 

Meanwhile, the SME credit is delivered either as a payable tax credit or as an enhanced deduction against profits. This means that the benefit is not subject to taxation. Evidently, this constitutes an advantage for small and medium-sized enterprises, which enjoy a higher benefit rate compared to their larger company counterparts.  

See the table below for a side-by-side comparison of the two schemes’ thresholds: 

Introducing the Merged Scheme 

On November 22, 2023, HMRC announced a significant overhaul to the R&D tax relief scheme, combining RDEC and SME into what was later introduced as the Merged Scheme. The scheme has since taken effect, applying to companies claiming R&D expenses incurred on account periods beginning on or after April 1, 2024. Whereas the old scheme created a distinct line between companies that could qualify for SME or RDEC, the merged scheme is designed to resemble RDEC, allowing for SMEs to claim under a RDEC-style credit scheme without having to meet certain criteria. 

Similarly to the previous RDEC scheme, the merged scheme is attributed as a single taxable expenditure credit of 20% of qualifying R&D expenditure. This typically results in a net benefit after corporation tax of between 14.7% to 16.2% of qualifying spend. As it is recognised as trading income in the profit and loss accounts, R&D support is visible in metrics such as Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA). This provides a measurable metric that justifies R&D budgets. 

Alongside the merged scheme remains the Enhanced R&D Intensive Scheme. To qualify for ERIS, a company must be a loss-making SME with a trading loss for tax purposes prior to any additional deductions. Additionally, it must meet the intensity condition, which requires that at least 30% of overall expenditure be related to R&D as opposed to 40% in the previous scheme. 

The scheme also introduces new rules for the expenditure that can be claimed for under the R&D relief. Subcontracted R&D must now be claimed by the company that makes the decision to undertake or initiate R&D. Overseas R&D expenditure can only be claimed under specific exceptions (see CIRD150000 for an overview of conditions and exclusions), subject to restrictions on overseas R&D expenditure. This includes externally provided workers (EPWs), who must now be paid through a UK PAYE/NIC scheme to qualify for R&D tax relief, or their work must have been physically conducted in the UK. 

Implications of the new scheme on eligible companies 

Although the new rules under the Merged Scheme apply to all companies seeking to claim R&D tax credits, their impact varies depending on which companies were eligible for which scheme prior to April 1, 2024. 

Companies that could previously claim under the RDEC scheme benefit from the introduction of the new scheme. Not only do they continue to receive a taxable above-the-line credit at a rate of 20%, but they are now able to declare subcontractor costs as opposed to the old RDEC rules, resulting in benefit figures that resemble or exceed those previously observed. 

Meanwhile, for small and medium enterprises, the benefit rate on the Merged Scheme is lower compared to the SME scheme for profit-making companies. In adopting a RDEC-inspired approach, these companies must now claim a lower net benefit for claims starting on or after April 1, 2024, as the benefit becomes taxable as opposed to the SME scheme.  

This adjustment is likely influenced by recent findings from HMRC, which indicated significant levels of error and fraud within the SME scheme at an estimated total of 24.4% for the years 2020-2021. The rate of non-compliance was significantly higher in the SME scheme compared to the RDEC scheme, which had a non-compliance rate of approximately 3.6% for the same period. As such, the Merged Scheme appears to incentivise larger companies to apply as opposed to smaller enterprises, who now benefit from a lower effective relief rate. 

Different yet similar 

Regardless of the most recent changes to the scheme, companies should not be deterred from continuing to apply for the R&D tax relief. There continue to be tangible benefits for all businesses that undertake R&D activities, most notably improved cash flow. Instead, companies that are unsure whether to apply for the R&D scheme will benefit from consulting an industry specialist, who will be better equipped to address their concerns and advise on whether to submit a claim.