Overseas R&D on crucial UK life sciences innovation safeguarded from tax reforms

Penny Simmons, a tax expert at Pinsent Masons was commenting after the UK Treasury published draft legislation to reform the R&D tax relief rules (15-page / 176KB PDF).

Under the draft legislation, a territoriality restriction will be introduced to limit eligibility for R&D tax reliefs to R&D undertaken in the UK. However, there will be an exemption where it is necessary for R&D to be undertaken overseas due to geographical, environmental or social conditions not present or replicable in the UK, or where there are regulatory or other legal requirements for R&D to be undertaken outside the UK. The cost of the R&D and availability of workers to carry out the R&D are specifically excluded and will not be considered necessary for R&D to be undertaken overseas.

Simmons said: “The exemption will be vital for many R&D-intensive businesses, particularly those in the life sciences sector where undertaking R&D activities overseas may be essential to develop the UK innovation. For example, to gain licensing approvals for new drugs or vaccines, clinical trials may need to be undertaken outside the UK.”

Currently, there is no requirement that R&D activity must be undertaken in the UK for companies to be eligible for R&D tax reliefs. UK companies that incur R&D expenses overseas may still be eligible for full tax relief.

The new territoriality restriction was first announced by the chancellor in last October’s Budget, with the intention of ensuring that the tax reliefs are targeted and refocused on UK innovation. The introduction of a limited exemption for overseas R&D was later confirmed in documents published at the Spring Statement in March.

“Industry representatives have been engaging with the Treasury extensively since the restriction was first announced in last year’s Budget. It is very positive and constructive that the Treasury has listened to concerns and introduced this exemption. R&D tax reliefs often provide an important source of funding to R&D intensive start-ups. Without access to tax relief, R&D costs may be prohibitive, preventing the development and progression of UK-based innovation,” said Simmons

The new rules will be introduced from April 2023. The draft legislation will be included in next year’s Finance Bill and a technical consultation is open until 14 September.

Simmons said: “There are still areas of uncertainty regarding when the exemption will be available, for example, what will be included as ‘geographical, environmental or social conditions’. It is hoped that any uncertainty or ambiguity in the exemption can be resolved either by amending the draft legislation or through HMRC guidance and that the Treasury and HMRC will continue to engage constructively on this.”

The draft legislation also includes provisions to expand the categories of R&D expenditure that will qualify for tax relief, to include data licences and cloud computing to “better reflect developments in technology and the different ways that cutting edge R&D is now undertaken”. New measures to combat abuse of R&D tax reliefs are also included. These involve a requirement for all claims to be made digitally with endorsement by a named senior officer of the company; and requiring advance notice to HMRC before making a claim – unless the company has made a claim in one of the previous three accounting periods – with details of any agent who advised the company making the claim.

The definition of R&D is also being amended to cover pure mathematics. This change will be introduced in secondary legislation and will also take effect from April 2023.

“The expansion of activities qualifying for relief to reflect modern research practices and the inclusion of pure mathematics in the definition of R&D is hugely welcome,” said Simmons.

“Safeguarding the R&D tax reliefs system against abuse and fraud is vital. However, the changes are complex and increase the admin involved when making claims - something that HMRC acknowledges in its policy paper on the latest reforms. It is important to ensure that the reliefs remain accessible to small businesses and start-ups that are driving forward UK innovation and who may be reliant on tax reliefs as a source of financing,” she said.