Panel

• Lindsey Wicks, Senior Technical Manager, Tax Policy, ICAEW
• Stephen Relf, Technical Manager, Tax, ICAEW
• Richard Jones, Senior Technical Manager, Tax Policy, ICAEW

Producer

Ed Adams

Transcript

Lindsey Wicks: Hello, and welcome to The Tax Track, the podcast series from ICAEW, where we explore the latest developments in the world of tax, and what they mean for our members and tax professionals alike. In this episode, we’ll be looking at the implications behind the new measures introduced in the recent Budget.

Stephen Relf: We all know that HMRC are struggling at the moment with service standards, but there’s an awful lot in the Budget that actually puts a bigger burden on them.

LW: And we’ll be delving into the new research and development tax reliefs that are coming into effect this month.

Richard Jones: Knowing which characteristics are from which regime is what’s going to make it tricky for companies and agents to get to grips with it.

LW: I’m Lindsey Wicks, Senior Technical Manager for Tax Policy at ICAEW. I’m joined this month by two colleagues with an encyclopedic knowledge of tax: Stephen Relf, Technical Manager, Tax, and Richard Jones, Senior Technical Manager, Tax Policy. Welcome to you both.

The dust has now settled on the Budget announcements from March. If you want a recap of the main measures introduced you can listen back to our recent Insights In Focus episode, which offers some initial feedback. Today we’re looking at why some of the new tax measures have caught the public eye more than others and considering the practicalities behind some of them. Stephen, remind us about the headlines from the Budget.

SR: On Budget day, and in the following days, we published roughly 10 articles on Budget measures. And on the Friday of that week, we also ran a webinar. So, based on the number of views of those articles, and the feedback we got from the webinar, which is the questions and other engagement, three of the measures really stood out in terms of most popular interest. This is no order of priority, but the first one I’m going to cover is the national insurance cuts. Now this is obviously the headline change that came out with the Budget, the class one NICs paid by employees is being cut from 10% to 8% from April this year. And there’s also a further cut in the rate of class 4 NIC, which is paid by self-employed people. That’s currently 9%, but for the next tax year, 24/25, it will go down to 6%.

Again, no surprises in the next most popular measure, which is the high income child benefit charge, or HICBIC. This is the income tax charge that claws back child benefit received by high earners. The lower limit has increased from £50,000 to £60,000, and the upper limit from £60,000 to £80,000. Now, this will benefit a significant number of people, some 485,000 families will be better off as a result of this, according to government estimates. But one important point to note is that of that figure, roughly 180,000 families do actually need to take some action in order to benefit. And they’re the families who have not claimed child benefit, possibly in order to avoid the high income child benefit charge. If they do want to benefit from this, then they will need to look again at claiming child benefit, and there is an article on our website which helps with that.

LW: Yeah, and they might have even claimed but then stopped their payments and they should look at restarting their payments again.

SR: Yeah, you wouldn’t necessarily think it, but you can actually claim it and just reduce the payment to nil. So again, you may need to revisit that. So that’s the first two measures. Now, they are both tax cuts, and both quite expensive for the government. So, to balance the books, the government did also announce a series of tax rises, and one of those was the abolition of furnished holiday let status, FHL status. This brings with it a range of tax advantages, and they will be lost from April 2025. That includes being able to deduct the full amount of interest paid, rather than have a credit capped at the basic rate of income tax. It’ll also lose access to that 10% CGT rate, which applied because of business asset disposal relief.

Now, of the three, I would have thought that the NICs article would have been the most viewed given that was the real headline coming out the Budget, and that’s where the mainstream press coverage was. If not that, then I probably would have thought the high income child benefit charge because it’s a very well-known tax, probably not for good reasons, but certainly well known. But actually, of the three, the one that got the most views – and significantly more than everything else – was that furnished holiday let abolition, which came as quite a surprise. But I suppose with hindsight, there are a lot of holiday lets in the UK now. In 19/20, there were around 130,000, and that’ll have only increased post-COVID. And also I think there are a lot of unanswered questions around this one. So, I can imagine people were quite keen to find out as much as they possibly could at that point.

LW: Yeah, we haven’t had a policy paper on it, for example, so there’s all kinds of unanswered questions such as what might happen to carried forward losses and what happens to capital allowances you claimed and things like that.

RJ: That’s right, it’s a very big measure and we have very little information at the moment. And one of the problems with getting rid of this is the fact that the regime is very prescriptive. So, it details how many days per year a property has been let, and how many days it’s been available, etc. If you do away with that, and you’ve got trade versus property business, you’re then relying back on case law, which can be harder to apply. So maybe that’s what our members are trying to seek a bit of certainty on.

SR: I certainly think so, yeah. That’s a very good point about that division between trade and property letting. That’s probably the main reason why FHL status was introduced in the first place, to try and reduce those disputes. And you do wonder that in the absence of anything, whether we just go back to that kind of landscape.

LW: And the Office of Tax Simplification, in its report in November 2022, did say that if the furnished holiday letting rules were abolished, then a bright-line test might remove some of that uncertainty between trading and property business. And it did make some recommendations about what that might look like, so when somebody might be holding something more for capital appreciation, or where somebody is carrying on a business where they’re looking to generate income from it.

SR: Yeah, I think what we can definitely take away from that is there’s an awful lot of work for HMRC and government here in terms of how you cater for the aftermath, a world without furnished holiday status. And I think that’s actually a wider issue that comes out of the Budget, because we all know that HMRC are struggling at the moment with service standards. But there’s an awful lot in the Budget that actually puts a bigger burden on them, just for example, those three issues we’ve talked about. So, we’ve mentioned furnished holiday letting status, and the fact that HMRC are going to have to tackle this property letting trading distinction, but even the national insurance contributions cuts, they apply from April this year. Now, that’s a really short timescale for HMRC to turn that around, that’s a big ask. And the high income child benefit charge as well, we’ve mentioned the increase in the limits, but it was also announced that they’re going to move from individual income to household income. And that’s by April 2026. But again, the huge challenge for HMRC is they have to make some significant changes to their systems to collect more information and different information.

RJ: Or they can marry up, so to speak, you know that the income between different people in a household, that could be difficult to prove for them.

LW: And they had also talked about trying to simplify HICBIC as well, and do it outside of the self-assessment regime. And the question really is, is that now achievable on a household income basis?

RJ: That’s right. I guess one of the things that HMRC has been looking to do is increase its digital capacity, and so this possibly might be a measure that gets thrown into that. And obviously, those things take time to implement, as we’ve seen with making tax digital.

LW: April 2026 is quite ambitious.

SR: Yeah, I think as well, in the run up to the Budget, the week or two before we’d had that report from the Public Accounts Committee, which had looked at HMRC’s level of services, and said that they were at an all-time low. So, I think if we start from that very low point, and when we throw it all this additional work at it, then it’s going to be interesting to see how this all pans out in the next few years.

LW: But child benefit is one that is already quite digital. It was actually quite an easy one to add in to the HMRC app. So, you can claim your child benefit in the app, you can manage your payments, you can view your payments that you’ve received in the app, you can change your details, change your bank details, so there’s loads of stuff that you can actually do digitally with child benefit.

SR: Yeah, I’m a big fan of the app, but I have to say that’s quite recent because I only started using it on Friday. I was prompted to do that, by obviously the move to digital. But I have to say I was extremely impressed by what you can do in the app, and how quick and easy is to actually do it. So, I would definitely encourage everyone to engage with the app, download it and try it.

LW: A couple of items were buried in the announcements but will be significant. One is raising standards in the tax advice market, which was slightly unexpected. We had thought that we were going to get an announcement on this on tax administration and maintenance day on 18 April. And we spoke about some of the issues back in episode one of this podcast around the fact that the tax advice market is currently unregulated. Now we have three broad options for strengthening the regulatory framework. The first is mandatory professional body membership. The second is a hybrid regulatory model between the professional bodies and HMRC, where HMRC would take a greater role in supervising the unaffiliated tax market. And then the third is having an independent government regulator across the whole market. So, Richard, tell us what else was hidden in the red book?

RJ: Well, one thing we did spot, and it was just a short paragraph, but it could be quite significant was the introduction of a new R&D expert advisory panel. Now, we have to kind of read between the lines here due to the lack of detail so far. But it sounds like this is going to be an independent panel that will advise HMRC about what forms of expenditure and types of projects could qualify for the relief based around certain sectors. And technology and life sciences were mentioned in that paragraph. Hopefully, there will be a number of others. And so hopefully, that will give a little bit more certainty both to HMRC in terms of how it approaches reviewing claims, but also give a little bit more assurance to agents and companies that when they submit claims in those particular sectors, that they’re going to be reviewed and assisted in that by experts, as opposed to perhaps a more general and broad way that HMRC has currently been reviewing claims submitted to them. We have certainly seen over the past year or two that HMRC has been struggling in terms of its own expertise in understanding what is R&D in a particular sector. So hopefully, this will help them to move away from the kind of blanket type of inquiries that they’ve been issuing, and perhaps focus more into specific questions that are more relevant to the particular claim.

LW: And just before the Budget, we also got confirmation that the new rules for R&D will start from 1 April 2024.

RJ: That’s right, it’s actually going to be applying for accounting periods commencing on or after 1 April of this year, that is slightly different from the original proposal. It’s slightly later. In our and other rep bodies’ submissions, we were calling for a longer period of transition, but we are where we are. So, we have to support our members in helping them to transition to that commencement date.

LW: And we’ve got an article covering the detail of those changes, and lots of other changes over the past couple of years, in the TAXline hub. There’ll be a link to that article in the show notes. And with that in mind, we thought we’d look at R&D tax reliefs more broadly – why they were introduced and why they’re changing now. Richard, what is the point of R&D tax relief?

RJ: R&D tax relief came in in the year 2000. It was there initially only to small and medium-sized companies. The idea was that by incentivizing companies to invest more in their R&D functions, that means that they potentially create more wealth, more productivity, so it sounded like quite a sensible policy to bring in. It then got extended to larger companies in 2002. And what we’ve seen since then is that the larger companies have tended to provide more value for money, if you’d like, to the exchequer. They’re the ones that seem to have been driving more of the actual productivity investment arising from the R&D, whereas the small company regime, it’s become more and more generous over the years, but it’s actually started to yield less and less in terms of percentage of return compared to the tax relief given. So, this is why perhaps HMRC have been looking to change the rules to make it more cost effective.

LW: At the end of the day, what they want is additional spend, they don’t want to be incentivizing R&D that would have happened anyway. So, what they’re looking for is additionality. And I think the SME scheme was generating additional R&D expenditure of between 60p and £1.28 for every £1 of tax relief. But that compares to between £2.40 to £2.70 of additional R&D expenditure for every £1 of R&D expenditure credit that the large companies were getting.

RJ: We’ve seen a number of changes both legislative in the past couple of years, and also in the way that HMRC handles inquiries in order to try to get more value for money out of the system. And then of course, the most recent thing that will be coming in, as we said from this year, is a merged scheme. So, in other words, there won’t be a separate scheme for SMEs and for large companies, which currently claim under the RDEC, the R&D expenditure credit. They will essentially have one scheme between them. And then there will be a separate scheme for what are called R&D intensive companies.

SR: It’s interesting that we have been on quite a journey with R&D tax relief. At the moment, in the last few years, it’s pretty much been bad news. We’ve had a lot of talk of fraud, error and abuse, and quite a lot of it linked to the SME side of the fence. But as you say, R&D tax relief did actually kick off just for SMEs only, and then for a long period as well, we had successive measures, new measures, trying to make it easier for SMEs to claim. And I think that peaked probably around 2015, when we had the consultation on making claims for R&D tax relief easier. It’s fascinating to look back at that document and look at the language that was used, the sentiments that were expressed, because they are so different from where we are now. I’m kind of reminded of our manifesto work, and the message we get from businesses is that from the tax system, they really want stability, that would give them the confidence to invest. But stability is probably the one thing we’re really missing from R&D over the last few years. I do wonder whether this journey we’ve been on has possibly eroded trust a little bit, and whether that might have an impact going forward on business investment.

RJ: It’s a possibility. We’ve been hearing anecdotally that companies have just been not bothering to claim any more, because they’re thinking that they’re just not going to get the relief agreed.

LW: There’s definitely a cost/benefit that will be going through their mind in terms of how much is it actually going to cost me in terms of professional fees, time spent in making my claim, compared to the additional tax relief I might get? We had quite a few changes in R&D tax relief in 2023 that will just be starting to be reflected in claims being made now. And the next change is the merged scheme. Can you talk me through the basics, Richard?

RJ: First of all, the basic principle is that we’re going to be having one scheme for both SMEs and larger companies. The commencement date is for accounting periods commencing on or after 1 April 2024. So that means that companies, depending on the year end, are going to be staggering into the new regime. Essentially, it’s a little bit like a hybrid of the two existing schemes. Some of the characteristics have been taken from the SME regime, such as who gets to claim in what we call contractor-type arrangements. And then some characteristics are more common to the RDEC regime, such as the fact that it’s going to be a taxable credit regime rather than an enhanced relief regime.

The legislation for it is pretty lengthy, and it is largely based on those two existing bits of legislation mushed together, but obviously, knowing which characteristics are from which regime is what’s going to make it tricky for companies and agents to get to grips with it, because whatever regime they’re currently using, there’s going to be some form of change for them to deal with.

LW: And are people ready for these changes?

RJ: I think there are two main areas where there’s going to be the biggest hurdle to get over in terms of understanding it and potentially having a change in approach. The first one relates to what I called contracted expenditure, and this is when one party – let’s call them the customer – contracts for another party to carry out the R&D. Now, in this situation, it’s the customer that can claim the R&D rather than the contractor. But there are three tests that have to be met in order for that to be the case. The first one is that there needs to be a contract between the two parties. The second one is that R&D needs to have been carried out by the contractor. And then the third one – and this is going to be the one that people will struggle to get to grips with – is that it’s reasonable to assume that the customer intended or contemplated that the R&D would be undertaken in order to meet the needs of the contract.

We’ve got some draft guidance from HMRC on this area, which we’ve inputted into and I assume will be going live fairly soon, and that actually is pretty useful. It does dig into what do we mean by contemplated? And broadly speaking, that suggests quite a high level of understanding, so not just a minor or fleeting consideration. But there are some situations, which we’ve pointed out, where there could be still a little bit of uncertainty. For example, what if you had multiple contracts? Which contract do you look at to decide which the R&D is carried out under? And then what happens if there’s a change in arrangement? There’s an example in the guidance where it says that if the contractor suddenly points out that they’re actually going to be carrying out R&D, they could change the contract. Then HMRC’s view is that then the customer would be entitled to the relief. I can see why they’re saying that, but that in a way sounds like you could just arrange things so that whichever party you wanted to would get the relief, and then maybe you could come to some kind of financial arrangement between the two parties. So that was quite a surprising one.

LW: It sounds quite challenging to get to grips with. But also, presumably, it could happen with contracts that are already in place and work that’s already ongoing.

RJ: Yes, and that’s a problem, because at the moment, the two parties will have an expectation as to who’s going to claim the R&D. Going forward that could change. There isn’t any kind of provision in there to allow for existing contracts, so anyone in that kind of situation is going to need to look at their existing arrangements very carefully.

LW: And what’s the other big change?

RJ: The other area that was going to be coming into play from last year, but actually was deferred for a year, is this idea that there’s going to be restriction on expenditure related to work carried out abroad. Now, that’s only applying in two particular situations. One of them is under contractor arrangements, and the other one is where there’s externally provided workers, provided to the company making the claim. This could be difficult to apply because of the tests that need to be applied in determining what is actually eligible if it is carried out overseas. So, it is available if the conditions that are necessary for the R&D aren’t present in the UK, the conditions are present in the location where the R&D is undertaken, and it would be wholly unreasonable to replicate those conditions in the UK.

There are lots of examples in the guidance. One of them – which I think is quite sensible, I think anyone would probably agree with this decision – would be let’s say you’ve got some tropical plants that grow in a particular overseas territory, and there’s some testing to be done to determine whether they could form the basis of medicines. Obviously, those plants aren’t available in the UK, it would be wholly unreasonable for them to be grown in the UK, because there probably aren’t the conditions to do so. So that would be one example where that expenditure would be allowable.

LW: And all of this change is happening at a time when we know that more R&D claims are being scrutinized. Now, Stephen, you’ve picked up on a recent case on this, haven’t you?

SR: Yeah, there has been a recent case on R&D, and a claim that was rejected. It is in front of the First-Tier Tribunal, FTT, though I think it’s worth bearing in mind that it isn’t binding, it’s not precedent. Also, all cases are judged on the particular facts of the of the case, so you have to be careful pulling out any overarching principles. But that said, I do think this is quite an interesting case because it does give a feel for how HMRC seems to be approaching inquiries and their attitude to penalties when it comes to R&D.

This was a company carrying on a scaffolding business. They’d made a claim to R&D tax relief, and that claim was refused. HMRC also charged a penalty for careless inaccuracy on the basis that the company had failed to take reasonable care when it made the claim. The scaffolding company protested on the basis that it had used an R&D specialist to prepare the claim. Also, it had every reason to believe that specialist knew what it was doing, it had first come across it at events organized by the trade body. It had also checked with other companies who had used that specialist and had good things to say about it, and there was no indication in the work done by the specialist that there was a problem. HMRC rejected that reasoning, though, and believed that as the company didn’t qualify for R&D, therefore it had made a careless claim and the penalty was appropriate.

Now, the FTT wasted very little time in rejecting HMRC’s case, and in finding for the company. It made the point that if HMRC were correct, then every time you had an R&D error, the behavior would be careless, and therefore you would have a penalty. And clearly there has to be more to it than that. There was also some criticism of HMRC in the way it conducted the case. The FTT did say in particular that HMRC’s statement of reasons had been confused.

LW: Stephen, and what are the key takeaways from this case?

SR: First of all, I think this case kind of implies that when it comes to R&D tax relief, HMRC may be quite quick to impose a penalty. But it also shows that it may be appropriate to stand back from that and question whether or not the penalty is valid. And certainly pay attention to successful defence used by the scaffolding company here.

RJ: That’s interesting, because we’ve also seen members commenting on the fact that HMRC have tried to apply a penalty on the basis that they’ve followed the advice of an agent rather than read HMRC’s guidance, which is quite an interesting form of logic. So it’ll be interesting to see what impact that case has and whether HMRC starts to row back on those penalties.

SR: That’s right. In this case, HMRC, didn’t actually present much of a case, they seemed quite confident that they were in the right. But one thing they did say in the correspondence with the company is that the company appear to have failed to read the guidelines. And the company pointed out that what it had done was liaise with a specialist who dealt with the guidelines every day.

LW: That sort of brings us back to the expert advisory panel again, and that guidance, in the fact that actually some of the guidance is quite out of date. Some of the examples in the Department for Science, Innovation and Technology guidance go back to advances in DVD technology.

RJ: I think this is one of the problems, the fact that there is that disconnect. Which I understand because there’s a fully formed definition there already. But if we could have a separate definition in statute, in the tax law, then that might help to move things forward, because then HMRC or the government would be able to update that on a regular basis.

LW: And given that the overall aim of R&D is to boost productivity, boost innovation, it needs to be innovative guidance. So, let’s hope that the merge scheme does generate the much-needed productivity boost, and fingers crossed that we’ll move into a better climate.

That’s it for this episode. Many thanks to Stephen and Richard for your contributions. And thanks for listening. If you’ve missed anything, we’ve included some links for further reading in the show notes, and if you found it useful, then don’t forget to subscribe so you never miss an episode. You can rate and share the podcast, too. We’ll be back next month with the next Tax Track. In the meantime, why not check out the sister podcasts from ICAEW? Insights provides business, finance and accountancy analysis, while each episode of In Focus offers a deep dive into a selected topic. If you’re not already a member of ICAEW’s tax faculty, remember that ICAEW members can join the faculty for no additional cost. Faculty members receive our monthly TAXline bulletin. In addition, anyone can subscribe to receive our weekly TAXwire bulletin containing the latest tax news from ICAEW. Thanks for listening.