New combined R&D Expenditure Credit rules: why should the US get the credit?

Firstly, some background: the new combined R&D Expenditure Credit rules in FA 2024 appear to have all the right intentions. One unified regime for companies of all sizes? Inherently more sensible than a special SME regime. Clarity on which party in the R&D supply chain should get the credit? That too is hard not to welcome, unless you are the loser under an existing contract.

So it must be a cause of some frustration to HMRC and the government that these laudable intentions have caused so much of a stir. Small companies and their advisers have the most adapting to do because the new regime is largely similar to the existing large company regime. A resulting chorus demands more time to adapt. Further, the potential for start-ups who are almost solely R&D focused to lose out, and the potential downside of this in terms of that research being re-located outside the UK, has led to the to the emergence of a cumbersome ‘R&D intensity’ condition (see CTA 2009 s 1045ZA) to allow for increased relief. The unfortunate consequence is an undermining of the stated point of the revisions: one regime and not two.

Framing definite rules to set out who gets the relief has also proven troublesome in practice. We and others have pointed out how the rules contain ambiguities in practice; uncertainty does not help commercial negotiations between different and vital parties in R&D ecosystems.

It is therefore understandable that little bandwidth is left to resolve the unintended consequence that for UK subsidiaries of US multinationals, the relief now mainly effectively goes to the US government.

How so?

In early 2023, the US changed their foreign tax credit rules to exclude amounts of ‘tax’ that do not actually have to be paid because a credit (such as the RDEC) is applied to discharge the liability. Typically, the US regime allows for 80% of non-US tax suffered by non-US subsidiaries to be set against their GILTI charge. (For the uninitiated, GILTI is the tax levied by the US on the subsidiaries of US multi-nationals and is computed by reference to income less certain allowances for income attributable to tangible assets and employees.)

If £100 of taxable RDEC is claimed, the £75 net amount (after corporation tax at 25%) is first set against other corporation tax under CTA 2009 s 1042I. That reduces tax creditable in the US by £60 and, for a company that can use all its credits, that results in £60 more being paid to the US.

This means that, for every net £1 of RDEC, the UK tax liability goes down by £1 (in line with the purpose of the incentive) but US GILTI goes up by £0.80 because there is £1 less foreign tax and therefore £0.80 less to be credited against GILTI at the 80% credit rate. 80% of the incentive is therefore effectively wasted, a needless outflow that does not incentivise R&D as intended.

International tax is complex and one might be forgiven for thinking that this problem has not been addressed because it would be difficult to do that without impacting other taxpayers. Sadly, this is not the case; we made HMRC and HMT aware of the issue last May and proposed changes to the drafting of the legislation which we believe would solve this problem without undermining the efficacy of the regime for others or protections for the Exchequer.

Furthermore, we are aware of a number of MPs who have also alerted the government to this issue having received letters from organisations in their constituency who are impacted. Our understanding is that inaction is being explained by the government’s lack of data to assess the scale of the issue. Given HMRC has access to data on every RDEC claim made, this seems scarcely credible. Even if information on ultimate ownership were less well organised, examining the ownership of the highest claimants RDEC would already give a fair indication.

We understand from sources that HMRC’s reluctance may also be connected to a sense that taxpayers are already struggling with the changes already proposed and do not have bandwidth to consider anything further even though we believe the necessary changes can be made in a way which simplifies the regime.

We have real sympathy for the difficulties policymakers face when trying to design rules that meet all needs efficiently. Ridding any regime of all unintended consequences must be easier said than done.

But that said, can it really be right for government to ignore such a gaping deficiency in the regime which impacts some of the largest claimants? With a workable solution proposed, we suspect the government would have a hard time explaining why it failed to act.