Merged RDEC and ERIS Rules Explained

The UK revamped its R&D tax relief system on 1 April 2024, merging the SME and RDEC schemes into two simplified options: the merged RDEC scheme and ERIS (Expenditure Relief for Intense SMEs). Here's what you need to know:

• Merged RDEC Scheme: Available to all UK trading companies, offering a 20% taxable expenditure credit on qualifying R&D costs. The net benefit depends on your Corporation Tax rate (e.g., ~15% for companies taxed at 25%).
• ERIS Scheme: Designed for loss-making SMEs spending at least 30% of their total costs on R&D. Offers a 186% deduction or a 14.5% payable credit on surrenderable losses.

Key changes:

• Grants no longer reduce relief: Companies can claim the full credit even if R&D is partly grant-funded.
• Overseas costs restricted: R&D must generally occur in the UK unless specific conditions apply.
• Subcontracting rules tightened: Relief depends on the "decision-maker" and whether the work is UK-based.

For SMEs, the choice between RDEC and ERIS depends on your profitability and R&D intensity. Loss-making SMEs meeting the 30% threshold can benefit from ERIS, while others may find the merged RDEC scheme more suitable.

Quick Tip: Ensure your claims are well-documented and compliant with HMRC’s stricter guidelines.

Who Can Claim Under the Merged RDEC and ERIS Schemes

With recent reforms in place, the criteria for the merged schemes aim to provide fair access to businesses across different sectors. The structure is straightforward: most trading companies can claim under the merged RDEC scheme, while loss-making R&D-intensive SMEs can benefit from the ERIS option. In both cases, your project must meet the statutory definition of R&D.

Merged RDEC Scheme Requirements

If you're a UK trading company engaged in qualifying R&D, you can claim a 20% expenditure credit under the merged RDEC scheme, as long as you're subject to UK Corporation Tax. This updated framework is open to businesses of all sizes, from small start-ups to global corporations. The rules on subcontracted R&D work under the merged RDEC scheme determine which of those costs you can include.

The credit is treated as taxable trading income, meaning the net benefit depends on your Corporation Tax rate. For companies paying the standard 25% rate, the effective benefit is around 15% of qualifying spend. For those taxed at 19%, it's approximately 16.2%. However, a PAYE cap applies, which is set at £20,000 plus 300% of your company’s relevant PAYE and National Insurance contributions. This cap ensures that the scheme remains accessible while preventing misuse.

For SMEs that are not profitable, the ERIS scheme offers an alternative with its own specific requirements.

ERIS Scheme Requirements

The ERIS scheme is tailored for loss-making SMEs that meet an intensity condition: your qualifying R&D expenditure must account for at least 30% of your total expenditure. To qualify as an SME, your business must have fewer than 500 employees and either an annual turnover under €100 million or a balance sheet total under €86 million. Additionally, you must be subject to UK Corporation Tax. A company is classified as loss-making if it has a trading loss for tax purposes before applying the additional R&D deduction.

When calculating the 30% threshold, you must include expenditure from any connected companies. This rule is designed to prevent shifting costs artificially between entities. If you just miss the 30% threshold, a grace period might help: you can still qualify for ERIS if you met the condition and successfully claimed in the previous 12-month accounting period.

Eligible companies can choose to claim under the merged RDEC scheme instead if it offers a better outcome. However, you cannot claim under both schemes for the same R&D expenditure.

"A company meets the intensity condition if its... relevant R&D expenditure is at least 30% of its total expenditure." - HM Revenue & Customs

How the Merged Schemes Differ from Previous SME and RDEC Schemes

The move from the previous SME and RDEC schemes to the merged framework brings several changes to how UK companies can claim R&D tax relief. Understanding these changes is crucial for businesses navigating the updated rules. Below, we break down the key differences and their potential impact.

Standardised Credit Rates and Rules

Under the merged RDEC scheme, all companies now benefit from a single 20% gross credit rate. This replaces the older system, where SMEs could claim an 86% additional deduction, while larger companies used the RDEC credit. For profit-making companies paying Corporation Tax at 25%, the net benefit works out at approximately 15%. For loss-making companies taxed at the notional 19% rate, the net benefit is about 16.2%.

The ERIS scheme offers a more generous 186% total deduction, which includes 100% of actual costs and an 86% additional deduction. It also provides a 14.5% payable tax credit on surrenderable losses. This is significantly better than the 10% payable credit available under the non-intensive SME scheme from April 2023. The intensity threshold for the ERIS scheme is now set at 30%.

Another major change is how subsidised expenditure is treated. Previously, receiving a grant could disqualify a company from claiming the more favourable SME relief, pushing them into the less advantageous RDEC scheme. Now, businesses can claim the full 20% credit even if their R&D is partly funded by grants.

"The rules relating to subsidised expenditure in the existing SME scheme will not be carried forward into the new merged scheme, meaning that where a company receives a grant... the amount of relief available will not be reduced."
– HM Revenue & Customs

Next, let's look at updates regarding subcontracting and overseas costs.

New Rules for Subcontracting and Overseas Costs

The merged scheme introduces a "decision-maker" principle, which determines that claims are tied to the company commissioning the R&D, rather than the one performing the work. This is a shift from the old system, where subcontractors could claim under RDEC if their client was a large company. Now, subcontractors can only claim if their principal is an "ineligible body" - such as a charity, university, or an overseas organisation not subject to UK Corporation Tax.

For overseas R&D work, new restrictions have been introduced. Costs for overseas subcontractors or Externally Provided Workers (EPWs) are only eligible if the R&D cannot reasonably be performed in the UK due to specific geographical, environmental, or social factors. Lower overseas labour costs or a lack of available UK workers are not valid reasons for claiming these costs. However, SMEs registered in Northern Ireland under the ERIS scheme are exempt from these restrictions.

"Only the company that decides to undertake the R&D and bears the risk can usually claim. Overseas subcontractor and externally provided worker costs now qualify only in rare, strictly defined circumstances."
– Christopher Toms, Compliance Director, RandDTax

Comparison Table: Merged Schemes vs Previous Schemes

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Qualifying Expenditure Rules and Restrictions

Types of Qualifying R&D Expenditure

The rules for qualifying expenditure are the same under both the merged RDEC and ERIS schemes. The largest category for most companies is staffing costs, which include salaries, wages, Class 1 National Insurance Contributions, and pension fund contributions for employees directly involved in R&D. Other eligible costs include software, data, and cloud computing (such as data licences and cloud services) and consumable items like fuel, water, electricity, and raw materials that are used up or transformed during R&D.

Payments for Externally Provided Workers (EPWs) and subcontracted R&D are also eligible but come with specific conditions. EPW payments qualify only if the workers are subject to UK PAYE, regardless of where they are located. Subcontractor costs are only eligible if the R&D work is physically conducted within the UK.

Expenditure Restrictions

While the definition of qualifying costs is broad, there are targeted restrictions, particularly on overseas costs. Payments to overseas subcontractors or EPWs working abroad are generally excluded unless the R&D requires unique conditions unavailable in the UK, such as specific geographical features, environmental factors, or regulatory requirements. Lower costs or difficulties in hiring UK workers are specifically not acceptable reasons for including overseas expenditure. These restrictions align with the aim of keeping R&D activity focused within the UK.

"A company cannot carry out R&D overseas solely because it is cheaper to do so, or use overseas workers because they are struggling to hire in the UK, and include those costs in their R&D claim."
– WhisperClaims

For subcontracting, the rules vary depending on the relationship between your company and the subcontractor. Payments to unconnected subcontractors are capped at 65% of the amount paid. For connected subcontractors, the qualifying expenditure is the lower of either the payment made or the subcontractor's actual R&D costs. This is further capped at £20,000 plus 300% of the company's relevant PAYE and NICs. SMEs in Northern Ireland claiming under ERIS are exempt from the overseas restrictions on contractors and EPWs.

How to Claim RDEC and ERIS Tax Relief

With the merger of the RDEC and ERIS schemes, the process of claiming tax relief has become more straightforward for UK businesses.

Checking Your Eligibility

Start by identifying which scheme applies to your business. Large companies and profit-making SMEs now fall under the merged RDEC scheme. On the other hand, loss-making SMEs with at least 30% of their R&D expenditure (including costs from connected companies) can qualify for ERIS. To qualify for ERIS, your company must show a loss before applying R&D enhancements. Remember to factor in the expenditure of connected companies in your calculations.

If you’re claiming for the first time or haven’t claimed in the last three years, you’ll need to submit a notification form to HMRC within six months of the end of your accounting period. Once your eligibility is confirmed, you can move on to calculating and filing your claim.

Calculating and Submitting Your Claim

Under the merged RDEC scheme, a 20% credit is applied to your qualifying R&D expenditure. This credit offsets your Corporation Tax liability, but it’s subject to a PAYE/NIC cap, which is set at £20,000 plus 300% of your contributions. Any unused credit can be carried forward, offset against future liabilities, or paid out in cash.

For ERIS, you have two options: an additional 86% deduction (making a total of 186%) or a 14.5% non-taxable credit on the surrenderable loss. The surrenderable loss is calculated as the lower of either the enhanced expenditure (186% of qualifying costs) or your total trading loss after applying the extra 86% deduction.

Before submitting your CT600, you must complete an Additional Information Form online and send it to HMRC. This form requires:

• A detailed technical narrative of your R&D projects
• A financial breakdown of qualifying costs
• Contact details for a senior internal R&D representative
• Evidence of PAYE and National Insurance contributions

If HMRC processes your CT600 before receiving this form, your claim will be rejected. Save a copy of the form before submission, as you won’t be able to access it again once sent. SMEs should carefully review these steps to ensure they’re claiming the maximum benefit.

Advice for SMEs Choosing Between Schemes

For SMEs, the choice between RDEC and ERIS depends on your financial situation and the extent of your R&D activities. Loss-making SMEs that meet the 30% R&D expenditure threshold can benefit from the 14.5% payable credit, while profit-making SMEs or those with lower R&D expenditure levels are better suited to the merged RDEC scheme.

If your company is close to the 30% threshold, it’s essential to review your R&D spending thoroughly to classify it correctly. Firms like Zest R&D Tax Advisors (https://zest.tax) can help you determine the most beneficial scheme and ensure your claim meets HMRC’s requirements, which is especially helpful for first-time claimants.

Summary

From 1 April 2024, the RDEC and ERIS schemes will merge, introducing updated R&D tax relief rules. Under this system, all trading companies can benefit from a 20% expenditure credit via the merged RDEC scheme. Meanwhile, loss-making SMEs with R&D costs making up at least 30% of their total expenditure can claim ERIS relief, offering a 14.5% tax-free payable credit.

Both schemes align under standardised qualifying criteria, with limits on overseas costs and externally provided workers (EPWs), unless the work is deemed essential. The PAYE cap has been set at £20,000 plus 300% of the company’s relevant PAYE and National Insurance contributions. Additionally, grants and subsidies no longer reduce the relief, simplifying what was previously a more complex system.

"The Merged Scheme will affect a large number of both existing and new claimants. Given HMRC's heightened scrutiny in recent times, businesses must ensure their R&D claims are robust, well-documented, and fully compliant with the new regulations."

• Jay Desai, Senior Manager – Research and Development Tax, MHA

For SMEs close to the 30% intensity threshold, it’s critical to monitor R&D spending carefully. A one-year grace period allows companies that qualified for ERIS in the previous period to continue claiming, even if their R&D intensity temporarily dips below 30%. With these stricter rules in place, SMEs are advised to seek professional advice, such as from Zest R&D Tax Advisors, to ensure compliance and optimise their claims.

FAQs

Should my company claim under merged RDEC or ERIS?

If your company operates on a larger scale or is currently loss-making, the merged RDEC scheme could be a good fit. It offers a relief rate of 18.6%, with taxable credits shown above the line in financial statements. On the other hand, SMEs with a high R&D intensity - where research and development accounts for 30% or more of total expenditure - might find the ERIS scheme more advantageous. This option provides a higher relief rate of 26.97%, with non-taxable credits recorded below the line. To figure out the most suitable choice for your business, it’s wise to consult a tax advisor.

How do I calculate the 30% R&D intensity test for ERIS?

To work out the 30% R&D intensity test for ERIS, take your qualifying R&D expenditure and divide it by your total relevant expenditure. The result needs to be 30% or higher to meet the requirement.

Make sure both numbers are precise and include any applicable costs from connected companies. The formula to use is:
R&D Intensity = (Qualifying R&D Expenditure) / (Total Relevant Expenditure).

Which overseas R&D costs can still qualify after 1 April 2024?

Overseas R&D costs could still be eligible after 1 April 2024 under the new schemes, but specific conditions must be met. For example, the ERIS scheme, aimed at loss-making SMEs, stipulates that at least 30% of R&D spending must be on qualifying R&D costs. Some overseas expenses might qualify if they align with these requirements. It's essential to consult the scheme's detailed guidelines to understand the full eligibility criteria.

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