United Kingdom

Foreign tax credit

The United Kingdom has an extensive network of DTTs. Unilateral relief is generally available, in any event, to credit overseas tax paid on non-UK source profits against the UK tax on the same profits; while the relevant treaty might sometimes extend that relief, their main function for UK companies is to limit overseas WHTs that would otherwise be payable on passive income.

The United Kingdom has a complex regime allowing 'underlying' tax relief in respect of foreign dividends, so that tax suffered at lower levels can be relieved (at least in part) where dividends flow to the United Kingdom via a chain of companies. However, that relief is only available where the dividend concerned is subject to tax. It is therefore of limited application because most foreign dividends are exempt from tax.

Capital allowances

A variety of tax incentives are given in the form of enhanced tax depreciation allowances (known as capital allowances, see Depreciation and amortisation in the Deductions section). Some of these incentives are given by reference to the expenditure concerned and others by reference to the size of the company incurring that expenditure.

Annual investment allowance (AIA)

All businesses, regardless of size, can claim an AIA of 100% on the first GBP 1 million (from 1 January 2019, previously GBP 200,000) tranche per annum of capital expenditure incurred on most qualifying expenditure. This is restricted to a single allowance for groups of companies or associated businesses. The AIA has become permanent at GBP 1 million.

Research and development (R&D) incentives

Relief for expenditure of a revenue nature on R&D that is related to a company’s trade and is undertaken by the company or on its behalf is wholly allowable as a tax deduction. In certain circumstances, either enhanced relief is available or a credit is available that is offset against R&D costs in the company’s profit and loss account.

Expenditure of a capital nature on R&D related to a company’s trade is also wholly allowable as a tax deduction (i.e. 100% capital allowances are available). This covers capital expenditure on the provision of laboratories and research equipment; however, no allowance is available for expenditure on land.

The government has consulted on wide-ranging reform of R&D tax relief. The Chancellor’s Spring Statement, on 23 March 2022, provided some further information on the reform of R&D tax reliefs, and these changes are included in the draft Finance Bill 2023. The key changes that apply for accounting periods commencing on or after 1 April 2023 are: 

• A company will need to pre-notify that they are making a claim if they are a first-time claimant or if they have not made claims in the past three years. The notification must be made by six months after the period in which they intend to make a claim. HMRC have indicated that late notifications will not be accepted, so companies will need to be planning much further ahead when considering whether to make claims.
• It will become mandatory for claimants to share certain information when making a claim. The key documentation that will need to be shared with HMRC includes:
• a description of the R&D undertaken
• a breakdown of qualifying costs
• details of any agent who has advised on the R&D claim, and
• sign off from a senior officer of the company.

• Cloud and data costs will become qualifying cost types; however, these costs need to clearly align with direct R&D and cannot be included in R&D claims where these costs only relate to indirect supporting activities.
• Overseas costs relating to externally provided workers (EPWs) and subcontractors, as well as contributions to independent R&D (such as payments to universities), will no longer be eligible, except where the conditions necessary for the R&D are not present in the United Kingdom but are present in the place where the R&D is carried out, and where it is wholly unreasonable for the company to replicate the conditions in the United Kingdom. The legislation confirms that these conditions could include geographical, environmental, social, legal, or regulatory requirements but do not include factors relating to the cost of R&D or the availability of skilled workers to undertake the R&D. This list is not exhaustive, and in the short term is likely to create greater uncertainty as to what could be seen as meeting these criteria. The practicalities behind these proposals remains to be seen, as it will likely require the claimant to prove they were unable to undertake the R&D activities in the United Kingdom. 

• A new announcement to include pure math research within the scope of the R&D relief, which is likely to benefit those undertaking data science or artificial intelligence-based R&D activities.

Draft legislation has been published as part of the draft Finance Bill 2023. The changes will apply for accounting periods commencing on or after 1 April 2023. HM Treasury continues its review of the R&D schemes, and we expect further announcements in 2023. At Autumn Statement 2022, changes to the rates of both the SME scheme and RDEC (see below) will apply from 1 April 2023.

HM Treasury will open a consultation before the next Budget in the Spring in merging the regimes into a combined RDEC-like above-the-line regime. The government will also discuss with industry possible additional support for high-R&D-intensive SMEs to compensate them for the drop in the SME rate.

R&D relief: SMEs

Certain companies incurring R&D expenditure of a specific nature are entitled to claim R&D tax relief.

A standalone company (or the group where the UK company is part of a global group) must be an SME, as defined by the European Union. The company (broadly together with any company of which it owns 25% or more or that has more than 25% interest in it, subject to some exceptions) should have fewer than 500 employees and either an annual turnover not exceeding EUR 100 million or an annual balance sheet total not exceeding EUR 86 million.

The R&D may be undertaken by the company or directly on its behalf. The R&D must be related to the company’s trade. Expenditure for which state aid is received is excluded. R&D that is deemed to be funded or subcontracted to the company may only be claimed under the large companies RDEC scheme (see below).

Detailed below are the types of expenditure that may be included within claims.

Enhanced R&D tax relief is given by increasing the deduction for qualifying R&D in a company’s corporation tax computation from a 100% deduction to 230% deduction for qualifying expenditure. This rate will reduce to 186% deduction from 1 April 2023.

One of the ways HMRC is tackling abuse in the SME regime is through the SME cap that applied from 1 April 2021. The amount of payable tax credit a qualifying loss-making business can receive is capped at three times the company’s total PAYE and NICs liability for that year. There is a threshold of GBP 20,000, so that the smallest claims are uncapped (i.e. a company receiving a payable credit of below GBP 20,000 for a 12-month period will not be impacted by the cap). There are also rules that attempt to limit the impact of the cap on some businesses with genuine R&D and IP substance in the United Kingdom.

R&D tax credits

Where an SME company has a ‘surrenderable loss’ it may claim an R&D tax credit. Generally, a surrenderable loss arises where the company incurs a trading loss.

The surrenderable loss is the lower of the unrelieved trading loss or 230% of the qualifying research and development expenditure. This will change from 1 April to 186%.

The cash payment is currently 14.5% (to reduce to 10% from 1 April 2023) of the amount of losses surrendered (at January 2021). This equates to a cash repayment of up to 33.35% (being 230% at 14.5%)of the qualifying expenditure. This will drop to up to 18.6% (being 186% at 10%). Where the R&D tax credit is claimed, the trading loss carried forward is reduced by the amount of the surrendered loss.

R&D Expenditure Credit (RDEC)

Relief under RDEC is available to large companies (unless subcontracted to the claimant company by a UK SME) and SME companies where expenditure has been funded or subsidised (by grant income, customer funding, or otherwise).

This credit is different to the payable credit referred to above for SMEs. Companies may claim to receive a taxable credit payable at 13% (from 1 April 2020). This rate will increase to 20% from 1 April 2023. The credit is brought into account ‘above the line’ and reflected in the operating profits of the company, similar to a grant. The credit itself is taxable and so taking a 19% corporation tax rate into account, the net benefit to the company of the credit is 10.5%. This will increase to 15% from 1 April 2023 (taking a corporation tax rate of 25%).

Patent box

Where the taxable profits can be attributed to the exploitation of patents, a lower effective rate of corporation tax applies. For 2022/23, the rate is 10%. Profits can include a significant part of the trading profit from the sales of a product that includes a patent, not just income from patent royalties. This scheme closed to new entrants from June 2016 (but continued until 2021 for existing taxpayers), when a new Nexus scheme was introduced. The Nexus rules apply to new entrants to the patent box or new IP created on or after 1 July 2016 and to all companies from 1 July 2021. The Nexus scheme retains most of the features of the earlier scheme but requires companies to stream their IP income and the application of a fraction to relevant IP profits based on the proportion of R&D undertaken by itself. The Nexus scheme meets revised OECD principles and limits the qualifying IP profits based on the proportion of R&D undertaken by the company, by applying ‘the R&D fraction’.

Other incentives

A deduction equal to 150% of the qualifying expenditure on the remediation of contaminated or derelict land is given in the year incurred, which can be surrendered for a cash payment (at a rate of GBP 24 for each GBP 100 of qualifying land remediation spend) by companies that are trading at a loss.

There are special tax reliefs available for certain expenditure on UK film production, high-end television, animation, video games, theatres, orchestras, and museum and gallery exhibitions. 

The government has announced a number of potential changes to audio-visual tax reliefs, which include film, television, and video games tax reliefs. The proposed changes include the following:

• Merging the film and television tax reliefs, including aligning some of the eligibility requirements, such as the cultural test.
• Amending the way that the reliefs are given, to operate in a similar way to the RDEC. The intention would be to ensure that the benefit of the reliefs is preserved following the introduction of the 'Pillar 2' rules.
• For video games tax relief, removing the GBP 1 million cap on eligible subcontracted spend and restricting eligible costs to UK expenditure only (EEA spend may no longer qualify).
• For high-end television tax relief, reviewing the minimum slot length and minimum expenditure requirements, and defining a ‘documentary’ in the legislation. 

A consultation into the potential changes has been published, with responses due by 9 February 2023.

There are no tax holidays and no foreign investment incentives in the United Kingdom.