How R&D Merger Affects Your Small Business Claims
- Adil Akhtar
- 1 day ago
- 15 min read
How the 2024 R&D Merger Affects Your Small Business Claims in 2026/27
From 1 April 2024, the separate SME and RDEC schemes were replaced by a single merged R&D Expenditure Credit (RDEC) regime for all companies, regardless of size. For most small and medium-sized businesses that previously claimed under the SME scheme, this is a material reduction in the value of their relief. The net effective rate for a profitable company paying the 25% Corporation Tax main rate is now approximately 15% of qualifying expenditure, down from roughly 21.5% under the old SME scheme. The difference is real money, and the structural changes to how subcontracting and overseas costs are treated add further complications that many SMEs are only discovering when they prepare their first claim under the new rules.
If your accounting period ends on or after 31 March 2025, the merged scheme will already apply to at least part of your most recent R&D claim. For accounting periods beginning on or after 1 April 2024 (which for a 31 March year-end means from 1 April 2024 onwards, and for a 31 December year-end means from 1 January 2025), the merged scheme is your default regime with no SME scheme fallback available.
What Changed and Why It Matters for an SME
The old SME scheme allowed a profitable company to deduct 186% of qualifying R&D expenditure (the original spend plus an additional 86% uplift), effectively reducing taxable profits by £1.86 for every £1 spent on qualifying R&D. At a 25% Corporation Tax rate, that translated to a cash saving of around 21.5p per £1 of R&D spend. For a loss-making SME, the old scheme allowed surrender of the enhanced loss for a 10% payable credit, or up to 14.5% for R&D-intensive companies under the rules in force before April 2023.
The merged scheme abandons the enhanced deduction model entirely. Every company, whether a two-person tech startup or a multinational group, now claims a 20% above-the-line credit on qualifying expenditure. That credit is taxable, so a company paying 25% Corporation Tax on it retains a net benefit of 15p for every £1 spent. For a company with profits below £50,000, where Corporation Tax applies at the 19% small profits rate, the net benefit after tax on the credit rises to approximately 16.2p. A loss-making company with no tax liability can, subject to the normal payment waterfall rules, receive the full 20% credit as a cash payment, giving an effective cash benefit of 20p per £1 of R&D spend.
The reduction in value matters most for profitable SMEs. A company that was previously retaining a 21.5% effective benefit on its R&D spending is now retaining 15%, a cut of nearly a third in the value of the incentive for the same qualifying activity. For a business spending £300,000 per year on qualifying R&D, that reduction represents roughly £19,500 less in cash retained compared to the old scheme. Worth factoring in to any financial plan that was built on the assumption the old SME rate would continue.
The Enhanced R&D Intensive Support (ERIS) Scheme
The government recognised that the merger would hit loss-making, R&D-focused SMEs hardest, and introduced a parallel scheme called Enhanced R&D Intensive Support (ERIS) as a partial offset. ERIS is available only to SMEs (fewer than 500 employees, and either turnover below €100 million or a balance sheet total under €86 million) that are loss-making, and that spend at least 30% of their total expenditure on qualifying R&D activity.
For companies meeting that threshold, the 30% R&D intensity test applies to total expenditure rather than just the qualifying R&D element. This is a meaningful distinction. A company with £400,000 in total costs, of which £130,000 is qualifying R&D spend, sits right at the 32.5% intensity mark. If its cost base increases to £500,000 through hiring additional non-R&D staff or taking on more commercial premises, the R&D intensity drops to 26% and ERIS eligibility is lost.
Under ERIS, the qualifying company claims under the old-style enhanced deduction model at 186%, surrenders the resulting enhanced loss, and receives a payable credit at 27% (not 10% or 14.5%). The effective cash benefit under ERIS works out at approximately 50.2p for every £1 of qualifying R&D spend. That is significantly more generous than the merged scheme's 20p for a cash-strapped loss-making company, and the difference in cash terms can be material during the growth phase of a technology or life sciences business.
One restriction that is easy to miss: the additional benefit from claiming ERIS over the standard merged scheme rate is capped at £250,000 over any rolling three-year period. Beyond that cap, additional qualifying R&D expenditure falls back into the merged scheme. This cap is separate from the PAYE and NIC cap that limits the overall payable credit a loss-making company can receive.
The Subcontracting Rules Have Fundamentally Changed
This is where many SME claims under the merged scheme run into trouble, particularly those in software, engineering, and manufacturing, where subcontracting R&D activity to third parties is common.
Under the old SME scheme, the rules on who could claim for subcontracted R&D were structured around whether the SME itself was bearing the financial risk and making the substantive decisions. An SME that paid a third party to carry out R&D on its behalf could typically claim for those costs, provided certain conditions were met, while the subcontractor could not also claim on the same expenditure.
The merged scheme reframes the question. Under the new rules, the right to claim follows which party is "making the decision to undertake the R&D" and is "carrying the financial risk" of the project. HMRC has confirmed that contract wording alone is not conclusive. Internal project documentation, board minutes, project plans, and the commercial terms and conduct of the relationship are all relevant. A company whose contract simply describes a fixed-price deliverable, with the subcontractor bearing the cost risk of delivery, is unlikely to be treated as the party that can claim for those costs under the merged scheme, even if the commercial purpose of the arrangement was to commission R&D for the claimant's benefit.
This matters in practice because a number of SMEs have historically structured subcontracting arrangements in ways that gave them control over the R&D direction while outsourcing the actual technical execution. Under the old SME scheme that approach generally worked. Under the merged scheme, HMRC's guidance focuses more closely on where the financial risk actually sits and how decisions are made during the project, and arrangements that appear similar on the surface can produce different outcomes depending on the contract terms and the actual conduct of the relationship.
If your R&D involves payments to third parties to carry out technical work, it is worth reviewing the contracts and your internal documentation before preparing the claim. Getting the "contracted-out R&D" question wrong in the merged scheme creates a double risk: your claim may be disallowed, and the subcontractor may not be in a position to claim either, since the right to claim under the merged scheme shifts depending on which party the analysis concludes was directing the R&D.
Subcontractor costs are also capped at 65%
A separate but related point: under the merged scheme, payments to unconnected subcontractors for qualifying R&D activity are capped at 65% of the payment for the purposes of calculating the qualifying expenditure base. This mirrors the old RDEC rules rather than the old SME scheme, under which 65% of relevant subcontractor payments were claimable. Different rules apply for connected party subcontracting, where the amount claimable is restricted to the lower of the actual payment and the relevant staff costs of the connected subcontractor plus a 15% uplift.
Overseas Costs: A Significant New Restriction
For accounting periods beginning on or after 1 April 2024, R&D expenditure on overseas subcontractors and overseas externally provided workers (EPWs) is no longer qualifying expenditure under the merged scheme (or ERIS), subject to very limited exceptions. This is a substantial change from the position under the old SME and RDEC schemes, where overseas costs were generally claimable without restriction.
The restriction applies to the location of the activity, not the location of the company. An overseas-based subcontractor doing work physically in the UK is claimable. A UK-based subcontractor sending employees abroad to conduct the R&D activity is not (for those overseas elements). The test for EPWs is slightly different: it turns on whether the worker's earnings are subject to PAYE and Class 1 National Insurance contributions. If a worker provided through a staff agency has earnings subject to PAYE/NIC, the payment for their services can qualify even if they are not UK-based, provided they are conducting R&D in the UK.
The exceptions to the overseas restriction are narrow. Overseas activities can qualify where the conditions necessary for the R&D (environmental, geographic, regulatory, or social) cannot be replicated in the UK and it would be wholly unreasonable to expect the company to do so. Conducting clinical trials in a jurisdiction with specific regulatory approval, or research requiring specific environmental conditions not present in the UK, can meet that threshold. Sending work offshore because it is cheaper, or because a particular team happens to be based there, does not. HMRC has confirmed that cost and workforce availability are explicitly excluded as grounds for the overseas exception.
For any SME that has previously included overseas development costs, overseas contractor payments, or payments to workers employed through non-UK payrolls, reviewing the claim against these new restrictions before submission is not optional. If a prior-year claim included such costs under the old scheme rules and the company's first merged-scheme period has now arrived, those costs need to be re-assessed under the new framework.
Scotland and Wales: No Devolved Variation
R&D tax relief is entirely a UK-wide corporate tax matter. There is no Scottish or Welsh variant, no devolved rate, and no separate registration requirement north of the border or in Wales. The merged scheme, ERIS, the overseas restrictions, and the subcontracting rules all apply identically across all four nations. Scottish companies will apply Scottish income tax rates if they pay the credit out to individual shareholders as income, but the credit itself and the Corporation Tax interaction are the same.
One area where location does sometimes matter in practice is the overseas R&D exception. A company conducting field trials in Scotland, Wales, or Northern Ireland that has specific environmental or geographic characteristics unavailable elsewhere in the UK would clearly not need the overseas exception, since the activity is UK-based regardless. This is more relevant to companies considering whether to shift development activity to UK locations to replace previously claimable offshore spend.
The Additional Information Form: A Non-Negotiable Compliance Requirement
Since 8 August 2023, every R&D claim must be supported by an Additional Information Form (AIF) submitted to HMRC before or at the same time as the Company Tax Return containing the claim. There is no grace period, and HMRC will not process an R&D claim that arrives without a valid AIF already on record.
The AIF requires, among other things, a description of each R&D project included in the claim (at least one project and up to 10, with a narrative description of the science or technology challenge and how it was addressed), the number of employees engaged in R&D, and the qualifying expenditure split by cost category. For companies making their first claim, or whose previous adviser prepared the claim without producing the kind of project-level documentation that the AIF now demands, assembling this information retrospectively from financial records alone is difficult. The AIF is effectively forcing a more substantive narrative justification for every claim, which is a deliberate design choice by HMRC to tackle the high volume of poorly-supported claims that reached it in 2021 to 2023.
Some companies also need to notify HMRC of their intention to claim before the AIF is submitted, using HMRC's Claim Notification Form, for accounting periods starting on or after 1 April 2023 where the company has not claimed in either of the two previous accounting periods. Missing the notification deadline can bar the claim entirely.
What a Realistic Merged-Scheme Claim Looks Like
Consider a profitable software company with 15 employees, an accounting year ending 31 March 2026, and qualifying R&D expenditure of £220,000 comprising: £140,000 in directly employed staff costs, £50,000 to a UK-based unconnected subcontractor, and £30,000 in software licences used directly in the R&D.
Under the merged scheme:
● Staff costs: £140,000 x 20% = £28,000 credit
● Subcontractor costs: (£50,000 x 65%) x 20% = £6,500 credit
● Software: £30,000 x 20% = £6,000 credit
● Gross credit: £40,500
● Tax on credit at 25% Corporation Tax: £10,125
● Net benefit: £30,375 (approximately 13.8% of total R&D spend)
Under the old SME scheme, the same company would have received a deduction of £220,000 x 186% = £409,200, saving Corporation Tax of £409,200 x 25% = £102,300 against notional full-rate CT, but more practically the effective saving was around £220,000 x 21.5% = £47,300. The difference between £47,300 and £30,375 is not trivial for a business where R&D investment is central to its product development roadmap.
Note that the subcontractor cap makes a visible difference here. Under the old SME scheme, the full £50,000 subcontractor payment would have qualified (subject to meeting the contracted-out R&D conditions). Under the merged scheme, only 65% (£32,500) enters the qualifying cost base.
Practical Steps for Claims Being Prepared Now
If you are preparing an R&D claim for an accounting period that falls under the merged scheme, several things are worth addressing before the claim is submitted rather than after.
First, check whether your accounting period start date means the merged scheme applies, or whether there is any straddle position. For a company with a 30 September 2024 year-end, the merged scheme applies from 1 April 2024, so only six months of the 2023/24 year fall under the new rules and the other six under the old SME scheme. The split requires two calculations on a time-apportioned basis.
Second, review whether any costs previously included relate to overseas subcontractors or EPWs who are not on UK PAYE. Those costs will need to be excluded, and including them without addressing the restriction is likely to attract an enquiry. HMRC's R&D Anti Abuse Unit is applying high scrutiny to merged-scheme claims, with an estimated 17-20% of all claims currently being flagged for compliance checks.
Third, if your company is loss-making and your R&D spend represents 30% or more of total expenditure, prepare the ERIS calculation in parallel with the merged-scheme calculation and confirm which gives the better outcome. The two are mutually exclusive for the same period, but the choice between them has a significant cash impact.
Fourth, prepare the AIF content before the year-end accounts are finalised, not after. The project narratives, employee time allocations, and cost categorisations are much easier to document accurately when the activity is recent.
Key Takeaways
The merged RDEC scheme applies to all accounting periods beginning on or after 1 April 2024. Most profitable SMEs will see their effective R&D benefit fall from approximately 21.5% to 15% of qualifying expenditure. Loss-making SMEs with R&D intensity above 30% can access the more generous ERIS scheme, with an effective cash benefit of approximately 50.2%, subject to the £250,000 cap on the additional benefit compared to the merged scheme. Overseas subcontractor and EPW costs are no longer qualifying expenditure unless a narrow geographic or regulatory exception applies. The subcontractor cost cap at 65% now applies to unconnected third-party subcontracting. And the Additional Information Form is mandatory for every claim, making contemporaneous project-level documentation a compliance requirement rather than a best-practice recommendation.
FAQS
Q1: Does the merged scheme change how a small business claims R&D relief now?
A1: Well, it changes the route, but not the basic idea. For accounting periods beginning on or after 1 April 2024, the old SME and RDEC routes have been replaced by the merged scheme, with ERIS sitting alongside it for certain loss-making, R&D-intensive SMEs. In plain English, a small company is no longer choosing between the old SME box and the old RDEC box in the same way it used to. The key check is still whether the company is trading, chargeable to Corporation Tax, and carrying out a project that seeks an advance in science or technology.
Q2: Can someone still claim if the claim notification form was missed?
A2: In my experience, this is one of the most expensive admin slip-ups. For first-time claimants, or where the last valid claim was more than three years before the end of the claim notification period, HMRC requires a claim notification form. That form has to be in within the claim notification period, which normally ends six months after the period of account ends. If the Company Tax Return goes in before the form, HMRC will reject the claim, and the window to fix it may already be closing.
Q3: Can a company still claim where part of the project was funded by a grant or subsidy?
A3: Yes, and this is a big change many owners miss. Under the merged scheme and ERIS, there is no restriction on subsidised costs in the way there was under the old SME rules. That means a business that received a grant does not automatically lose the claim, although it still needs to keep the claim clean and avoid double counting the same spend in more than one place. A common pitfall is assuming “grant funded” means “ineligible” when, under the current rules, that is no longer the right starting point.
Q4: Can a business claim R&D if it was doing work for a customer rather than inventing for itself?
A4: Yes, but the claim depends on who made the decision to carry out the R&D. Under the current rules, the company that decides the R&D needs to happen is the one that should claim, provided it can show it planned the work and took the technical call. That matters a lot for agencies, developers and specialist manufacturers working under contract. I have seen the difference come down to a single paper trail: one Leeds software firm could claim because it led the technical uncertainty, while a similar contractor could not because it was merely delivering a spec.
Q5: Can subcontractors, agency staff or external workers still be included?
A5: Yes, but the detail matters more than it used to. For staff supplied by an agency or staff provider, connected providers can be claimed differently from unconnected ones, and for unconnected providers the claim is generally 65% of the payment. For contractor payments and externally provided workers, the 2024 reforms also introduced overseas restrictions and a PAYE/NIC condition for some cases. So a business with a remote development team in Poland, for example, needs to check whether the work and the worker’s status fit the current rules before assuming the spend is in.
Q6: What happens if the R&D credit is bigger than the PAYE cap?
A6: This catches smaller companies with low payroll more often than you might expect. Under the merged scheme and ERIS, the credit for the period cannot exceed the PAYE cap unless the company is exempt. The cap is £20,000 plus 300% of the company’s relevant PAYE and National Insurance liabilities. If the merged-scheme credit is above that cap, the excess does not vanish; it carries forward to the next accounting period. That can matter a lot for a small tech business with strong R&D spend but only a handful of employees.
Q7: Can overseas contractors or remote teams still qualify?
A7: Sometimes, but this is now one of the most tightly checked areas. For contractor payments, HMRC looks at where the R&D activity actually takes place. For externally provided workers, the earnings generally need to be subject to UK PAYE and Class 1 NICs, unless an exception applies because the activity necessarily has to take place abroad. So a Bristol company using a developer in Spain for convenience is in a very different position from a lab project that genuinely has to be tested overseas. Northern Ireland has its own separate ERIS position as well.
Q8: Can software, cloud computing and data licence costs still be claimed?
A8: Yes, and for many modern small businesses these are now some of the most valuable items in the claim. Data licence and cloud computing costs can qualify for accounting periods beginning on or after 1 April 2023, and software licence fees can qualify too, including a reasonable share where the software is used partly for R&D and partly for normal trading. The practical mistake I see is over-claiming the full bill when only part of the tool was used for the project, or including costs tied to indirect admin work rather than the actual R&D.
Q9: Should a loss-making R&D-intensive SME use ERIS or the merged scheme?
A9: It depends on the numbers, but the owner should compare both rather than assume one is always better. ERIS is designed for loss-making R&D-intensive SMEs, and the intensity condition is based on R&D spend being at least 30% of total expenditure for accounting periods beginning on or after 1 April 2024. Even where a company qualifies for ERIS, it can choose the merged scheme instead, but it cannot claim both for the same spend. In practice, that choice often comes down to whether the business values a payable credit now or a different tax outcome later.
Q10: Can a company still fix or amend a missed R&D claim later?
A10: Sometimes yes, but the deadline depends on the period. For periods ending after 31 March 2023, claims can usually be amended within two years from the end of the period if the period of account is up to 18 months, or within 42 months from the first day of the period in other cases. If the company has already overclaimed, HMRC expects the error to be disclosed properly through the disclosure route rather than quietly left in place. So if a Manchester business spots that its claim was filed too late or too high, the right move is to check the time limit first and then correct the record cleanly.
About the Author:
Adil Akhtar, ACMA, CGMA, FCMA, (membership ID is 990250923) serves as CEO and Chief Accountant at Pro Tax Accountant, bringing over 18 years of expertise in tackling intricate tax issues. As a respected tax blog writer, Adil has spent more than eighteen years delivering clear, practical advice to UK taxpayers. He also leads Advantax Accountants, (registered with Companies House), combining technical expertise with a passion for simplifying complex financial concepts, establishing himself as a trusted voice in tax education.
Email: adilacma@icloud.com
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