The merged R&D scheme, introduced from 1 April 2023, fundamentally changed how UK companies claim research and development tax relief. If you run a digital agency, a creative agency, or a software development shop, this affects you directly.
Before April 2023, there were two separate regimes: the SME scheme (for companies with under 500 employees and either under €100m turnover or €86m gross assets) and the RDEC scheme (for larger companies and those doing subsidised or subcontracted R&D). The merged scheme replaces both for accounting periods beginning on or after 1 April 2024. For periods starting between 1 April 2023 and 31 March 2024, there is a transition period with reduced SME rates and a new "intensive" SME scheme.
This post explains the merged R&D scheme specifically for agency founders. We'll cover the rates, the qualifying criteria, the documentation you need, and the practical steps to take if you're considering a claim.
What the Merged R&D Scheme Actually Is
The merged scheme is HMRC's attempt to simplify R&D tax relief. It creates a single set of rules that apply to all companies, regardless of size. The old distinction between "SME" and "large company" disappears for periods starting on or after 1 April 2024.
Under the merged scheme, the relief is calculated as a taxable credit: 20% of your qualifying R&D expenditure. This replaces the old enhanced deduction (186% for SMEs) and the separate RDEC rate (which was 13% for periods before 1 April 2023, then 20% from 1 April 2023).
For an agency, the key change is that you no longer get a deduction from profits. Instead, you get a cash credit or a reduction in your corporation tax bill. The credit is taxable as income, so the net benefit after corporation tax is roughly 15% of your qualifying spend (20% credit minus 25% corporation tax on the credit).
Does Your Agency Qualify for the Merged R&D Scheme?
Many agency founders assume R&D relief is only for pharmaceutical companies or engineering firms. That is not correct. Agencies regularly carry out qualifying R&D in areas like:
- Developing new software platforms or tools
- Creating novel algorithms for data analysis or automation
- Building proprietary technology for client work that goes beyond off-the-shelf solutions
- Designing new processes for digital marketing that involve technical uncertainty
- Developing new AI or machine learning applications
To qualify, your project must seek an advance in science or technology. It must involve resolving scientific or technological uncertainty. It cannot be routine work, even if it is complex. A good test: did you try something where you genuinely did not know if it would work, and did you have to experiment or test to find out?
For example, a digital agency building a custom analytics dashboard for a client using standard React and Python libraries is unlikely to qualify. But an agency developing a new natural language processing tool to automate social media sentiment analysis, where existing tools are inadequate, might well qualify.
Common Agency Activities That Do NOT Qualify
- Standard web development using existing frameworks (WordPress, Shopify, Webflow)
- Routine design work, even if creative
- Implementing off-the-shelf software for clients
- Marketing campaigns that do not involve technical innovation
- Project management or account management
Key Changes Under the Merged Scheme for Agencies
1. The Rate Structure
For accounting periods starting on or after 1 April 2024:
- Merged R&D scheme credit rate: 20% of qualifying expenditure
- Taxable credit: The 20% credit is treated as income, so you pay corporation tax on it (25% for most profitable agencies)
- Net benefit: Approximately 15% of qualifying spend after tax
For accounting periods starting between 1 April 2023 and 31 March 2024, there is a transition period. The old SME scheme still applies, but at a reduced rate: the enhanced deduction is 86% (down from 130% for pre-April 2023 claims). The payable credit rate for R&D-intensive loss-making SMEs is 14.5% (down from 14.5% for pre-April 2023 claims, but note the definition of "intensive" changed).
2. The R&D Intensive SME Scheme
If your agency is loss-making and your qualifying R&D expenditure is at least 40% of your total expenditure (up from 40% for pre-April 2023 claims), you may qualify for the R&D intensive scheme. This gives a payable credit of 27% of the surrendered loss (up from 14.5% for pre-April 2023 claims). This is a significant boost for genuinely R&D-intensive startups.
For agencies, this is relevant if you are pre-revenue or early-stage, spending heavily on developing proprietary technology. Most established agencies with healthy profit margins will not qualify.
3. Subcontracting Rules
Under the merged scheme, the rules around subcontracting have tightened. If your agency subcontracts R&D work to a third party, the costs may not qualify as readily as before. HMRC is now much stricter about ensuring that the company making the claim is the one actually carrying out the R&D.
If you use freelancers or contractors for R&D work, you need to be careful. The subcontractor must be "directly engaged" in the R&D, and you must have a clear contract that specifies the R&D activities. General "development" or "implementation" work is unlikely to qualify.
4. Overseas Expenditure Restrictions
From 1 April 2024, the merged scheme restricts qualifying expenditure on overseas activities. Only costs for work carried out in the UK or in certain qualifying overseas territories (generally, those with similar IP frameworks) will qualify. If you use developers in India, Eastern Europe, or other non-qualifying jurisdictions, those costs are now excluded.
This is a major change for agencies that rely on offshore development teams. You need to review your R&D cost base now if you are planning a claim.
How to Prepare a Merged R&D Scheme Claim for Your Agency
The documentation requirements under the merged scheme are more rigorous than before. HMRC has increased compliance checks significantly. You need to demonstrate that your project genuinely sought an advance in science or technology, and that you resolved technical uncertainty through systematic investigation.
Here is what you need to prepare:
Technical Narrative
A clear, non-technical description of the project. What was the scientific or technological uncertainty? What did you try? What did you learn? What was the advance? Avoid marketing language. HMRC wants to see the technical problem and your systematic approach to solving it.
For an agency developing a new AI tool for content personalisation, the narrative might describe the limitations of existing personalisation engines, the specific technical challenges in training a model on sparse client data, the experiments you ran, and the final approach you took.
Financial Evidence
A breakdown of qualifying costs by category: staff costs, software, consumables, subcontractors, and externally provided workers. You need timesheets or other records showing the time each person spent on R&D activities. HMRC now expects to see project-level time recording, not just a percentage allocation.
If you use Xero or QuickBooks, you should set up a separate cost centre or project code for R&D projects. This makes the claim much easier to substantiate.
Competent Professional Evidence
For claims over £25,000, you must submit a report from a qualified R&D adviser (usually an accountant or specialist firm). This report must confirm that the project meets the qualifying criteria. Our ICAEW qualified team at Agency Founder Finance can help with this.
Real Example: A Digital Agency Claiming Under the Merged Scheme
Let us take a 12-person digital agency in Manchester's Northern Quarter. They develop a proprietary machine learning tool for optimising Google Ads campaigns. They spend £80,000 on staff time, £15,000 on cloud computing costs, and £5,000 on subcontracting a specialist AI consultant.
Under the merged scheme (period starting 1 April 2024):
- Qualifying expenditure: £80,000 (staff) + £15,000 (cloud) + £5,000 (subcontractor) = £100,000
- R&D credit: 20% of £100,000 = £20,000
- Tax on credit: £20,000 × 25% corporation tax = £5,000
- Net benefit: £20,000 - £5,000 = £15,000
The £15,000 would reduce the agency's corporation tax bill or, if loss-making, be payable as cash.
Compare this to the old SME scheme (pre-April 2023). The enhanced deduction of 186% would have given a deduction of £186,000 against profits. At 19% corporation tax, that is a tax saving of £35,340. The merged scheme gives less relief for profitable companies. This is a deliberate policy shift by HMRC to reduce the cost of R&D relief.
Timing and Deadlines
You must submit your R&D claim within 12 months of the end of your accounting period. For a company with a 31 December year end, the deadline is 31 December of the following year. Claims made after this date are invalid.
If you are making a claim for a period that straddles 1 April 2023 or 1 April 2024, the rules are apportioned. You need to calculate the relief for the part of the period before and after the change. This is complex and requires careful calculation. Do not attempt it without professional advice.
Common Mistakes Agency Founders Make
- Claiming for routine development. Just because it was hard does not mean it was R&D. HMRC looks for genuine technical uncertainty.
- Including non-qualifying costs. Marketing, sales, and general overheads do not qualify. Only direct R&D costs.
- Poor documentation. Without timesheets and project notes, HMRC will reject the claim. Start tracking now, even if you are not planning a claim until next year.
- Ignoring the overseas restrictions. If you use offshore developers, check whether their costs qualify. Most do not under the new rules.
- Assuming you cannot claim because you are profitable. You can still claim the credit against your corporation tax bill. It is not just for loss-making companies.
Should Your Agency Make a Claim?
That depends on whether you have genuinely carried out qualifying R&D. If you have developed new technology, solved a technical problem that no one else has solved, or created a novel process that advances the field, you should investigate a claim.
If your work is standard agency fare, building websites, running campaigns, designing logos, you almost certainly do not qualify. Do not be tempted to stretch the rules. HMRC is actively auditing R&D claims and the penalties for incorrect claims are severe (up to 100% of the tax relief claimed).
If you are unsure, speak to an accountant who specialises in R&D for agencies. We work with agency founders across the UK, from Soho to Bristol Harbourside, and we can help you assess whether your projects qualify. Get in touch to discuss your specific situation.
What to Do Next
- Review your projects. Identify any where you faced genuine technical uncertainty and resolved it through systematic investigation.
- Start tracking time. Set up project codes in Xero or FreeAgent for R&D activities. Record time spent by each person on qualifying work.
- Gather evidence. Keep technical notes, design documents, test results, and emails that show the problem and your approach.
- Check your subcontractor costs. If you use offshore developers, assess whether their costs qualify under the new rules.
- Talk to us. We can review your projects, prepare the technical narrative, and submit the claim. Contact Agency Founder Finance to start the conversation.
The merged R&D scheme is less generous than the old SME regime for profitable companies. But it still offers a meaningful reduction in your tax bill if you are doing genuine R&D. Do not leave money on the table, but do not claim for work that does not qualify. The risk is not worth it.
If you are a marketing agency, digital agency, or creative agency founder, read more about how we help agencies like yours with tax planning and compliance.