Tax Relief: two words not often found in apposition. Yet Research and Development (R&D) tax credits are just that, tax relief as an incentive for attempting innovation.
Simply put, money spent on innovation can be used to reduce corporation tax and/or receive a cash payment. Around 50,000 claims are put in to HMRC each year, a remarkable success for a scheme which received little initial lobbying before introduction in April 2000. Needless to say, there have been many changes and additions to the idea (as illustrated) and there are more to come.
“Indeed, the new parliament should easily find common ground regarding R&D tax credits.”
The Conservative Party, the Labour Party and the Liberal Democrats all made manifesto promises to increase the scope of R&D tax credits, be that into cloud computing, datasets or green technologies. Further, Boris Johnson proposed an increase in the tax credit rate by 1% for the R&D expenditure credit (RDEC) which is used for large companies and some SMEs – as a compensation for a Brexit that businesses did not want and to balance the maintenance of the corporation tax rate. Labour set out gradually abolishing the R&D tax relief for large companies, over suspicions it aids avoidance of corporation tax, and have promised reform of SME support, to ensure a lack of “policy drift”. The Liberal Democrats promised “simplifying the regulatory landscape and speeding up regulatory change”.
This is a strange policy area politically; all parties have much in common regarding supporting innovation by SMEs. Indeed, the new parliament should easily find common ground regarding R&D tax credits.
What qualifies for R&D tax credits?
An outsourced BEIS report in 2018 states that many businesses view tax relief on either investment or profits as a way “to encourage and de-risk investment” in R&D. Current regulations set out four criteria to qualify for the credit, which ensure that money was invested in a project which sought a truly innovative creation through testing and analysis. The project does not have to be successful, it must try to overcome uncertainty. There are plenty of guides for successful applications. The claim is to be made on a CT600 form; claims usually take four to six weeks. HMRC views this tax relief system as an example of its best work: the R&D Consultative Committee reviews, maintains and protects this tax relief – ensuring protection against abuse and a continuing ability to handle claims.
How have businesses responded?
Businesses like R&D tax credits, and all the more as caps have been lifted and positive rate changes enacted. I will limit my summary to the SME specific tax relief (thus excepting the occasions when R&D is outsourced by large companies to SMEs and tax relief is applied for through RDEC). The number of businesses making claims has rapidly increased with, Figure 1, showing increasing popularity. It should be noted that businesses can make more than one claim per year, and also that claims greatly increased after a minimum expenditure requirement was lifted in 2012. The number of first-time applications has increased, Figure 2, suggesting increasing awareness or valid of the scheme. The amount of expenditure referenced in business claims has risen and almost caught up with GERD (gross domestic expenditure on R&D), Figure 3, suggesting businesses are making the most of this tax relief. There is a small, relative increase in GERD since 2012, perhaps aided by the lifting of the minimum expenditure requirement. Businesses know of, like and claim R&D credits.
Figure 1: Data source: HM Revenue & Customs
Figure 2: Data source: HM Revenue & Customs
Figure 3: Data source: HM Revenue & Customs; OECD
What have others done?
As the United Kingdom seeks to achieve an extraordinary rise in R&D spending to 2.4% R&DI (GERD as a percentage of GDP), we can pick up ideas from the actions and experiences of other countries who have increased their R&DI. These remind us that R&D tax credits: are an important part the of R&D picture; might be used to beyond their original incentive; and sit within a whole tax system.
Israel, R&DI = 4.25%. Heavily dependent on its tertiary industry sector, one supportive policy measure is Yozma which offered (foreign) investors insurance on risk through heavy investment in venture capital. Can the UK further minimise the risk for businesses to try R&D?
Denmark, R&DI = 3.05%. From 2006 onwards, Denmark made international links with Silicon Valley and Shanghai whilst also pushing an innovation agenda nationally. How can innovation be tempted to and also retained in the UK?
Estonia, R&DI = 1.25%. This is higher than nearby Lithuania (0.9%) and Latvia (0.5%). Yet Estonia, like Germany, does not have R&D tax incentives. However it has a unique tax system that supports reinvestment of profits and does not punish development or growth. Where does the UK tax system, even rewarding R&D, inhibit business investment of R&D?
Austria, R&DI = 3.15%. Rising from 1.89% in 2000, evaluations of 2000-2008 found positive effects upon new products through tax incentives, especially when these were combined with subsidies. The tax credit has increased by 4% in the last two years, showing the competition laid down by other nations. How can the UK stay ahead of the competition?
South Korea, R&DI = 4.23%. South Korea spends hugely on R&D but has struggled with innovation and commercialisation at SMEs, particularly with exports to Japan falling. However, development assistance funds have been found to aid regional SME innovation. Should the UK offer more funding beyond tax relief?
Thoughts for the future?
How can relief for businesses doing R&D become motivation for businesses to do R&D?
This is the “2x GVA pounds” question, and it does not have a short answer. The decision of a company to engage with the uncertainty and possibility of innovation is complex and not fully understood. At NCUB we are about to commence two investigations, one quantitative and one qualitative, into this subject area. One outcome on the horizon will be a fair and full evaluation of how financial support affects decision making.
“At NCUB we are about to commence two investigations, one quantitative and one qualitative, into this subject area.”
This is also a policy question, asking how can R&D tax relief be used to incentivise as well as reward R&D: perhaps by encouraging first time claims or, though this may increase complexity, diversifying the nature of claims to inspire bold R&D in novel areas. Additional tax relief could be given if projects fell within the bounds of stated mission-orientated R&D, as defined by Innovate UK or UKRI, be that green technologies or otherwise.
Feeling exists that the UK research is innovative and flexible but rarely results in substantial, long-term, dominating outcomes. Perhaps businesses could, through collaboration with universities, be encouraged and supported in managing the second half of this puzzle. The UK, from the West Midlands to the North East is better at commercialisation of research than people give it credit. Further, CR&D grants generated over 13,000 jobs and returned £5.75 GVA per pound and GRD/Smart grants returned £9.00 GVA. Commercialisation can and does happen.
Thus I advise:
- You to watch this space! As NCUB reveal business motivations to innovate and collaborate
- An analysis of the success and limits of R&D tax credits to incentivise and inspire R&D in innovating and not-yet innovating businesses, leading to policy suggestions
How can all sectors be encouraged to invest in R&D?
The industry sectors of ‘Manufacturing’, ‘Information & Communication, and Professional’, ‘Scientific & Technical’ accounted for 68.6% of SME claims and 73.1% of the total credit claimed by SMES in 2016-17. ‘Wholesale & Retail Trade, Repairs’ lies a distant fourth with all other sectors even further behind. This may be anecdotally expected or even partially explained by outsourcing of R&D by the other sectors. Another angle to consider is the size of the mean average claim. The top three sectors then emerge as ‘Electricity, Gas, Steam and Air Conditioning’ (£105,263), ‘Mining & Quarrying’ (£100,000), and ‘Arts, Entertainment & Recreation’ (£95,744). Whilst the sector descriptions may muddy the waters, there are clearly stories to be told by these sectors; especially by the last, a sector not immediately associated with R&D. (Though there are also additional tax reliefs for the creative industries.)
Thus I advise:
- A quantitative and qualitative examination of sort and size of R&D projects across sectors
- A quantitative investigation into what extent R&D is outsourced to “technical” organisations
- User researchers to investigate the ease in application for each sector to make R&D claims
How can the R&D credit process be positively reformed in a nonpartisan fashion?
“Conciliatory, reconciliatory talk must lead to unifying action that puts country ahead of party.”
Parties must find what they have in common: a desire for a prosperous United Kingdom. The success of SMEs means success for the national economy; growth of SMEs means growth for the national economy, and that growth comes through innovation. The three major English parties would agree that the system would benefit from a clearer and simpler structure and, for SMEs at least, they have common goals. They would also agree on action to encourage collaboration with universities and to prevent fraudulent claims. They could hold nationally useful discussions on definitions of innovation, productivity and value, encouraging all innovation in all sectors. There is cross-party consensus of thought, but what will it lead to? Conciliatory, reconciliatory talk must lead to unifying action that puts country ahead of party. Analyses and suggestions should be made to ensure tax relief fairly incentivises and rewards R&D in an accessible manner, and in the context of an innovation-friendly tax system.
Thus I advise:
- Regular audits and analyses to ensure the accuracy and success of regulatory change
- Cross-party support by MPs to aid SMEs
- Consideration of further methods to incentivise R&D in every sector