In his Spring Statement this week, UK Chancellor Rishi Sunak signalled that further reforms to UK’s research and development (R&D) tax relief would be introduced later this year.

The latest announcement comes amidst increased focus from government on incentivising greater private investment in the UK. With capital spending by UK companies averaging just 10% of GDP (less than the 14% of the OECD average for advanced economies), the Chancellor promised to introduce tax reforms aimed at boosting investment and encouraging companies to spend on training and R&D.

The case for reform

A number of changes to R&D tax relief have already been announced so that the current R&D tax system remains up to date, targeted and competitive. This includes support for data and cloud computing costs, refocusing relief on R&D undertaken in the UK, and allowing businesses to claim relief on R&D supported by pure maths.

However, the UK Government is keen to go further. Why?

In part, the Chancellor signals that he is not persuaded that all parts of the current system deliver value for money. Research published by the HMRC showed that although “UK R&D tax reliefs offer the most generous tax breaks in the world”, spending by British businesses on R&D was only four times the value of the tax relief, compared with the OECD average of 15 times.

The evaluation shows that while the scheme aimed at larger businesses generates £2.40-£2.70 of additional R&D expenditure for each £1 of tax relief claimed, the small and medium sized enterprises (SME) scheme only generates £0.60-£1.28. At the same time, the SME scheme costs more than its equivalent aimed at large businesses and has grown at a faster rate, and the R&D reliefs are forecast to continue growing.

However – in our response we strongly cautioned that as the UK strives to become more research intensive and innovative, discussions about R&D relief should be about boldly strengthening R&D reliefs, not about cutting them. The scheme needs to grow and be optimised, and that must be the focus of upcoming consultation.

Increasing headline R&D tax rates

In a response to the UK’s consultation on R&D reliefs published last year, NCUB recognised that the current support aimed at larger profitable firms is less than half as generous as it is for some of the UK’s international competitors. This was despite the large company R&D tax rate (RDEC) increasing from 11% to 12% at the 2017 Budget and from 12% to 13% in 2020.

A 1% increase in R&D tax reliefs is unlikely to make a significant difference when the UK is already lagging behind its competitors. Additionally, plans to increase corporation tax to 25% will likely diminish the benefit of a small increase in the R&D tax rate, making the UK even less attractive in several years time. The headline rate of R&D tax, corporate tax and capital expenditure will need to go further towards making the UK offer competitive and incentivising more businesses to do their R&D activity in the UK.

Targeting SMEs

Creating a more innovative economy also requires incentivising more of the six million SMEs in the UK to invest more in R&D. Many small business owners will have, in recent years, struggled to adequately invest into their businesses. A combination of the pandemic’s detrimental effects, and the rising price of energy and materials have prevented companies from taking advantage of the R&D tax relief system. Although the number of SMEs accessing R&D tax reliefs is growing, more targeted relief towards SMEs – including simplifying the system – can go a long way to help ensure continued investment and realising better value for public money.

Incentivising R&D training

Unsurprisingly, the Chancellor’s statement also highlighted the need for more training for existing staff in R&D. In a recent report commissioned by NCUB, which surveyed over 4,000 businesses on their motivations and experience interacting with universities, interactions to develop future talent were infrequently reported. Encouraging more employers to invest in staff training and dedicate time to curriculum development came out strongly as an area where more could be done to help businesses. A tax relief system aimed at incentivising training and staff secondments could also help to strengthen the UK’s talent system and improve conditions for investment and growth.

The challenges and opportunities ahead

Understanding the drivers for businesses’ R&D investments is fundamental to recognising the importance of R&D tax reliefs. R&D tax reliefs sit within a wider ecosystem of incentives and considerations that affect decisions taken by businesses on where and how to invest. We identify a wide range of factors in our R&D Taskforce report, that includes the tax framework, but also human capital, regulation, enabling infrastructure, market opportunities etc.

With growing concerns from businesses about soaring inflation, fuel prices and increased corporation tax, changes to R&D tax reliefs expected in the Autumn will need to sit alongside other incentives aimed at businesses of all sizes, both here and abroad. This is essential if we are to achieve more private R&D and innovation investment in the UK.