As part out of his Autumn Statement on 17 November, setting out plans to balance the UK government’s books, address the cost of living crisis, and aim the UK towards long-term growth, Chancellor of the Exchequer, Jeremy Hunt, introduced reforms to the UK’s R&D tax reliefs to “ensure taxpayers’ money is spent as effectively as possible” amidst “concerning reports of abuse and fraud” in the UK’s R&D tax relief scheme.
Included in the changes is a significant increase to the large business relief scheme (RDEC) rate, raising it from 13% to 20%. However, at the same time, the small and medium-sized enterprises (SME) scheme’s deduction rate will decrease from 130% to 86% and the payable credit rate, which can be claimed for surrenderable losses in return for a cash R&D tax credit, will fall from 14.5% to 10%.
The changes to the SME scheme are expected to have the biggest impact on early-stage technology companies that are most in need of funding in the early phases of the technology development.
Office for National Statistics (ONS) statistics, released just weeks ago, showed SMEs are investing £16 billion more than previously thought in R&D (1). This shows that SMEs are a hugely significant element of the UK innovation ecosystem, and it will be really important to fully understand what impacts the changes to the SME scheme will have on the appetite and ability of innovative SMEs to continue to invest heavily in R&D.
The impact of the reforms
The announcements follow a series of Government consultations and proposed changes to the two UK schemes. This has provoked significant debate about the role and effectiveness of the UK’s R&D Tax Credit system.
As of 2021, the UK offered competitive R&D tax subsidy rates for SMEs, ranking 12th out of the 38 OECD countries in the level of support for profitable SMEs and 9th for early-stage firms not yet generating a profit (2). The level of support for large companies, however, does not rank as highly, falling in the bottom half of OECD countries for both profitable and loss-making firms.
The increased generosity of the RDEC scheme, therefore, should be welcomed as it makes the UK’s tax relief system more competitive, supporting large UK R&D-active businesses as well as contributing to the UK’s attractiveness for globally mobile R&D investment. This will also go some way to offset the impact of planned rises to the corporation tax rate.
For SMEs, however, the tax credit rate reduction will reduce the overall amount that early-stage, but high potential, companies can claim under the scheme. Tax credits for these companies provide a cash repayment up front, offering reliable support for start-ups and rapidly scaling companies that are typically pre-revenue, which forms an important part of the funding and capital they draw on – including grants, debt and equity – to develop, test and ultimately commercialise their innovations.
R&D tax credits form a core part of the government’s support for innovation. Therefore, these changes will need to be carefully considered alongside other support and incentives provided by the Government.
R&D tax reliefs to fuel growth
R&D tax reliefs support innovative businesses as they invest, driving growth and productivity across the UK. An effective system that puts a series of positive incentives in place will be important in delivering the Government’s long-term, innovation-led economic vision.
NCUB Chief Executive Dr Joe Marshall recently presented evidence in front of the House of Lords Finance Bill Sub Committee. He advised the committee to consider differential tax reliefs, like the systems set up in Spain and Canada. This would target firms and sectors that might be more likely to secure strategic advantage to the UK, or those that require more tailored state support due to specific market failures.
If the UK is serious about securing competitive advantages in the sectors and technologies that will power the future global economy, we should consider how best to target our R&D support and incentives to help us achieve this.
Despite a diminished economic outlook, there are some positives on the horizon.
Plans to modernise the UK’s R&D tax relief scheme to include a wider, more up-to-date definition of R&D and innovation are enshrined in the new Finance Bill. This will include pure mathematics, cloud computing and data costs.
The Government has also said they will work with industry to understand whether further support is necessary for R&D-intensive SMEs. Hopefully this will target key growth sectors particularly affected by the reforms. There are plans to consult on the design of a single R&D tax relief scheme, giving SMEs access to certain benefits of the large business scheme, such as ‘above the line credit’.
Critical to the next few years will be ensuring that the reforms achieve the Chancellor’s stated aim to cut down on fraud without negatively affecting SMEs’ ability to innovate and grow. Additionally, it will be important to ensure that the different parts of the system are joined up and clear about defining R&D, particularly for SMEs carrying out new innovative activity.
This means an R&D tax credits programme that is targeted, fit-for-purpose and generous enough to continue to attract world-class R&D to the UK.
Encouraging research and investment into the UK will be instrumental in realising our ambitions to drive growth and productivity.
1 ONS: “The methodology used to produce estimates of R&D performed in the business and higher education sectors has been improved to better reflect all R&D activity in these sectors; values of total expenditure on R&D performed in the UK, by all sectors, in 2018 and 2019 are both £21.1bn higher than previously published.”
2 The Chancellor’s Autumn Statement announcements confirmed plans to increase corporation tax from 19% to 25%.