R&D Tax Incentives Require Companies to Look Past Headline Rates

The UK’s strength in science and research has made it a mainstay of the Global Innovation Index, despite dropping one place in the latest league table.

The British government’s re-commitment to research and development in its recent Modern Industrial Strategy underlines the need to keep focusing on innovation as a mechanism for stimulating growth and attracting inward investment in the face of tough international competition.

Western countries, including the UK, remain among the world’s innovation leaders and take eight of the top 10 spots, according to the 2024 Index. Delve deeper into the report, however, and it’s clear that China, India, Vietnam, and other countries including Turkey, Brazil, and Saudi Arabia are gaining ground.

Growing Momentum

Western countries, perhaps aware of this shift, have responded with increasingly valuable incentives designed to attract investment and innovation. Central to this effort is R&D tax relief.

The advantage of a general R&D tax incentive, compared with other investment programs, is its flexibility. Typically sector and technology agnostic, with a broad rule base, companies can set their own priorities without permission or approval and still benefit from their efforts.

Countries can use this type of versatile incentive mechanism to continue their upward trajectory in the innovation race. The United Arab Emirates, for example, now hopes to leverage some of its wealth to pursue more diversified future revenues.

Part of that goal revolves around encouraging innovators and innovative businesses to come to the UAE, and take advantage of a new generous R&D tax incentive starting in 2026. The new incentive is set to offer a potential 30% to 50% tax credit on eligible expenditure, linked to the level of revenue and employees in the UAE.

This is another benefit of R&D tax incentives over grant-style mechanisms of support. Whereas with grants a company typically will or won’t meet the criteria, the UAE proposal is less binary. The relief is there for a qualifying business doing qualifying work, but through some carefully structured limitations it can seek to influence behavior over time.

Ireland is a vastly different country but has similar goals. It has long attracted large multinational enterprises with generous corporate tax strategies and has had an R&D tax incentive since 2004, with built-in incremental adjustments. For accounting periods from Jan. 1, 2024, Ireland has introduced a modified and more generous rate, increasing the headline rate of relief to 30% and accelerating the timeline for payment of the credit.

With the complexity of Pillar Two’s 15% global minimum tax requirements and balancing multinational tax obligations, the R&D tax incentive is a flexible tool that can be used as a quick response to a given set of conditions.

That incremental increase in generosity is a typical part of a country’s evolving R&D tax incentive. Germany, for example, which historically preferred grants and subsidies as its direct intervention methods of choice, introduced an R&D tax incentive for the first time as recently as 2020.

While the incentive was initially limited in scope, its trajectory has followed the usual pattern, with gradual increases in generosity. The headline rate of 25% relief on qualifying R&D expenditures was limited to 500,000 euros ($581,000) on its introduction, rising to 1 million euros in 2020 for a limited period. In 2024, the restraints were further loosened and this limit was extended to 10 million euros.

Stability and Complexity

Other countries have already gone through this process—France and the UK have long had generous R&D tax incentives.

France established its research tax credit in 1983 and, following a reform of the relief in 2008, it arguably has been the most stable R&D tax relief in Europe, offering a relief rate of 30% on eligible expenditure up to 100 million euros and 5% thereafter.

The road for the UK has been bumpier, with its two-scheme approach an outlier (at least until the introduction of a merged scheme), split between small and medium-sized enterprises and large companies.

Until recently, the trajectory of the relief broadly increased generosity, particularly for small and medium-sized enterprises, but a dramatic—and unsustainable—increase in uptake of the relief left the tax administration scrambling and the Treasury seeking solutions. The result for the UK has been a succession of incremental changes culminating in the introduction of a new merged scheme.

This type of response isn’t unique to the UK. There is a tension between a well understood and generous tax relief in a framework of minimal bureaucratic intervention, and the potential for manipulation of that system. France has, over the past year, adjusted its scheme with a goal of saving over 400 million euros.

The complexity for companies is that the focus is often on the headline rate. Even within the confines of a single R&D tax incentive, this can be misleading.

For example, some countries’ schemes—including the US and Canada, as well as the UK going forward—largely exclude overseas expenditure, while in other countries it will continue to be a permitted category of qualifying expenditure (albeit often subject to limits).

Similarly, while the UK’s new merged scheme allows for grant-funded R&D projects to benefit from R&D tax relief, conferring a form of double benefit on the same expenditure, many other countries consider it a choice of one or the other.

Future Interaction

The Global Innovation Index illustrates how many multiple layers feed into a country’s innovation ecosystem. The interaction between those different layers goes well beyond a headline rate and requires companies to take that broader approach in order to create the increase in innovation and productivity they are seeking.

R&D tax incentives are, however, a key tool and are here to stay. A recent statistical release from the OECD stated that almost 55% of total support for business R&D in the OECD area is provided through tax incentives. So while it’s not the whole picture, it’s nevertheless an important part of it.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

James Dudbridge is a director and leads the tax advisory practice with ForrestBrown.

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