UK Aims to Be Innovation Hot Spot With Changes to R&D Tax Relief

Although the government has remained resolute in its ambition to establish the UK as a global hot spot for innovation, one of the key policies meant to support this objective—research and development tax relief—has been subject to a series of piecemeal and complex changes in the last year. This has left many innovative businesses facing delays, added complexity, and long-term uncertainty when it comes to navigating the incentive.

Looking ahead, the government’s Autumn Statement in November promises to set the tone for the future of R&D tax incentives. Businesses are bracing for yet more change to the scheme that could impact their budgets as early as next year.

Specifically, the government has recently held a consultation on merging the existing R&D tax relief schemes—combining the existing incentive for small and medium-sized enterprises with the research and development expenditure credit (RDEC) aimed at larger companies.

Historically, SME R&D tax relief was offered at a much more generous rate compared to RDEC, reflecting the higher cost of financing R&D in smaller businesses. However, the government chose to “rebalance” the rates last autumn, increasing the generosity of RDEC and then bringing SME rates into line. Merging the rates into a single scheme would take this one step further, and the government recently published draft legislation for consultation showing what this might look like ahead of its potential implementation.

A decision on whether to go ahead, as well as when the merged scheme would commence, will be made in line with the Autumn Statement in November, but it could be introduced as early as April 2024.

While the government will be busy between now and November considering feedback from stakeholders on the design of the single scheme, there are some key areas that will be critical to a successful implementation.

These proposals mark an opportunity to end a tumultuous period for R&D tax policy, to reconnect the incentive with its policy aims, and to provide clarity to the businesses contributing to the UK’s economic recovery through investment in innovation.

R&D Supply Chain

There is currently a set of rules which govern which company in a supply chain claims R&D relief, and under which scheme. The merging of the current schemes necessitates an update to these rules, but it will be essential to make a clear distinction between the contracting out of R&D and R&D that’s carried out in the normal course of proving goods and services to customers.

This distinction isn’t always obvious, but from a policy perspective, R&D tax relief should be awarded where it will have the greatest influence on R&D investment decisions. It’s important to remember that R&D tax relief is for companies, rewarding R&D that takes place in a commercial context.

Commercial R&D will often be carried out to deliver goods and services to customers. However, the intention of the relief is to encourage businesses to increase their investment in R&D, so relief should be given to the company that controls the decision of whether to carry out more R&D.

The UK tax authority, HM Revenue & Customs, recently adopted a broad interpretation of what constitutes contracted-out R&D based on concerns that the same R&D could receive relief twice. HMRC’s broad view has so far only affected SMEs, denying relief to some SMEs entering into normal commercial contracts with customers, leading to disputes and causing much uncertainty.

The merger proposals broadly adopt the SME approach to the contracting out of R&D—so if unresolved, a merged scheme would build in this uncertainty and expand it to all companies, causing significant disruption.

Many companies will be concerned that claims could shift from the party performing the R&D to their customer. Not only is this disruptive and confusing for businesses, but it risks negatively impacting the policy aims of the incentive.

Supply chains are an integral element of most R&D projects, so refining this detail and ensuring that we don’t stifle innovation while all parties receive the funding they deserve will be critical to the success of a single scheme.

Clarifying Rules for ‘R&D-Intensive’ SMEs

The consultation’s January launch intended to implement a single scheme for qualifying R&D expenditure, with one rate, based on the RDEC mechanism. However, the draft legislation released in July comes with an important caveat—the existing SME R&D tax relief scheme would continue for “R&D intensive” SMEs, due to the commitment made in the Spring Budget in March to retain a higher credit rate for these businesses.

To avoid complicating matters further, the merged scheme should instead consider universally adopting the RDEC mechanism, while providing ongoing support for R&D-intensive SMEs through a higher RDEC rate.

The merger is also an opportunity for government to take a closer look at how “R&D-intensive” is defined, to give companies greater certainty on the financial support they can receive. The current threshold—which requires 40% of total expenditure to be allocated to R&D—is a challenging benchmark, meaning many businesses realistically won’t meet this threshold even while pioneering R&D projects.

If the single scheme is going to work in the best interests of those businesses that are pushing the boundaries of innovation, we must adopt a holistic view that accounts for how these businesses plan and forecast R&D investment.

Meeting a Tight Timeframe

While the single scheme represents a positive step toward simplification and an opportunity to create stability for an incentive that has seen so much recent change, ensuring that it remains an effective driver of R&D investment will mean businesses must have adequate time to get to grips with the changes.

We anticipate a final decision on implementation in the November Autumn Statement. If the government announces that the new scheme will take effect from April 1, 2024, businesses may have limited time to adjust their financial plans. The UK’s innovators are looking for carefully considered design, clear communication, and a clear message that this government’s policy actions align with its science superpower ambitions.

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

Author Information

Jenny Tragner is director and head of policy with ForrestBrown.

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