Bloomberg Tax
May 25, 2023, 7:00 AM

The UK Continues to Change Its R&D Tax Relief System for Business

Jenny Tragner
Jenny Tragner

A Spring Budget viewed as cautious in some quarters was anything but bland for research and development tax advisers. Chancellor Jeremy Hunt continued the trend of adding new rules to the government’s flagship policy to encourage private sector innovation, with more piecemeal changes to the incentive creating ever more complexity for businesses.

Although peppered with positive policies, Hunt’s budget statement lacked a coherent narrative to help businesses navigate a constantly changing R&D tax landscape, with a number of reforms already in force as of April 1—and more in the pipeline. A road map coordinating this raft of rate changes through to the end of the ongoing consultation remains conspicuous by its absence.

The government continues to trumpet British ingenuity as the key to unlocking economic growth, so in some respects it’s fitting that the chancellor takes an inventive approach to reforming R&D tax relief. Enhanced support for R&D intensive small and medium-sized enterprises is welcome, but the qualifying criteria set a high bar that many innovative businesses will find hard to reach. A threshold of 40% of total business expenditure risks limiting the enhanced rate to a select few sectors such as life sciences and biotech, and even then, mainly to those businesses yet to commercialize their R&D.

This enhanced rate still represents a decrease from the previous rate of relief for SMEs. Such has been the pace of change in recent months that this sleight of hand seems to have passed under the radar—but SMEs whose runway to profit has been significantly shortened as a result could see their chance of take-off severely jeopardized.

The squeeze on the rates for SMEs is informed by contestable data on additionality ratios—the extra spend stimulated by R&D tax relief. The received wisdom in Treasury circles is that the Research and Development Expenditure Credit scheme drives greater private sector investment for the money spent by government. But this ignores the positive spillover effects of R&D and the reality of where innovation occurs in the supply chain, with SMEs playing an important role in many sectors.

Indeed, some large businesses have voiced concerns about the impact of the reduced SME rates on their supply chain, despite benefiting from the corresponding increase in the RDEC rate that the chancellor introduced as part of his rebalancing of the two incentives.

Single Scheme Plans

This recalibration of rates of relief should be viewed in the context of future plans for a single scheme, consultation on which closed just two days before the spring budget. With the potential to simplify the system, this proposal has its merits.

A single scheme can take the best components of the SME and RDEC incentives, including the visibility the latter gives to R&D tax relief for boardroom decisionmakers. It also would provide greater certainty, with the benefit of a claim consistently proportional to the qualifying R&D expenditure incurred, enabling businesses to more easily factor R&D tax relief into financial planning.

It is unsurprising that the government is looking to simplify the scheme against the backdrop of HM Revenue & Customs’ concerns regarding abuse in the system. However, rather than making piecemeal changes, an overarching priority should be improving the regulatory framework for professional tax advisers. Abuse of the relief can be mitigated with the right resources, and we can’t let a minority of fraudulent claims impact all innovative businesses if we want to the UK to cement its place as a science and technology superpower.

Elsewhere in the documents published alongside the budget speech was confirmation that measures to restrict R&D relief on overseas R&D activities will be delayed for a year to enable further consultation and consider how these rules will work alongside the proposed combined future incentive. It was encouraging to see that the government listened to feedback, including recommendations by the House of Lords Economic Affairs Committee, with potential for mitigating measures to be included in the design of the new single scheme.

Although the government has delayed the introduction of these restrictions, the draft legislation already is influencing businesses when considering whether to locate cutting-edge innovation projects in the UK. According to our research, 50% of the UK’s STEM businesses expect to move some of their R&D activity abroad because of the upcoming changes. While the delay may have given some businesses added time to plan and adjust R&D budgets and resourcing strategies, some of our clients are already losing funding to teams in other European countries with a stronger R&D incentive and more stable policy outlook.

Investment Zones

Looking beyond R&D tax relief, the budget contained several other nods to innovation, not least the announcement of 12 investment zones across the UK to catalyze growth. These could kickstart regional clusters, with evidence for positive spillover effects from R&D investment. But the devil will be in the details. More than seven out of 10 companies we surveyed said they decide where to invest in innovation based on tax incentives and grant funding, so creating a supportive ecosystem for R&D can clearly be a powerful tool for leveling up. Getting this right could make or break the success of the investment zone policy.

The geography of investment zones also could be contentious, with none of the proposed English locations situated south of Birmingham. As with other direct interventions—such as grant funding for priority sectors from AI to carbon capture, usage and storage—there are risks in trying to pick winners, with potential for politics to come into play. For example, according to our research, there are UK regions with untapped potential for delivering economic gains, beyond the proposed investment zones alone.

It’s good news that the government understands the economic value of innovation—indeed, it’s name checked in the new Department for Science, Innovation and Technology. But it’s also important that R&D tax relief policy, which has been effective in fostering innovation for more than 20 years, isn’t overlooked in the quest to support “the next big thing.”

By their very nature, innovators often don’t fit neatly into existing categories—they redefine the fields in which they operate or even create new ones. Picking winners and losers by sector, science or geography could close the door to funding for the very businesses we should be helping to flourish.

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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