2021 is turning out to be a big year for UK innovation. We have seen the government commit to spending £15bn ($20.8bn) on R&D and launch the new Advanced Research and Invention Agency. However, there is more to come; this summer the government will launch its innovation strategy, which will include changes to R&D tax credits, writes Ben Craig, R&D tax senior manager at Ayming UK & Ireland
There has been fierce debate as to the R&D Tax Credit Scheme’s future. And while the majority want to see the scheme tweaked, some have questioned its effectiveness altogether.
It is true that the scheme is in drastic need of an update, but there is also no question that it has been pivotal to driving innovation in the UK because it encourages businesses to reinvest in R&D projects.
If anything, it is positive that the government has recognised there are shortcomings, and the consultation is an opportunity to augment what has been a very successful program.
Backing the scheme
A few weeks back, the Cambridge Judge Business School released a report arguing that the current scheme actually stalls innovation, highlighting that R&D spending is, in relative terms, lower than when the scheme was first introduced.
The core argument here is that the theory behind R&D credits is flawed because reducing the cost of R&D does not encourage businesses to invest into R&D overall. Instead, the authors believe that companies simply use the tax credit to save money, rather than to drive investment.
These conclusions are misguided. Not only does the government data suggest that £1 of R&D tax credits generates between £1.40 and £1.70 of additional R&D spending above the credit provided, but the experiences of any R&D consultant counter this. Companies we work with, both big and small, extract massive benefits from the scheme.
The credits provide smaller companies with a vital cash injection when resources are tight, while larger companies factor them in when deciding whether to proceed with certain activity. They can be the very reason a company does an R&D project, because there is less financial risk should the project not pay off. And that is exactly their intention: encourage businesses to do R&D they would not otherwise.
Having vocalised this support, there are several areas that need the attention of policymakers.
- Adjust and simplify the cost criteria
The most obvious of these is to update the cost criteria, which have remained unchanged since the scheme was first introduced 20 years ago. To put that into perspective, that is when the world saw the first digital camera.
We are well into the digital era, but companies still cannot claim for costs associated with technology that now forms the backbone of modern innovation, including those relating to cloud computing and data. The criteria must be updated to better reflect how businesses spend their innovation budgets, and be updated more regularly.
Additionally, the criteria should be simplified where possible. For example, the scheme also currently distinguishes between capital expenditures (typically one-time large purchase of fixed assets) and revenue expenditures (ongoing operating expenses), which is an unnecessary complication.
Some firms are put off by the complexity of the claiming process so, by making it simpler, the government will encourage more claimants and drive innovation forward.
- Avoid cashflow glitches for SMEs
As it should, the government currently distinguishes between large and smaller companies, offering more generous credits to SMEs than to bigger companies. However, there is a technical but very important snag preventing some SMEs from benefiting from the incentives. Unlike the Research and Development Expenditure Credit (RDEC) scheme for larger companies, the SME scheme interacts with a company’s tax in a way that can affect when the company receives the money.
SMEs that are profitable, but with no immediate tax liability due to making losses in previous years, can only benefit by reducing future tax liabilities, potentially deferring the cash benefit by many years into the future. Under RDEC, on the other hand, companies receive cash up front, regardless of their tax position.
For a small business, where cashflow is very important, this can be a major concern, particularly if the company has been used to receiving a payable cash credit for its R&D claim in previous years. Most concerningly, the Treasury appears not to be aware of this problem, or understand why it is a concern for SMEs.
Ideally, a company’s tax position should not have a negative effect on the money they can get out of the R&D scheme, so the SME scheme should be modified to mirror the RDEC. It is an administrative change that is cost-neutral to the government, but could make a big difference to small start-ups, for which money now is much more valuable than money in several years’ time.
- Rethink the administration
The government should not just look at the details of the scheme itself, but also look at how HMRC deals with claims, which is currently a slower process than necessary. This is mostly a resourcing issue, but it could easily diminish the burden of claims assessments.
HMRC staff have to spend time scrutinising claims because of fraud. Over the last year we have seen several high-profile cases of fraud, but this is probably the tip of the iceberg. There is an abundance of anecdotal evidence that people are filing for more credit than they should – and getting away with it.
In response, HMRC’s approach is that the claimant must prove that their claim is not fraudulent, assuming guilt over innocence. And because HMRC staff are not R&D experts, they can fixate on awkward details without looking at the claim as a whole, discouraging claimants, delaying the application process, and taking up HMRC’s time.
Now is the time for an approach that stays on top of fraud without hampering the overall process.
HMRC’s limited resources would be better spent evaluating the claim as a whole, considering the fundamental questions of whether R&D is taking place, and whether the values claimed are appropriate. It is a waste of inspectors’ time to be engaged in ‘box-ticking’ exercises that do not really look into the fundamentals.
That said, part of the problem lies in the fact that tax advice is an unregulated market, with some consultancies actively recommending businesses apply for more than they should. If there was a framework in place that better regulated the market and improved the standard of advice in the market by having pre-approved consultancies, HMRC’s governance would be much simpler and the whole process could be sped up for all parties.
Upgrades, not overhaul
The fact that the government is looking to make changes to the R&D tax credits is welcome news, and the review is a great opportunity to build on the success of the scheme.
There is no need to reinvent the wheel, but what the government needs to do is make small, focused changes to bring the scheme up to date to better suit contemporary business needs and to make life easier for all parties involved.