Three reforms to enhance R&D tax relief scheme

Dave Philp, Head of R&D Tax at accountants Chiene + Tait

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By Dave Philp, Head of R&D Tax at accountants Chiene + Tait

LAST November, when Chancellor Jeremy Hunt rolled out his first mini-Budget statement, he announced major changes to the UK’s R&D tax relief scheme. This included a boost for larger companies which qualified for the Research & Development Expenditure Credit (RDEC) scheme which was increased from 13% to 20%, equating to a £5k increase for a loss-making tech start-up with £100k worth of qualifying R&D expenditure.

Mr Hunt also however announced a cut in SME R&D Tax relief scheme, the enhanced deduction will decrease to 86% from 130% and the SME tax credit rate will decrease from 14.5% to 10%. Using the above example, this equates to a decrease in a tax credit from £33.35k to £18.6k – so it was little wonder that tech founders and science chiefs queued up to criticise these measures.

In announcing these changes late last year, the Chancellor did however state that he would work with industry to better understand what further support R&D-intensive SMEs may require.

With a House of Lords sub-committee recently concluding its consultation into how to improve the scheme and the UK Government remaining committed to its support for R&D tax relief, I expect it will a key area that Mr Hunt will want to address in his March budget.

R&D tax credits have proven to be an effective means of driving innovation to help UK companies become world-leading. Statistics from 2020 show around £7.4bn in R&D tax relief claims helped drive over £47bn in R&D expenditure within companies. While the principle of the scheme is sound, there are three specific areas which need to be addressed to ensure it continues to reward genuine innovation and deliver value for money for UK taxpayers.

Firstly, much more needs to be done to tackle abuse, particularly within the SME scheme. In previous years there was an open dialogue between dedicated R&D units within HMRC and the applicant companies or their tax advisors which helped improve understanding of the scheme. Unfortunately, these seem to no longer exist as HMRC struggles to keep up with cost-cutting measures amid a significant increase in the level of claims. New measures announced –  such as the pre-notification requirement or the recent nudge letter campaign – point towards a short-term strategy to combat abuse due to lack of resources.

This approach however risks genuinely innovative companies missing out, while its impact on countering abuse is  questionable. Indeed,  the recent House of Lord’s sub-committee consultation recommending that the pre-notification requirement should be dropped before the Bill is introduced into Parliament in its entirety.  New resources are therefore required to support HMRC if the UK Government expects greater compliance measures to be suitably implemented.

Tackling fraud must include greater scrutiny over the one in five current R&D claims which are for less than £5K in value. Serious questions need to be asked about whether companies behind such relatively small claims are actually pushing the boundaries of the overall field of science or technology, as they are required to do to be eligible. Re-introducing the minimum expenditure requirement could help in addressing this issue.

In reforming R&D tax credits, ministers must also think globally as innovation is often not confined to our borders. UK Government plans to restrict overseas subcontractor costs are flawed as they will inadvertently impact innovation where part of the knowledge required to drive this forward comes from outside the UK. Exemptions should therefore be put in place to help UK companies that set up subsidiaries overseas to undertake part of their R&D work provided the application of the technology and ownership of the resulting IP is retained here.

The R&D tax relief scheme also needs to be simplified, and the recently announced consultation looking to adopt the RDEC methodology to combine the two schemes is an ideal starting point in making it more straightforward. It’s also important that the guidance surrounding the scheme is updated and provide current, relevant industry references (the current guidance includes an explanation of the technological uncertainty in a DVD player!) This will further support a drive towards legitimate claims and help companies better determine what types of R&D investment will be eligible for tax relief.


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