Is the R&D tax regime due a major overhaul?

Over the last couple of months the press has featured various views on the effectiveness of the UK R&D tax regime and suggestions as to what, if anything should be done to change it.

The Chancellor of the Exchequer, Rishi Sunak, who delivered the Mais lecture on 24 February 2022, expressed the view that the UK has “one of the most generous tax regimes for R&D anywhere in the world, measured by how much we spend on it compared to other nations” and that going forward “it would be sensible to make sure our tax regime for innovation is globally competitive and so properly incentivises business investment in R&D”. He added “but in spite of spending huge and rapidly growing sums, clearly it is not working as well as it should”. That is fair enough, but it wasn’t necessarily clear, from this lecture, what aspects of the R&D tax regime he felt weren’t working, nor that the Chancellor was necessarily considering an overhaul of the UK regime.

However, an indication of what this could mean emerged in an article in the Financial Times on 2 March 2022, leaning heavily on information provided to the journalist by “government insiders”. They highlighted Sunak’s concerns over the “poor value” of the R&D tax regime, a flagship industrial policy that, according to Office of Budget Responsibility estimates will give rise to £7.7bn of government spending in 2021/22, rising to £11.9bn by 2026/27. It was also noted in Sunak’s Mais lecture that level of R&D expenditure in UK businesses was approximately four times the value of the R&D tax relief provided, as against and OECD average of fifteen times.

The Chancellor’s thinking had been inspired by a 2021 Cambridge University report into the R&D tax regime, which highlighted the escalating cost of the regime and the limited impact on stimulating new R&D investment, particularly amongst SMEs. HMRC had also undertaken a consultation on aspects of the R&D tax regime in 2021, partially driven by questions as to the differing rates of return from the scheme.

The consultation document quoted figures of £0.60 to £1.28 of additional R&D expenditure for each £1 of tax relief provided to SMEs compared to an average additional R&D investment of £2.70 for each £1 of tax relief provided to larger companies. The “government insiders” referred to in the Financial Times’ article indicated that Sunak’s view was that the tax relief was better focused on larger companies and, by implication, this suggested a possible limitation of the relief, to provide support solely to larger businesses.

This suggestion of a major overhaul of the R&D tax regime has prompted overwhelmingly negative responses, in the press and online. These have generally questioned the proposed direction of travel of government on R&D tax relief and, in some cases, whilst acknowledging the UK’s R&D tax regime requires change to become more effective, have suggested that this is best achieved by means other than limiting the relief to the majority of the UK’s businesses.

Particular concerns have been expressed as to the impact on many SMEs who currently rely upon support through the R&D tax regime to fund R&D, this often being the case in start-ups and rapidly growing newer businesses, where reliable alternative finance is not always readily available for the higher levels of risk inherent in R&D based enterprises. There is also an apparent lack of alignment of the proposal and the government’s avowed intention to level up poorer regions, whose economic resurgence depends heavily upon SMEs, and its net-zero agenda, the success of which, in the business sector, will depend to a large degree on SMEs.

The 2022 Spring Statement from the Chancellor did not propose any major overhaul of the R&D regime but neither did it rule one out. The government concerns as to whether the regime gave value for money were reiterated and it was confirmed that the government was continuing to review the R&D regime with a view to possible further announcements in the autumn.

What’s next?

If restricting the availability of R&D tax reliefs is not a preferred policy, what could be done instead to ensure that the return that the UK economy gets from the R&D tax regime is optimised? Perhaps the answer lies in building on the changes proposed to the R&D tax regime that were proposed by Sunak in his Autumn 2021 Budget, which were slightly amended in the recent Spring Statement. These came out of the consultation conducted by HMRC earlier that year into the R&D tax regime and the proposal was that they would be legislated in the second half of 2022 and come into effect in April 2023.

The proposals made a start to modernising the UK’s R&D tax regime and to addressing three key challenges:

• A need for better guidance as to what sort of expenditure qualifies for tax benefits and ensuring that guidance reflects the modern world. Hence the inclusion of data and cloud computing costs and pure mathematics within the definition of qualifying expenditure for R&D.
• Clarity over the policy that drives and guides the R&D tax regime. For the current government that includes re-focusing support towards UK based innovation.
• Tackling abuse and ensuring compliance with the rules. This is a major frustration for HMRC who have been unable to stop increasing fraudulent and unethical behaviour by unregulated advisors.

These proposals, if legislated, would be a start to addressing these three challenges and to moving towards a modern R&D tax regime that optimised the return to the UK economy of the public investment provided to UK businesses under this regime. However, they only represent small steps down the road to meeting the challenges fully. To make real progress, there needs to be further consideration to the R&D Tax regime given by government and HMRC.

This needs to include a transparent review, to agree the aims of the R&D tax regime and how it should operate in practice, in consultation with the business community and their advisors, followed though with legislation, clear guidance to taxpayers and advisors and proper implementation and enforcement by HMRC.

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