David Philp: Careful reform needed with R&D tax reliefs
R&D and innovation was a key feature in Rishi Sunak’s Autumn Budget. The Chancellor underlined his aim to raise direct and indirect public support for R&D to 1.1% of GDP in 2024-25, well above the OECD average of 0.7%.
The Government hopes to bounce back from the financial impact of the pandemic by focusing on invention, discovery and creation with a clear and concise innovation strategy. The modernisation of the R&D tax relief regime - an extremely generous support to encourage companies to innovate – is an integral part of the Chancellor’s plan as to how this can be achieved.
In last week’s Autumn Budget, Mr Sunak announced reform of the R&D tax relief regime to ensure it is suitable in supporting modern research methods. Qualifying expenditure has been expanded to include cloud computing and data costs, which is coming into place from April 2023. Further reform is expected in the coming months to accurately define and target the relief to better support cutting-edge research methods.
The UK definition of R&D was last set out in 2004 and needs updating. There’s a particular opportunity to identify better ways to address R&D practices and fields, which have changed significantly since then. While the current definition is purposely broad, it’s a positive step that the Government is considering updating it as greater clarity could further widen the types of research covered by relief.
The Chancellor appears focused on leveraging more innovation from off the back of taxpayer-funded R&D activities. While UK companies claimed tax relief on £47.5bn of R&D expenditure in 2019, the Office of National Statistics estimates that businesses only carried out £25.9bn of privately-financed R&D. These estimates are not directly comparable due to differences in how they measure R&D expenditure, but the gap is partly explained by companies being able to claim for activity taking place overseas.
We’ve already seen the reintroduction of the PAYE and NIC cap on SME payable credits, a move aimed at preventing fraud within structures set up to claim a tax credit despite there being no evidence of UK-based innovation activity or job creation. We could see further anti-avoidance measures like these rolled out, or the Government may opt to re-write the legislation to fully restrict overseas R&D expenditure. I believe this would be a mistake.
While focusing on UK-based innovation is highly commendable, this type of activity is rarely defined by borders. We live in a global economy where R&D collaboration with other parties outside the UK is sensible, making overseas expenditure incurred to help push technological or scientific boundaries beneficial to our economy. If the core benefits accrued from overseas collaborations – improved skills, greater know-how, understanding, etc – remain or return to the UK, it makes sense to provide relief for UK companies that are engaged in such activities.
Any new legislation should therefore ensure we don’t lose the benefits of globally collaborative innovation activities. Targeted measures, such as reviewing the PAY/NIC Cap, should be considered instead and focus on those who look to strip out the relief without paying back to the UK.
Along with reform of R&D legislation, the Government will also set out plans to tackle abuse and improve compliance in the coming months. This has been an ongoing issue and there have been growing concerns over the past few years that the system does not provide adequate controls for the allocation of tax credits.
HMRC aims to process claims within 28 days, however, due to their sheer number, it is an uphill battle to consider every case in detail. It’s also been taking steps to combat fraudulent claims with the recruitment of an additional 100 R&D tax inspectors, underlining its intentions to ensure UK taxpayers are funding only genuine claims.
The forthcoming changes to R&D tax relief measures are welcome but they must be carefully thought through to ensure they reflect the global economy so they don’t infringe on innovation of UK companies. Just as innovators are pushing the boundaries of technological and scientific advancements, the tax legislation must adapt so that it continues to play a key role in promoting UK investment by reducing the cost of innovation. This will only be possible if the relief remains up-to-date, competitive and well-targeted.
- David Philp is head of R&D tax at accountants Chiene + Tait.