David Philp: New R&D regime requires government rethink

David Philp: New R&D regime requires government rethink

David Philp

R&D tax expert David Philp discusses the effectiveness of the UK government’s R&D tax relief scheme, and what upcoming changes to the scheme will mean for SMEs, giving critique and emphasising the need for more consultation to ensure the scheme’s success in driving innovation in UK companies.

The UK government’s R&D (research & development) tax relief scheme has been an effective means of incentivising British companies to invest in innovation as they aspire to be world-leaders within their market. Statistics from 2020 show around £7.4 billion in R&D tax relief claims helped drive over £47bn in R&D expenditure within UK companies.

With ministers keen to ensure it continues to reward genuine innovation and deliver value for money, changes to the R&D tax relief scheme are about to be introduced. From 1 April 2024, a newly merged regime will replace the current SME scheme, for smaller businesses, and the RDEC scheme, which supports larger companies. The unified scheme seeks to simplify the process for applicant companies but it also comes with a lower rate in tax relief for SMEs.

After strong lobbying from the life sciences sector, the Chancellor also created a new SME ‘high intensive’ scheme for expenditure incurred after 1 April 2023 which is very much aligned to the previous SME scheme but targeted at companies spending a minimum of 40% of their total expenditure on R&D, with the threshold reducing to 30% for accounting periods beginning on or after 1 April 2024. Under this new scheme, loss-making ‘high intensive’ SMEs will be eligible to claim £27 in relief for every £100 of qualifying expenditure.

While there is logic behind the new R&D tax relief scheme, the legislation appears to have been rushed through and could prove detrimental in achieving the wider aim of increasing UK company investment into innovation.

New requirements for companies to notify of any R&D expenditure within six months of their year-end or have their claims invalidated, appear to be designed as a tripping-up mechanism rather than an effective means of combating fraudulent claims. It’s little surprise the House of Lord’s sub-committee recommended that this measure should be dropped before the Bill is introduced into Parliament.

Furthermore, a restriction on overseas subcontractor costs included as part of the new regime demonstrates shortsightedness from the UK government as innovation is rarely restricted to borders. UK companies that are focused on R&D investment will often have overseas subsidiaries and their R&D activities could be significantly impacted if there is no exemption for these.

New contracted out R&D rules have also been provided as part of the legislative changes in an attempt to simplify the ongoing debate on “who owns the R&D.” Detailed guidance on this was issued in mid-February, allowing for an extremely short consultation where feedback is required by the end of the month.

The hurried nature of the new R&D tax relief regime leaves much to be desired. While the UK government set out to simplify things, businesses are still left with two schemes which does little to increase clarity for applicants. It also seems logical that the additional support being offered to ‘R&D intensive’ SMEs should also be incorporated into the merged scheme.

As the new legislation stands, it will create added complexity for businesses and raise the potential for envelope pushing to meet the SME intensive threshold of achieving the upper threshold of more than 40% expenditure on R&D activities.

With the UK operating in a challenging post-Brexit environment, it is crucial that we maximise incentives that promote investment in R&D. We need to look to the examples of France, where the R&D tax credit is equal to 30% of eligible innovation investment expenses, and Ireland, where the rules governing R&D tax relief are far less complex compared to the UK.

Ultimately, the uncertainty around the UK’s new R&D tax relief regime is likely to have an adverse effect on innovation investment as it’s not possible for many companies to commit to the long-term forward planning the new legislation will require.

The new regime has been rushed through without proper scrutiny and its timetable for implementation is too tight. If the UK government wants to ensure R&D tax relief will continue to drive innovation to make British companies world-class then its needs to allow more time for consultation to iron out the flaws of its proposed legislation.

David Philp is head of R&D tax at accountants CT

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