Jak Henderson

While much of the recent discussion has revolved around speculation as to whether she will break Labour’s manifesto commitment and increase personal taxes, a renewed focus on R&D (research and development) tax relief could provide an important route for stimulating the economic growth that is so badly needed to bolster UK finances.

R&D tax relief is a UK government scheme introduced in 2000 which has proven to be an extremely powerful measure incentivising investment into emerging and innovative companies. It had, however, also become a source for fraudulent claims which led to a reduction in the benefits available to many SME applicants. This was offset by an increase in the Research and Development Expenditure Credit (RDEC) rate for larger companies.

The most recent statistics covering 2023–24, which followed the implementation of the non-compliance crackdown, showed a two percent fall in the estimated level of R&D tax relief support for UK companies accompanied by a 26% decrease in the number of overall claims. While we witnessed a 36% increase in tax credits granted for RDEC claims, support for SMEs plummeted by 29%.

The moves by HMRC to address non-compliance issues around R&D tax relief claims appear to be having a disproportionate impact on smaller companies – understandable given that smaller claims were the most prevalent area of non-compliance, but causing issues nonetheless. Among these are likely to be highly innovative businesses that are missing out on tax system support to help them develop their technology to become world-leading businesses. Such businesses are key in helping fuel economic growth, and the ones that typically benefit the most from assistance like R&D tax relief.

The crackdown was necessary and HMRC’s approach to tackling inappropriate claims appears to have been extremely effective, however it also appears to be impacting genuinely innovative companies which rely on tax credits as an extra runway between funding rounds to support growth. It seems crucial that we now consider a new mindset to support these types of up-and-coming businesses to help them scale up.

There is simply not enough concentrated capital to allow such UK companies to bridge the gap to become global leaders, especially for those approaching larger level funding rounds. As a result, some are falling by the wayside while many others are being gobbled up by foreign entities long before they reach their maximum potential as UK-headquartered businesses. The UK’s role is therefore as an incubator rather than a scaler of its brilliant ideas.

In determining how we can best stimulate growth through the economy and tax system, Rachel Reeves should look carefully at Ireland which has increased its R&D tax relief rates to 35%, significantly higher than what it is here. This signals a real intention to promote and reward innovation amongst Irish companies.

Change has been a consistent presence in R&D tax relief over recent years, culminating in the move to the new Merged and Enhanced Research-Intensive Schemes (ERIS), both of which apply additional limitations on the quantum of claims. Whether this is by overseas restrictions or by simply reducing the surrender rate achievable by a company, neither of these can match the benefit of the SME scheme at its peak. In an environment where access to funding is becoming increasingly challenging, a method to bridge the gap is vital. The Chancellor should consider Ireland’s example and look at increasing the benefit of both the Merged and ERIS schemes as they currently stand.

Of course, enhancing the allure of these schemes also increases the chances of non-compliance. To address it, one potential option is for HMRC, with direct input from industry experts, to take a much stricter and defined definition on what fields of science and technology can qualify. This would also give government the flexibility to tailor where it most wants to deploy additional capital. Other methods such as the re-introduction of the long-dormant advance assurance scheme could also prove helpful, as well as requiring R&D advisors to be registered with a professional body.

Many more innovative UK spinouts and startups within the technology and science ecosystem could benefit from an increase in R&D tax relief grants. This would offer an ideal platform to provide equity and debt free income to those potential high growth companies trying to bridge the gap between funding rounds.

With the Chancellor already facing calls to raise taxes to meet spending shortfalls, it may not be a popular move to increase spending on tax relief for business. However, if the UK truly wants to embrace innovation and support successful, global facing companies, Ms Reeves must not overlook the key role R&D tax relief can play in driving forward economic growth.

Jak Henderson is assistant manager in the R&D tax team at accountants CT