The Chancellor, Jeremy Hunt, unveiled a priority for stability and growth as part of his Autumn Statement. Most of the new measures announced were focused on lowering inflation and overcoming unprecedented global headwinds. Significant adjustments to rates of R&D tax relief were also introduced.
As you might expect, as the broader economic outlook has darkened, media coverage has been dominated by tax rises and spending cuts intended to shore up the country’s balance sheet. But close attention was also paid to reforming R&D tax relief to ensure taxpayers’ money is spent as effectively as possible by rebalancing rates within the incentive.
Increased generosity to Research and Development Expenditure Credit (RDEC)
The Chancellor reaffirmed the government’s commitment that R&D spending will increase to £20 billion a year by 2024-25, which equates to a cash increase of around a third compared to 2021-22. According to government estimates, this is the largest ever increase in R&D spend over the course of a Spending Review period.
On the face of it, this appears to be good news. An increase to R&D investment is welcome, especially as a country we look to innovate out of recession.
As part of this spending commitment, the Chancellor has announced that the RDEC rate will increase.
For expenditure on or after 1 April 2023, the Research and Development Expenditure Credit (RDEC) rate is set to increase from 13% to 20%.
These changes in rate for RDEC will be legislated for in the Autumn Finance Bill 2022 and look to ensure that the efficacy of taxpayer support for innovation continues to improve.
The government has also announced the intention to consult on the design of a single version of the R&D tax incentive. Prior to the Budget next year, it has said it will work with industry to better understand the support needed by R&D intensive SMEs.
As announced by a previous Chancellor at Autumn Budget 2021, R&D tax reliefs will be reformed by expanding qualifying expenditure to include data and cloud costs, refocusing support towards innovation in the UK, and the targeting of abuse and improving compliance. These legislation changes will be enacted in the Spring Finance Bill 2023. These measures are subject to an ongoing inquiry by the Finance Bill Sub-Committee of the Lords’ Economic Affairs Committee.
What this means for companies accessing RDEC
The RDEC rate increase from 13% to 20% equates to a 42% increase in generosity (after tax) from 10.5% to 15%.
This likely will go some way to mitigate the impact of the forthcoming changes to relief for overseas R&D, softening the blow on multinational companies impacted by domestic skills shortages.
The econometric model published as part of HMRC’s Evaluation of RDEC in October 2020 calculated additionality for RDEC as having greater potential of the two schemes. This means it is seen as providing a greater return for taxpayer’s money and goes some way to explain the Chancellor’s decision to ‘rebalance’ the relief in favour of RDEC.
Increasing the generosity of RDEC should therefore translate to a significant increase in business investment in R&D, underpinning the government’s growth strategy for the UK.
The additionality ratio advantage of RDEC over the SME rate should also continue to help to make the UK an attractive place to invest.
This rebalancing also represents a step towards a simplified, single RDEC-like scheme for all. This is something ForrestBrown has long advocated for, albeit not at a lower rate of generosity for R&D intensive SMEs.
Not only would this move simplify the relief, RDEC offers greater certainty and visibility, providing clearer benefits to business decision-making.
A reduction in the generosity of SME R&D tax relief
The Chancellor’s rebalancing act failed to bring positive news for smaller companies claiming SME R&D tax credits.
The changes include a significant reduction in the generosity of the relief for SMEs as part of a drive to improve compliance, reduce fraud and error, and to increase the efficacy of the relief as a whole. The Chancellor has reduced the enhancement rate for SMEs from 130% to 86% and the credit rate from 14.5% to 10%. A typical loss-making SME currently receives up to 33% payable credit on qualifying R&D expenditure. Following today’s announcement, from the 1 April 2023, the generosity of this credit will be reduced by 44% to 19%.
This means that a business making an SME claim that includes £500,000 of qualifying expenditure would now benefit from a payable credit of £93,000, compared to the previous amount of £166,750.
Impact on SME R&D investment
These figures paint a potentially daunting picture for smaller innovative SMEs, with the likely consequence being a slowdown in their R&D investment which has the potential to affect growth and jobs – even in R&D intensive sectors.
The drop in generosity is starker for smaller businesses, including both loss makers and those with smaller profits, because of the impact of the previously announced rise in corporation tax to 25% for businesses with profits over £250,000. This means that the changes will be felt by smaller businesses, including highly innovative pre-revenue start-ups, which contradicts the Chancellor’s suggestion that “Those with more should contribute more”.
It is not clear how this measure specifically targets error and fraud, which the Chancellor cites as the reason behind the changes. The announcement is due in no small part to HMRC’s estimates of error and fraud in the SME scheme – reckoned to be at 7.3% (contrastingly, the RDEC estimate is 1.1%).
The investment of further funds to help HMRC allocate additional staff to tackle fraud and error is welcome, but equally further transparency on the percentage split of error and fraud within the relief is needed to fully understand the scale of the problem, and evaluate any future measures taken.
What do these changes mean for innovative companies?
According to the Office for Budget Responsibility (OBR) the measures announced in the Chancellor’s Autumn Statement will have “no detrimental effect” on the level of R&D investment in the economy.
The government has said the changes will ‘support fiscal sustainability by raising revenue and reducing fraud and error, without materially changing the levels of R&D expenditure over the forecast period’.
But changes to the SME rate will hit the smallest hardest and R&D intensive high-tech start-ups may feel unfairly hit at a time when protecting and growing R&D investment is particularly challenging.
Additionally, introducing a further suite of changes increases complexity for all businesses accessing relief and a lack of certainty is likely to have a detrimental impact on investment decision-making.
In truth, the Chancellor had few levers to pull to solve the UK’s growth problem. It is a positive sign that the government is committed to increasing R&D spending in the longer term, but whilst this ambition is commendable and necessary, the UK is still mid-table internationally, lagging behind OECD competitors in terms of R&D spend as a percentage of GDP.
A modernised definition of R&D – one that mirrors the great advances made by UK innovators – would go someway to closing this gap, providing greater returns for UK plc.
The good news is that his acceptance of the importance of R&D tax incentives is explicit, and demonstrates the mainstream view, in that R&D tax credits play a vital part in the innovation ecology and wider economic growth.
At ForrestBrown we will continue help shape the future of the incentive, working with government on the ongoing reforms and consulting on improving standards in the R&D tax market.