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Industrial Strategy 2017, research and development (R&D) and the UK tax system

Director & Head of Policy
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Industrial strategy - woman with innovation icons

The government’s Industrial Strategy White Paper, published earlier this week, sets out a long-term vision for the UK in a post-Brexit world. Here we review what it means for UK businesses using research and development (R&D) tax incentives.

ForrestBrown is proud to be one of the 2,000+ organisations that helped to shape this new strategy. Earlier this year, we responded to the government’s consultation on its Industrial Strategy green paper. We suggested the government should prioritize increasing awareness of its innovation incentives for start-ups and refine the R&D tax credit system. You can read more about our recommendations in our consultation response.

Increased government R&D spending

What is clear is that the government puts public and private sector investment in R&D at the core of its new strategy. It offers R&D as a solution to the productivity problems that were highlighted in last week’s Autumn Budget 2017 – and as a means to transform the UK’s economy.

A key policy announcement is the government’s commitment to reach 2.4% of gross domestic product (GDP) investment in R&D by 2027 (and to reach 3% of GDP in the longer term). This is good news, and something that many – including the CBI – have called for.

It is particularly heartwarming given that the proportion of the wealth that the UK spends on R&D has been stagnant for 15 years – and is much smaller than in similar EU countries. According to the latest ONS statistics, R&D spending in the UK was 1.7% of GDP in 2015. In terms of actual spend, this equates to £31.6 billion (in 2015) and so the government’s increase represents an extra £13.5 billion. To put this figure in perspective, £13.5 billion is the same as the cost of building Wembley Stadium more than twelve times over – which, back in 2007, cost £798 million (£1.07 billion today). It’s certainly not an inconsequential sum.

But, is it enough for us ‘to be world’s most innovative economy’? Only time will tell – especially with Brexit just around the corner. However, the government is certainly giving itself plenty of time to deliver this increase. Given it is not as ambitious as the Europe 2020 target of 3% by 2020, we hope that the government is not underinvesting in the UK’s future.

An improved UK tax system to support innovation

The government says it will improve the UK tax system to support R&D, indicating it views the incentive as an important part of the innovation landscape. It then recaps the three announcements it already made in its Autumn Budget 2017 last week. We will now explore each of these in detail.

1 – The RDEC rate increased from 11% to 12% – effective from 1 January 2018

This increase is not just good news for large companies, but for the UK economy too. It is the second official rate increase since the scheme was introduced. Large companies should be delighted, considering they have actually benefitted from an increase in generosity when the new 19% corporation tax rate came into effect on 1 April 2017. The rate change for RDEC means that the net benefit of a claim increases to 9.7p for every £1 of qualifying R&D spend.

Example RDEC calculation based on new Autumn Budget 2017

2 – A new Advance Clearance Service for RDEC

There will be a new Advance Clearance Service for RDEC. The government already has a similar arrangement in place for SMEs called Advance Assurance. This is primarily targeted at small businesses claiming R&D tax credits for the first time, and provides them with assurance that their first three R&D claims will be accepted. HMRC, the administrator of R&D tax credits, makes it clear in its guidance for Advance Assurance that it is not a clearance scheme and so we expect this new Advance Clearance Service (ACS) to take a different shape.

The purpose of ACS is to provide businesses using RDEC with the confidence to make R&D investment decisions. R&D tax incentives exist to promote private sector investment in innovation, and so perhaps with this new service the government wants RDEC to be more explicitly factored into the decision-making of bigger businesses. This fits squarely with the introduction of RDEC, which served to make R&D tax credits more visible to stakeholders (and R&D decision makers) within large companies.

It remains to be seen who exactly will be eligible for this new service, and what the ‘clearance’ process will look like. Will it be open to all, including those already claiming RDEC, or only to those making a claim for the first time as with Advance Assurance? Established R&D tax credit claimants are likely to have robust records and a clear claim methodology, whereas first-time claimants often do not, as claims are made retrospectively in the company tax return. This may lead to different approaches for new and existing claimants to ensure ACS is available to all.

We’re also intrigued to find out more about what the process will be for ACS, and in particular, what aspects of an RDEC claim will be reviewed, as well as what documentation, representations, and records will be required. Typically, HMRC scrutinize claims after they have been submitted via an enquiry – these can be lengthy and time-consuming.

Some large businesses will likely welcome the chance to pre-clear their claims, rather than risk this review happening as part of a retrospective enquiry that could impact their prior-year claims. But in order for this service to be a success, it will be important for the government to put in place a clear process and timeline for review so that it can be carried out efficiently and fit in with the overall tax compliance cycle of a large business.

3 – The government will work with SMEs to ensure they can access the maximum amount of support and launch a campaign to raise awareness for R&D tax credits.

We are delighted to read this again in the government’s Industrial Strategy White Paper, especially as it is an idea we put forward in our own consultation response. There are two challenges that the government is likely trying to solve with this activity, both of which we explored in detail in A Nation of Innovators.

The first of these challenges is the chronic lack of awareness of R&D tax credits among SMEs. We recommended in our own consultation response that the government engage in a proactive and co-ordinated engagement campaign to boost awareness amongst SMEs. It is therefore positive that the government acknowledges action is needed. We hope that the government will itself be innovative in how it goes about this so as to have maximum impact. We believe that the right way to promote the benefits of R&D tax credits for SMEs is via the incubators and investors that already provide an established and successful framework of advice for small businesses.

The second challenge is helping SMEs to tackle perceived complexities in the R&D tax legislation – and maximize their claims. We know from our own work that a large number of misconceptions exist in the market about R&D tax credits. Time and time again, we are asked, what does the government mean by research and development? One of the most pervasive misconceptions is that R&D tax credits are only for those that carry out scientific research in a laboratory. We put this down to the definition of R&D, which we believe is confusing a number of SMEs; they cannot easily relate their business activities to the government’s terminology which defines what counts as technological innovation.

R&D tax credits are highly valued by the companies that use them. We know that when an SME is able to access them, and maximize their claim, that they see the incentive as a vital source of funding. It delivers cash that helps them to invest further in their R&D by growing their development teams, putting money into new technologies and taking on riskier, innovative projects.

We are thrilled that the Industrial Strategy explicitly recognizes these two challenges and that the government is taking steps not just to raise awareness for R&D tax credits, but also to improve overall understanding to ensure businesses fully maximize their claims.

If the government is able to help SMEs ensure they access the maximum amount of support it should have a fantastic impact on the R&D investment stimulated. In his Autumn Budget 2017 speech, the Chancellor said that there are 5.5 million small businesses in the UK that give our economy ‘extraordinary vibrancy and resilience’. Currently around 22,000 claims for SME R&D tax credits are made each year, which is less than 0.5% of that figure. Even if that proportion was increased by a small margin, that represents a fantastic opportunity for the UK government – and a more productive economy.