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March 3rd 2022

Chancellor signals major reform of R&D tax credit regime

Chancellor Rishi Sunak has signalled that a major overhaul of the UK's R&D tax credit system may be on the cards.

As reported in the FT earlier this week, the OBR has said that whilst the cost of the reliefs will increase from £7.7bn in 2020/21 to £11.9bn in 2026/27, studies have shown that the parts of the scheme that target SMEs have done relatively little to improve investment.

Some preliminary measures were announced in the October 21 Budget, including an extension of the relief to cover qualifying spend on data processing and cloud storage; and a refocus on R&D taking place within the UK.

However, the Chancellor wants to go much further. In the annual Mais lecture at Bayes Business School last month, Sunak commented:

..we will deliver our pledge to increase public investment in R&D to £22bn a year. As it is, total UK fiscal support for R&D, at 0.9% of GDP, is already in line with the OECD average, but it will increase by 50%, and is forecast to move to the top quartile over this Parliament.

But the target for government investment in R&D is only part of the story. In fact, our overriding challenge is increasing the amount of business investment in R&D. It is this investment that will ultimately drive the jobs, productivity, and growth of the future, and here we are significantly lagging. Self-financed business R&D as a % of GDP is less than half the OECD average. And as Cambridge economist Dr David Connell’s research shows, whilst other nations’ businesses have increased the share of GDP they devote to R&D investment by 50% in recent decades, UK business investment in R&D has stayed flat or even fallen.

So what should we do to support greater private sector investment in R&D? One obvious answer is to look at our tax regime. On the face of it, we have one of the most generous tax regimes for R&D investment anywhere in the world, measured by how much we spend on it compared to other nations. But in spite of spending huge and rapidly growing sums, clearly it is not working as well as it should. In the UK, business spending on R&D amounts to just four times the value of R&D tax relief. The OECD average? 15 times.

HMRC periodically evaluates the costs and benefits of the SME and RDEC schemes; in its last evaluations, published in 2020, it reported that the RDEC scheme (which targets larger companies) generated between £2.40 and £2.70 of additional R&D spend for every £1 of tax relief, whereas the SME scheme generated only £0.75 to £1.28 of additional spend per £1 of relief.

Whilst the SME scheme now costs more than the large company scheme to administer, it appears to offer the UK taxpayer relatively poor value for money.

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