Against a background of some “difficult decisions” being taken by Chancellor Jeremy Hunt in his 2022 Autumn Statement on 17 November 2022, the Treasury unveiled some further changes to the UK’s Research and Development (R&D) tax regime, signalling a move away from focussing support in this area on SMEs towards broader support for large companies which engage in R&D activity. These changes are in addition to the proposed legislative changes (discussed in one of my previous posts, with a full list of those changes here) which will be incorporated into the Spring Finance Bill 2023.
Research and Development Expenditure Credit
A key change mentioned in the Autumn Statement is the headline rate increase of the Research and Development Expenditure Credit (RDEC) scheme, primarily intended for use by large companies, from 13% to 20% of qualifying R&D expenditure incurred on or after 1 April 2023 – effectively a taxable credit which may be used to offset liability to UK corporation tax or claimed as a cash payment.
Whilst this will come as good news to large companies which incur (or plan to incur) large amounts of R&D expenditure, a change of this nature to the RDEC scheme had already been floated in the UK Government’s 2021 consultation, but following responses to the consultation, did not make the cut for legislative change (which was seemingly focussed on support for SMEs).
This may signify a broader move to support R&D activities for large companies in the UK – particularly in light of Jeremy Hunt’s statement that the UK Government is making these changes with a view to “rebalancing the reliefs” as between large companies and SMEs. The UK Government’s rationale behind increased support for SMEs (as opposed to large companies) in this area was premised on the thinking that so-called ‘short-termism’ should be discouraged and incentivising R&D investment at an early stage will discourage that in the long run (particularly where those same SMEs grow, list and may begin focussing more on creating immediate shareholder value rather than long-term investing).
The welcome change in tack as far as large companies are concerned is that the above thinking is now at odds with a recent BEIS Research Paper published on 9 November 2022 which found that “publicly listed companies invest up to 1% more of their assets in R&D when compared with similar private companies” and which generally reached conclusions that were “not consistent with the hypothesis that publicly listed companies are short termist in their investment behaviour”. As the UK Government becomes increasingly comfortable that supporting large companies with their R&D activities is good value for (taxpayer) money, the more likely the balance of (tax) incentives moves towards benefitting large companies.
SME ‘enhanced deduction’ and cash tax credit
With the broader move to support large companies came a, twofold, scaling back of the R&D tax regime as it applies to SMEs – both of which will come as unwelcome news for SMEs and those seeking to invest in SMEs. The first change is the reduction of the ‘enhanced deduction’ available to SMEs of 130% of qualifying R&D expenditure down to 86%. The second change is the reduction of the payable cash tax credit from 14.5% down to 10%.
To an extent, these should not be viewed as two wholly independent changes because the reduced 10% cash tax credit available to SMEs is calculated on the basis of the reduced 86% ‘enhanced deduction’ (rather than 14.5% of a 130% ‘enhanced deduction’).
I discussed in a separate blog post the importance that such cash tax credit entitlements may hold in the M&A context and part of the reason for that (which Jeremy Hunt acknowledged) is that the 14.5% tax credit rate (and the basis upon which it is applied) is relatively generous compared to other countries.
In that same blog post, I discussed the scrutiny around compliance and fraud in this area (and how that too may be relevant in the M&A context). In the draft legislation published earlier this year, the UK Government had already provided for increased HMRC powers and compliance measures to tackle fraud and abuse of the cash tax credit scheme for SMEs. Seemingly, upon a review, those changes are no longer enough and a hard reduction in the cash benefit is being used to further deter fraud with Jeremy Hunt making his view clear that it is the “generosity of the relief making it a target for fraud”.
It is clear that the UK Government’s reform of the R&D tax regime is not at an end. Jeremy Hunt reiterated the UK Government’s commitment to public spending on R&D of £20bn by 2024-5 to hit the target of UK R&D expenditure reaching 2.4% of GDP by 2027 (which data suggests the UK is close to meeting).
Perhaps the largest potential change to the R&D tax regime is the UK Government’s proposal to explore and consult on the design of a single R&D tax regime (again, something which was floated in the UK Government’s 2021 consultation but which failed to gain traction following responses). To what extent a single R&D regime would further incentivise investment from large companies (or, indeed, deter investment from SMEs) is unclear.
One thing is for certain, however, the Treasury is focussed on looking for “better value” and once again the R&D tax regime is on its radar.