One stated objective of the UKs coalition Government is to support innovation in the British economy. The R&D tax relief has been encouraging innovation for the last 10 years. Over this time some improvements have been made to the relief, but perhaps none more significant than the announcement made by the Chancellor in the Autumn Statement of an ‘above the line’ regime for larger companies. What are the implications of this announcement and what impact will it have on the UK as an R&D hub?
The current position is this. R&D tax relief for large companies presently offers a net tax benefit of 7.6 per cent of the qualifying costs—essentially staff, agency workers and consumables. To take immediate advantage of the relief, companies need to be in a tax-paying position. For small and medium-sized enterprises (SMEs), the R&D relief available for internally funded work can be up to 26 per cent of the qualifying costs, to be increased to 31.25 per cent from April 2012. SMEs can also claim under the Large company R&D regime for work that is subcontracted to them by a large company.
In addition 65 per cent of the costs of third party subcontracted R&D work can also be included in a claim under the SME regime, this rises to 100 per cent where the subcontractor is a connected party. And, for SMEs which are not yet paying tax, the R&D losses can be surrendered for a cash credit. While at present the cash is capped by the total amount of PAYE and NI paid over to HMRC, the cap has been removed with effect April 2012.
About 18 months ago, the Government and companies engaged in a discussion about assessing the value for money of the R&D tax relief, and its potential areas for improvement. The question on the table was: is the R&D tax relief actually encouraging additional R&D expenditure in the UK? One answer was that, if the relief was an ‘above the line system’, the incentive would achieve a substantial increment in the R&D activities. In this context, ‘above the line’ means above the tax line—that is, a credit whose nature is closer to a grant than to a tax relief.
This means the costs would be reflected in the profit and loss account at the operating level, reducing de facto the net cost of R&D. If the R&D tax incentive had this structure, it would have two effects: first, the net impact of the relief would be visible to the decision-makers, from boards to heads of R&D (as opposed to constraining its visibility to the tax departments), allowing them to incorporate it into the budgeting cycle; and, secondly, companies with any given budget would in practice have their initial budget plus the ‘grant-like’ incentive to invest in R&D. The consequence of these effects is not difficult to foresee: An incremental increase in R&D activities, potentially exponential, could be achieved.
There is still some uncertainty about the mechanics of how an ‘above the line’ credit could be implemented. Regimes such as those in Ireland or France which are based on a credit convertible in cash, may be a valid model to build upon. The main question is two-fold—will the regime incorporate a refundable credit for large companies with losses? And, what will the impact on the structure of the SME relief be? In any event, the Chancellor’s confirmation that the change for large companies will not be at the expense of the SME regime is welcome.
Although the R&D relief has been in place for over 10 years, some companies which perform R&D are still not claiming all the relief they are entitled to. In most cases this is because the definition of R&D which HMRC uses is much wider than that the average person on the street would apply. Broadly, if the company is overcoming technological challenges to create a new product or process, or to appreciably improve them, then it is likely that R&D activities are being undertaken.
In addition, the Government has just published draft legislation on a Patent Box regime. It would allow the revenue generated from the sale of products which have patented technology embedded in them, royalty or licence income, or the sale of a patent to be taxed at 10 per cent rather than the 24 per cent rate that will then be in force. R&D tax relief and Patent Box are meant to actively incentivise the full R&D and technology life cycle and would provide direct support to companies who rely on technological advances to keep their businesses at the cutting edge of technology. Hopefully, the final implementation of all these proposals will translate into an increase in the competitiveness of the UK in the world of innovation.