How a ￡15 billion revision to UK R&D statistics could change R&D Tax Credits
On 29 September, HMRC released its annual statistics relating to R&D Tax Credit claims.?
As usual, most R&D advisors and accountants focussed on the overall number and value of R&D claims being made, however, tucked away at the end of the announcement was news of a significant revision to the estimated value of R&D being undertaken in the UK economy.
In economic terms, this revision was substantial.?It could also have a profound impact on the future of R&D Tax Credits.?
Each year, the Office for National Statistics (ONS) publishes the BERD survey which estimates the total expenditure on R&D carried out by businesses in the UK.?The ONS’ BERD survey is separate from the value of R&D filed by businesses in R&D Tax Credit claims.
What has puzzled HMRC and the Treasury over recent years is why the ONS’ R&D estimates and the value of R&D for tax purposes have diverged significantly.?
In 2020 for instance, the total value of R&D being undertaken by businesses in the UK was estimated by the ONS at ￡26.1 billion, which is around ￡11 billion lower than the equivalent HMRC figure for R&D Tax Credits.?This variance suggested that there was 42% more expenditure being claimed for R&D Tax Credits than there was on R&D being undertaken in the UK economy.
Whilst some of the differences can be accounted for by factors such as overseas R&D not appearing in the ONS figures, the variance was so enormous that the spotlight has for some time shone on HMRC’s management of the R&D Tax Credit scheme.
A National Audit Office (NAO) report into the HMRC operation of R&D Tax Credits was commissioned by the Treasury in 2019 and concluded that HMRC was not operating a proper compliance regime and did not understand the risks it was supposed to be policing.?
As a result, the NAO placed a qualification over the HMRC accounts for 2020 and HMRC had to plan for substantial and urgent improvements.
Significant amounts of fraud and error were suspected to be at the root of the problem, and HMRC is known to have bolstered its R&D team with the addition of 100 new inspectors which has resulted in tax fraud investigations being opened into over 1,500 R&D claims.
Whilst fraud and error are undoubtedly a significant problem (HMRC’s own estimate is that 4.9% of the overall cost to the Exchequer of R&D tax reliefs is attributable to error and fraud) it still didn’t explain such a large discrepancy.?The political pressure has been firmly on HMRC to explain why its figures have grown so far apart from the ONS.?
Unexpectedly, HMRC announced last week that the ONS has found a solution to the variance:
“Following interim methodological improvements to better represent small businesses, the value of expenditure on R&D performed by UK businesses according to ONS' BERD survey were ￡15.0 billion, ￡15.6 billion, and ￡16.1 billion higher in 2018, 2019 and 2020 respectively than previously estimated; this brings the ONS estimates closer to the HMRC statistics”
At a stroke, the ONS has added at least ￡15 billion to its annual estimate of R&D being undertaken by businesses in the UK.??
This revision has potential implications for R&D Tax Credits because the ONS figures feed into the estimated UK Gross Domestic Expenditure on R&D.?
The UK government had set a target to increase the proportion of GDP being invested in R&D from 1.74% in 2018 to 2.4% by 2027.?However, the ONS revisions announced last week suggest that GDP for 2018 was partially calculated using a figure that was ￡15 billion lower than it should have been.?
Rather than being a perennial R&D laggard amongst developed countries, it turns out that the UK has already been meeting the 2.4% R&D target for several years!
There is no doubt that the ONS revision is incredibly convenient for the Government in that:
However, the Treasury could have an even bigger bonus in mind.
With the 2.4% “R&D as a proportion of GDP” figure appearing to have been achieved several years early, the government might see an opportunity to reduce the generosity of an R&D Tax Credits regime that costs the Treasury around ￡8 billion per year.?
With this revision, the Treasury could go one of two ways.
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1.???Reduce the value of R&D Tax Credits
Providing businesses, and particularly SMEs with exceptionally generous R&D reliefs was part of the agenda to achieve the 2.4% R&D target, therefore the Treasury could now declare “mission accomplished” and reduce the rates at which companies benefit from R&D Tax Credits, potentially saving billions of pounds in tax.?
When compared with similar schemes worldwide, the payable R&D Tax Credit for SMEs is amongst the most generous so with a Truss government retaining a lower Corporation Tax rate (19%) for all businesses rather than the higher rates (up to 25%) with targeted reliefs favoured by Rishi Sunak, we may well see the payable SME R&D Tax Credit rate of up to 33.35% reduced.
Such a move could form part of an integration of the SME and RDEC schemes which would save the Chancellor from the negative publicity of having to announce specific reductions to the SME rates on Budget Day.
Another option could be to restrict certain R&D cost areas, such as Qualifying Indirect Activities, or to re-introduce a minimum R&D spend similar to the one in place before George Osborne removed it in his 2011 Budget (a move which led directly to the large amount of highly dubious low-value R&D Tax Credit claims currently being submitted).
2.???Maintain or enhance the value of R&D Tax Credits
Alternatively, the Treasury could double-down on R&D incentives to help achieve the economic trend (GDP) growth of 2.5% targeted by the new Prime Minister and her Chancellor.?
This could be aided by increasing the 2.4% target for R&D spending as a proportion of GDP, perhaps towards the levels seen in countries such as Germany (3.2%) and the US (3.1%).
In this scenario, R&D Tax Credits would remain a key component of the government’s growth agenda as it seeks to both “cement the UK’s position as a science superpower and innovation nation” as well as attracting inward investment into the UK from around the world.?
After more than 20 years of operation, R&D Tax Credits are far too embedded in the UK innovation ecosystem to be abolished altogether and such a move would send a terrible signal to prospective investors in the UK.?
Whilst abolition would seem inconceivable, a significant downgrade of generosity may be on the cards.?
As someone who has been active in the R&D Tax Credit field for 17 years, I believe this would be a mistake.?With the government’s stated aim being to deliver “growth, growth, growth”, now is the time to build on the success of innovative UK business and enhance the role that R&D Tax Credits play in growing the economy.
Of course, HMRC needs to get a grip on the large amounts of fraud and error and in particular combat the rise of firms that operate R&D “claim farms” that submit spurious claims on a volume basis and which bring the R&D Tax Credit regime into disrepute.?
The problems of over-claiming and boundary-pushing that have plagued the R&D regime are resolvable.?In some ways, the rather inventive approaches that some R&D advisory firms?have adopted in their flexible interpretation of the HMRC guidelines highlights the creativity of UK entrepreneurs!
The onus should be on HMRC to publish clearer scheme guidelines, including an updated definition of what constitutes Research & Development, as well as instituting a more rigorous review process and having a less haphazard approach to R&D claims investigation.
The Treasury should not lose sight of the long-term benefits that incentives such as R&D Tax Credits bring.?Over the last decade, the UK has become a tech powerhouse and a magnet for investment that has resulted in the UK being second only to the US for start-up investment in the first quarter of 2022 and ahead of both India and China for the first time.
Venture Capital firms constantly tell me that R&D Tax Credits are a crucial component of their portfolio companies’ growth strategies and that a watered-down SME R&D credit would inhibit growth for UK tech businesses.?
Enhancing the benefit of R&D Tax Credits would indicate that government is not resting on its laurels and would be a fantastic signal to the rest of the world that the UK is serious about going for growth.
Rufus Meakin is a specialist in helping companies prepare large and complex R&D Tax Credit claims where robust HMRC compliance is essential.
If you would like to discuss any aspect of your R&D Tax Credits claim then please feel free to call me on 0794 110 3285
Tax Consultant, small business owner, small investor
2 年I think the real solution is for HMRC to employ some actual R&D specialists to review some claims (and pay commercial rates for doing so) and check whether the claim has merit- including site visits where it is felt it is required. Given the quite large sums involved this should prove very cost effective. Then bury the bad claim companies in a morass of paperwork and legal challenges. There are many genuine claims and I'd hate to see broad changes in the rules which negatively impact on small innotive companies in their early stages of development.
Tax Consultant, small business owner, small investor
2 年Thanks Rufus
R&D Senior Technologist
2 年A very interesting article. The real answer is to deal with those claiming incorrectly (either deliberately or simply in error) and then those whose claims are genuine can continue to reap the benefit of the scheme and ultimately this benefits the economy of course. Sadly though, as we see all too often, the government may choose to use a broad brush approach and make the scheme less generous as that's an 'easy fix'... a mistake in my view as it will negatively impact investment and stifle (to some extent) innovation.
Finance Solutions for Businesses - Providing comprehensive guidance on the options and access to Commercial Finance. Call 07816 511633
2 年How much of the 2.4% would be seen as relating to ‘actual’ R&D activity if there were the resources/technology within HMRC to check all claims or, how much would it reduce by if HMRC introduced measures that marginalised ‘rogue’ claim service providers and demanded key elements within a claim be evidenced whoever submits it.
Trusted tax adviser specialising in R&D claims for manufacturing and engineering SMEs
2 年Great article Rufus. Plenty of food for thought. When I read the articles published by HMRC I had picked up on the fact that the revised ONS figures were now very close to the HMRC claim figures and was struggling to see what this meant for the work being done to shut down fraudulent claims. As we both know the level of dodgy claims has risen significantly over the last 5 years and is my opinion higher than the 5% HMRC quote. Hopefully despite the realignment of the two measures, HMRC will continue with the proposed changes coming in next April. If anything is a threat to the good work R&D Tax Credits do for deserving innovative SMEs it is the crooked firms claiming the same relief for nursing homes, restaurants, plumbers and 100s of other business that do absolutely no R&D!