Is the Chancellor seeking to scrap or safeguard R&D relief for our SMEs?

Jenny Tragner, Director | ForrestBrown

It is a well-worn adage that SMEs are the backbone of the UK economy. Politicians and policy-makers alike bend over backwards to emphasise their commitment to small businesses and entrepreneurship. Indeed, SMEs are a central pillar of the UK’s innovation, Levelling Up and Net Zero agendas.

According to BEIS[1], there were more than 5.5 million SMEs at the start of 2021. This is 99.9% of the private sector business population. These businesses have contributed around half of all turnover - £2.0 trillion - in the UK private sector since 2016 and create three-fifths of all jobs, totalling 16.3 million.

Despite these figures and the rhetoric, recent reports detail a “misfiring £7.7bn R&D tax credit system” with questions being raised over its effectiveness in boosting growth and fingers pointed squarely at SME R&D claims.

These misgivings may be gaining traction in No.11. The Chancellor’s attention has been grabbed by a report from Cambridge economist Dr David Connell, who refers to R&D tax incentives as a “costly failure” and advocates for a radical rethink of the way we incentivise private sector investment in R&D.

Why are SMEs coming under particular scrutiny? Widely reported problems with error and fraud in HMRC’s R&D figures stem from unprecedented growth in the volume of R&D claims made by SMEs. Unregulated and malicious agents target smaller businesses with high volume business models, driving up cases of boundary-pushing and making HMRC’s compliance of R&D claims ever more difficult.

Sunak has big plans to drive innovation, but these long-standing problems with the R&D tax credit system could hamper his ability to do so. Will he therefore aim to secure more ‘bang for his buck’ by focusing relief on larger, more profitable businesses? Doing so would be alien to core Conservative values.

We must delve deeper to reinforce the link between tax relief and R&D investment and look at where genuine R&D expenditure is centred. At ForrestBrown, we see first-hand the positive impact of the incentive when R&D investment is genuine. It fuels growth, supports the recruitment of technical staff and accelerates strategic and capital projects.

We urge the Chancellor to focus on the real crux of the issue - the reshaping of the policy and more effective targeting of the funding. This policy must be streamlined and made to work for those businesses, large and small, who need certainty, consistency and simplicity.

The process is already underway with a review of R&D tax relief, but ForrestBrown believe there are three positive, deliverable steps to achieve reform:

1.    Build a foundation for growth

Effective targeting of the incentive starts with a clear statement of intent from the Government on the purpose and focus of R&D tax reliefs, underpinning a modernised definition of R&D, which is more accessible for businesses.

Updated, clear and well-publicised guidance, focusing on practical examples and case studies would directly help to reduce errors and avoid costly disputes in the application of the definition.

2.     Effective and flexible

A more effective and flexible relief is needed to keep pace with modern R&D processes. A modernised definition of software expenditure was announced in the Autumn Budget, but there is more work to be done to streamline the rule base and link the operation of the incentive with a clear policy intent.

A consistent mechanism for calculating relief, clarification on the treatment of subcontracted R&D and an enhanced relief for capital R&D expenditure would all help to supercharge growth and reduce scope for abuse at the same time.

3.    Protecting the taxpayer 

Fraudulent and unethical behaviour hampers the effectiveness of the incentive and HMRC’s ability to address agent behaviour is severely limited because they lack the data to identify the perpetrators.

Work to address this has begun, but regulation of the professional tax advice market, via mandatory membership of a relevant professional body, would have a direct and substantial positive impact on agent behaviour.  

There may be understandable concern that the current R&D tax relief policy is not good value for money, but the blame cannot be directed at SMEs. The evidence shows that businesses – regardless of their size – that invest in R&D are faster growing and achieve greater success – with wider benefits for the UK economy.

Providing greater certainty to businesses will attract more investment, boost growth and secure our global competitiveness, whilst ensuring that targeted use of the relief can help to deliver the Government’s innovation, Levelling Up and Net Zero agendas.

Jenny Tragner is a director at ForrestBrown, the UK’s leading R&D tax relief consultancy. Jenny is a chartered accountant and ATT fellow with 20 years of experience working in tax. She specialises in supporting businesses with complex cases involving R&D tax reliefs and has published many technical articles on R&D tax policy.

For more information please visit: www.forrestbrown.co.uk.

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