Following the Chancellor’s Budget announcements, the proposed changes to R&D tax relief and indexation allowance are examples of measures considered likely to have a significant effect – one positive and one negative - on impacted companies.
The good – changes to R&D tax relief
In a piece of good news, the Government has committed to increase the R&D expenditure credit (RDEC) to 12 per cent for large companies (broadly those with more than 500 employees) from 1 January 2018. This will have a significant impact for bigger businesses, and demonstrates the government’s continued support for investment in innovation and technology in the UK.
The rate will increase from 11 per cent to 12 per cent, which increases the after-tax benefit on qualifying R&D expenditure from 8.91 per cent to 9.72 per cent. The reduction in the corporation tax rate in April 2020 will further boost the benefit to 9.96 per cent.
In addition, a new advanced clearance service for RDEC claims, to provide pre-filing agreement for up to three years, will be piloted. This will be welcomed by many larger businesses that do not currently have access to an advance clearance process.
But the Government has missed an opportunity to also increase R&D tax relief for small and medium sized entities (SMEs). These companies account for a clear majority of R&D claims by volume, over 80 per cent of the claims made in 2015/16, yet command less government support in overall monetary terms when compared to large companies.
Extending support for SMEs would be a quick win for the Government, however it is perhaps understandable that after years of support for smaller businesses, it is now turning its attention to larger companies.
The bad: Removal of indexation allowance on corporate chargeable gains
In an unpopular move, the Chancellor also revealed plans to bring the UK into line with other major economies by freezing the indexation allowance on corporate chargeable gains from 1 January 2018.
Companies disposing of chargeable assets at a gain can currently ‘index’ the original cost of those assets to take account of inflation. However, following this announcement, companies must get ready to pay more corporation tax on the assets they sell as the indexation allowance that is applied to the original cost will only be calculated up to 31 December 2017.
Real estate investors are likely to be the biggest losers from this change. Historically, indexation allowance has provided a useful tax-free uplift on the costs incurred in acquiring and holding investment property to take account of inflation. Indeed, the original aim of the allowance was to ensure that businesses were only taxed on the real gains they made, particularly in periods of high inflation when assets rise in monetary value terms but not in real terms. Without this allowance, businesses in the retail and real estate sectors , which typically hold their property assets for a number of years, are likely to face a significant increase in their tax liabilities when they come around to selling that property.
This is recognised by the Government, that expects this measure to raise over £1.7bn over the next five years. The effect will also magnify over time as assets increase in value from 1 January 2018. Unlike individuals, companies do not have recourse to an annual exemption for capital gains purposes.
Whilst the Chancellor echoed his predecessor’s commitment to reduce the corporation tax rate to 17 per cent from 1 April 2020 and offer the lowest corporation tax rate in the G20, this change is another example of the Government continuing to broaden the tax base, offsetting the impact of the rate reduction.