31 October 2023
Against the backdrop of a challenging economic environment, an effective industrial strategy can play a critical role in building a stable and competitive business environment.
Our latest survey of 150 manufacturers, run in partnership with Make UK, investigates the UK’s tax and regulatory regimes and their effectiveness. With 44% of respondents believing the tax and regulatory environment as it currently stands to be unfavourable, what needs to change?
The incentive landscape for UK manufacturers
Manufacturing is a capital-intensive industry, with long-term investment cycles forming the core of growth strategies across the industry. The link between investment and productivity improvement is clear and it is vital that government does all it can to encourage investment through incentives that help UK productivity levels compete with other major trading partners and rivals. Something that is undoubtedly needed as can be seen by the latest international productivity data below.
One of the primary tools government use to incentivise investment is the capital allowances regime. And, given the capital-intensive nature of the manufacturing industry, it is no surprise that this relief was considered the most valuable to the businesses we surveyed.
Likewise, the manufacturing industry is a major driver of UK R&D activity, contributing 41% of overall UK R&D efforts and making more R&D claims than any other sector (23%). Against this backdrop, it is unsurprising that manufacturers ranked R&D Incentive regimes the second most useful tool. So let’s examine some of the recent changes to these regimes and explore how they have impacted the industry.
Capital Allowances – industry needs longevity
To be effective, it is important that capital allowances reliefs align with the long-term investment cycles of manufacturers. This is something which has been under the microscope lately, due to a number of short-lived recent policies.
In March 2021, with the aim of stimulating investment in the wake of the COVID pandemic, the government announced the most generous capital allowance regime to date, via the super deduction regime. But this regime was short lived and only applied to expenditure incurred between 1 April 2021 and 31 March 2023.
To bridge the gap left by the super deduction regime, the government introduced full expensing, offering 100% first-year relief on qualifying new main rate plant and machinery. Though less generous, the new regime was a welcome commitment to the continued incentivisation of productivity enhancing investment. However, the full expensing regime is set to end 31 March 2026, which is still relatively short lived.
As a result of the short life of these regimes, uptake across manufacturing has been lower than the generosity of the regimes may predict – highlighting the need for longevity of policy. This is evidenced in our survey findings, with 55% of businesses saying that making the full expensing regime permanent would be a priority.
R&D Incentives – more uncertainty on the horizon
The last 12-18 months have seen the largest number of changes to R&D incentives since the regimes’ inception. This includes changes to the rates of relief, with the SME additional deduction decreasing from 130% to 86%, and a decrease to the payable cash credit from 14.5% to 10% (with a new rate being introduced for R&D intensive SMEs at 14.5%). At the same time, the research and development expenditure credit (RDEC) available to large companies has increased from 13% to 20%, resulting in a net benefit increase from 10.5% to 15% once accounting for the new rate of corporation tax.
Alongside these changes, we’ve seen several new initiatives to tackle abuse and improve compliance. This has included the new requirements for claims to be made digitally, through the introduction of the additional information form, and requirements for first-time claimants to complete an R&D claim notification form. All of which is during a period of increased scrutiny, with an unprecedented increase in the number of enquiries from HMRC being observed.
Of further concern are potential future changes to R&D Incentives, with draft legislation currently in place to merge both regimes into a single tax credit. Proposed changes would prevent projects which have received grant funding or other subsidises from being claimed, in addition to restricting the inclusion of non-UK expenditure. This will have a detrimental impact on SME’s who depend on multiple funding sources to drive industry leading research, in addition to disincentivising both UK and international collaboration and R&D activity across the supply chain.
The driver of many of these changes is to improve the effectiveness of the incentives and reduce the level of fraudulent and erroneous claims, which is to be welcomed. However, these changes have disproportionally impacted genuine SME claimants most severely. It is difficult to reconcile these changes against wider policy objectives which seek to raise the UK’s position as an R&D powerhouse, as it is often SME’s who are the incubators for UK innovation.
Our Make UK survey findings indicate that the significant changes seen across both the capital allowances and R&D regimes have not had the desired impact with 54% of businesses reporting that frequent changes to policy incentives have made it more challenging to plan investments.
Systemic review of investment incentives is vital
The UK lacks a stable and long-term industrial strategy. It’s therefore wholly unsurprising that it lags behind peers in terms of investment and productivity – with UK business investment as a proportion of GDP being lower than the OECD average.
The UK government already has many generous tools and incentives in the tax and regulatory environment which, when used in the correct manner, can meet the overall policy objectives of a stable and competitive business enviroment. Therefore, the aim should not be for a full overhaul of the system, rather a systematic review of existing incentives to ensure these are easy to access, targeting the key areas for growth and generous enough to make an impact. Most important is the need for long-term vision and stability across the regimes.
If you would like to discuss any of the topics discussed in this article, please contact Rachel Milloy.