02 November 2022

It is no secret that innovation is crucial for long term economic growth – the government set out last year to raise investment in research and development to 2-4% of UK GDP by 2027.

Whilst R&D tax reliefs for UK businesses should play a fundamental role in achieving this, the government, and HMRC have long harboured a concern that the current R&D incentive regimes are not generating sufficient ‘additionality’ (i.e. encouraging businesses to invest more into R&D than they might otherwise have done, through the positive influence of the R&D tax incentive regimes). This, along with a rising level of abuse of the system has been a factor in the long running reforms of the R&D regimes, most recently with the changes announced with effect from 1 April 2023.

With this backdrop, the Autumn Statement 2022 announced changes that took many by surprise. For large companies, the news is good, as the chancellor increased the R&D Expenditure Credit (RDEC) rate from 13% to 20%, increasing the net of tax benefit from 10.53% to 15%.

Unfortunately for SMEs, the news was not so good and we saw the rate of benefit slashed, disproportionately impacting loss making businesses where the benefit falls from 33.35p to 18.6p per £1, and narrowing the gap in benefit between large and SME companies.

As we know, R&D tax regimes remain hugely important to the manufacturing industry and this is backed up by the latest available data from 20/21 that shows the industry was responsible for making 21 per cent of the UK’s total claims during that period.

Our latest survey findings

Our latest survey of manufacturers, run in partnership with Make UK has yielded some further interesting insights, that in many cases support the government’s concerns.

60% of business leaders did not list R&D programmes in their top 3 investment priorities for the next 2 years. Given that for manufacturers, remaining ahead of the competition through innovation, and competing with other highly industrialised countries is critical, this is a statistic as startling as it is concerning. Looking back over the past 2 years, our research confirmed that 92% of business leaders cited R&D as accounting for less than half of their total investments, whilst 44% suggested that investment in R&D accounted for less than 10%. While this will vary from business to business, we would have anticipated that investment in R&D would account for a greater proportion of our survey respondents total investments – notwithstanding that people and supply chain costs will also represent a significant outlay. Perhaps the focus has been on developing talent, or expanding and improving premises, which in turn will help to drive innovation, but again in isolation this is a worrying state of affairs.

Readers might look to the impact of Covid as a reason for this low level of investment, but unfortunately the research also confirmed that 56% of business leaders had not held back R&D investment in the past two years – suggesting that this low level of investment was not a temporary covid induced reduction, but rather, a longer term picture. With only 9% of respondents citing Government incentives as influencing their investment decisions, it is clear that the Government need to offer businesses more long term certainty over their availability, increase general awareness, and consider increasing the overall value offered.

Government intentions laid bare

The Autumn Statement announcements will be a significant blow to the SME community, increasing the net cost of innovation to small, fast-growing manufacturers that should play a large part in delivering the government’s industrial strategy. It is unclear why the government considers that reducing the rate of relief is the most effective route to targeting abuse of the system – a more targeted measure may have been to reintroduce a ‘de minimis’ limit, given the majority of abuse relates to high volume, low value claims. This would have reduced the collateral damage to genuine SME claimants, and a cynic might say that the measures announced have more to do with reducing the cost of delivering the relief to the exchequer than with reducing fraud in the system, with a potential impact on investment in more marginal genuinely innovative projects. Curiously, the chancellor stated in his Autumn Statement speech that the Office for Budgetary Responsibility (OBR) foresaw no impact on the overall investment in R&D in the UK as a result of these changes – only time will tell whether this is the case.

Aside from the Autumn Statement changes, the government already had plans to refocus the R&D regimes, and in our discussions with policymakers, it is clear that a focus, and a very definite policy change, is to encourage UK businesses to ‘Buy British’. It is doing this, by restricting R&D relief for costs incurred on either overseas subcontracting, or overseas provision of labour. Clearly it will take some time to build up the requisite skills in the UK, and so any measurable impact may be years ahead, but the intention is clear.

Further changes will be introduced from April 2023, seeking to tackle abuse of the system (through requiring more transparency and disclosure of details of the R&D undertaken when making the claim), whilst also expanding the definition of eligible costs to include additional expenditure on software, IT and hosting, in a move seeking to bring the regimes more up to date with how businesses typically now undertake their R&D.

Things to consider

In the meantime, we would emphasise that whilst R&D tax incentives may not (in and of themselves) influence investment decisions, they are nonetheless a very effective method of reducing the net cost of investment in innovation. When combined with a relatively benign rate of corporation tax (albeit rising to 25% from April next year), and a 10% rate of corporation tax for profits eligible for the UK patent box regime, the UK remains a competitive fiscal environment for innovative businesses.

We recommend that manufacturers:

  • carefully consider the impact of the Autumn Statement changes on their business, as there will be decisions to make to ensure that relief is maximised;
  • ensure that their professional advisors are providing them with forward thinking, proactive guidance on the availability of these tax incentives;
  • engage with the wider business to ensure that finance teams are aware of the extent of innovation that may be happening within the business; and
  • ensure that tax incentives and funding opportunities are escalated to Board level to ensure they are a factor in investment decisions.
James Tetley
James Tetley
Partner, Innovation Reliefs
James Tetley
James Tetley
Partner, Innovation Reliefs

Investment health in the manufacturing sector report

Our survey, with Make UK suggests manufacturers see boosting investment as critical to tackling skills shortages, energy costs and supply disruption.