Insight: Changes to the R&D tax relief scheme – a hydraulic hammer to crack a nut?

Sandy Findlay, partnership Director at ABGI, looks at the potential adverse effect of recently announced changes to the R&D tax scheme on UK business and overall economy.

When Make UK canvassed its members’ opinions for the latest “Executive Survey” in Autumn 2022, 57% of respondents announced they were planning investment in New Product Development over 2023. Fast forward to December 2022, just a few weeks after the Government announced a slew of changes to the R&D tax relief scheme and the mood is very different indeed – with Make UK’s Q4 Manufacturing Outlook reporting the first decline in the number of members planning to invest in their businesses in nearly 2 years!

Could recent changes to the R&D tax relief scheme, which is especially important to SMEs who rely on R&D tax benefit to support innovation and growth, be responsible for Make UK manufacturing membership experiencing a shift from optimism to trepidation?

The changes to the scheme are intended to reduce fraud, which HMRC suspects is occurring as a result of inaccurate R&D tax relief claims by SMEs. An unintended consequence however is the swingeing cuts to the net tax benefits received by companies claiming through the SME scheme.

This reduction in the enhancement rate from 130% (a rate which had been in place since 2015) to 86%, is scheduled for introduction in April 2023. Combined with the upcoming increase in standard corporation tax rate to 25%, this will leave SMEs with a net relief of 21.5% – a 13% reduction in the net benefit they have been relying on for the last 8 years.

Similarly, loss-making SMEs will see their tax credit rate reduced from 14.5% to 10%, reducing the cash credit payable from 33.5p/£1 of eligible spend to 18.6p/£1 spend – an eye-popping 44% reduction in benefit!

While no one would argue the need to ensure value for taxpayers’ money, these changes will have a significant impact on the resources available to SMEs for reinvestment in their businesses, creating a hostile environment, endangering management teams’ commitment to on-going investment and ultimately compromising businesses’ competitiveness.

Management teams are much less willing to commit funds to future investment in their business when the funding they used to rely on funnelling back into their business is slashed as a result of dramatic policy changes by Government at short notice, leaving them with little time to plan and accommodate for the impact.

Most senior executives would agree that it’s in everyone’s interest to safeguard against fraudulent activity and to deliver better value for taxpayers. However, without widespread consultation and serious thought, the moves being taken could be likened to Government shooting itself in the foot.

A sentiment shared by Brian Frame, CEO at Rautomead, a Dundee-based SME founded in 1978, who has been claiming R&D tax relief for years. He says: “Although we fully accept that some changes are needed such as: clearer rules, registration of advisory firms and stiffer penalties for false claims – we feel that if implemented as currently proposed, these changes would only result in decreased UK business investment in R&D and fewer opportunities for engineering graduate recruitment and training. It is particularly galling at a time when government and wider economic sources suggest it is imperative to the future success of our economy that investment and growth by British industry should be stimulated. In an altruistic sense, true innovation often occurs in smaller organizations prepared to take the entrepreneurial risks. We thus believe that in the interests of the long-term prosperity of the UK, technical innovation in the country’s sadly neglected manufacturing industry should be fully supported.”

For years, Westminster has looked for ways to stimulate and grow investment in UK industry. And yet, their proposed changes to the SME tax relief scheme will mean a minimum 13% and maximum 44% reduction of funds available for innovative SMEs within the year. A situation that could be made even worse if the Treasury’s current proposal to replace the current R&D tax regime next year with a new, single “RDEC style” system, is implemented without serious consideration of the impact to SMEs.

To tackle fraud and improve return on Government spend through the R&D tax relief schemes, the UK needs a more proactive approach. Investing in additional qualified resources to monitor claims and regulating third-party providers and agents could limit fraudulent activity without derailing the drive to grow investment by British industry.