Has the Government spotted the flaw in its R&D plans?

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Any large businesses watching the Spring Statement would be encouraged by the Chancellor’s words on R&D. It certainly sounds like the Treasury has every intention of increasing the UK’s R&D tax credits for big businesses.

But all is not at it seems. The reality is that large companies are currently on track to lose R&D funding, which the Government has not made clear.

Current R&D plans mean a net reduction in funding

In the Spring Statement, Sunak declared that the Government would consider making the R&D incentive scheme more generous in Autumn as part of a review to make it have a bigger impact. And judging by recent comments, Sunak intends specifically to increase the relief for big businesses.

Good news then for big businesses? Well, potentially not.

The UK’s R&D Expenditure Credit for large businesses – known as the RDEC scheme – is calculated based on the company’s total amount of eligible R&D expenditure, of which business can then claim 13% back from HMRC. However, this is a taxable benefit, and businesses pay Corporation Tax on the credit they receive.

This raises a significant problem. Corporation Tax is due to increase from 19% to 25% in April next year, which means that businesses will receive fewer credits than before. So, unless the scheme becomes more generous, businesses are on track to see reduced R&D funding, which will almost certainly mean less invested in innovation considering the vital role R&D tax credits play in financing innovation.

The big question is: what will the Government do?

Solution or spin?

It seems unlikely that the Government has not spotted this problem, and the Treasury has simply not worked through all of the complex implications of its Corporation Tax increase.  So there is implicitly recognition that companies will lose part of their R&D cash, and potentially reduce investment, as a consequence of the rise.  But will that be accepted, or will there be corresponding changes to RDEC to solve the issue?

There are hints that plans are afoot to mitigate the change; and perhaps even to increase the benefit.  Strategically increasing the RDEC rate from 13% to 14% would almost exactly cancel out the effect on net case of the Corporation Tax increase; a further increase to 15% would give a real-terms increase in R&D investment.  That would certainly contribute to the third part of the Chancellor’s “People, Capital, Ideas” pillars.  It would indirectly support the first two elements as well, given that HMRC’s report shows that every £1 invested in RDEC generates £2.35 in additional corporate investment (i.e. Capital), and that a substantial proportion of the funding is used to create jobs and hire more People.

The potential alternative is that the Government decides not to increase the RDEC rate, accepting that this would mean a reduction in the cash benefit and hence a probable reduction in innovation investment.  How would the Government reconcile this with the drive to boost R&D spending as a mechanism for driving the economy?  The pressure on the public finances is doubtless there, particularly given the expenditure on Covid measures in the last few years; however, that should not be allowed to constrain worthwhile investments

Putting pressure on the Government

We may have to wait until November to find out if the potential increase to the RDEC scheme will provide that real-terms increase in R&D funding.

But the cut that lies ahead goes directly against the Government’s long held ambitions. We cannot possibly expect to hit our R&D spending targets if businesses have their R&D spending cut.

It it now vital that those in the R&D community put pressure on Government. At a minimum, the Government needs to increase the RDEC scheme to cancel out the rise in Corporation Tax. But if they truly want to boost the amount of R&D funding available to big corporates, as Sunak suggests, the rise will need to exceed the impact of the new level of corporation tax.

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