On 29 September, HMRC released its annual statistics relating to R&D Tax Credit claims.
As usual, most R&D advisors and accountants focussed on the overall number and value of R&D claims being made, however, tucked away at the end of the announcement was news of a significant revision to the estimated value of R&D being undertaken in the UK economy.
In economic terms, this revision was substantial. It could also have a profound impact on the future of R&D Tax Credits.
Each year, the Office for National Statistics (ONS) publishes the BERD survey which estimates the total expenditure on R&D carried out by businesses in the UK. The ONS’ BERD survey is separate from the value of R&D filed by businesses in R&D Tax Credit claims.
What has puzzled HMRC and the Treasury over recent years is why the ONS’ R&D estimates and the value of R&D for tax purposes have diverged significantly.
In 2020 for instance, the total value of R&D being undertaken by businesses in the UK was estimated by the ONS at £26.1 billion, which is around £11 billion lower than the equivalent HMRC figure for R&D Tax Credits. This variance suggested that there was 42% more expenditure being claimed for R&D Tax Credits than there was on R&D being undertaken in the UK economy.
Whilst some of the differences can be accounted for by factors such as overseas R&D not appearing in the ONS figures, the variance was so enormous that the spotlight has for some time shone on HMRC’s management of the R&D Tax Credit scheme.
A National Audit Office (NAO) report into the HMRC operation of R&D Tax Credits was commissioned by the Treasury in 2019 and concluded that HMRC was not operating a proper compliance regime and did not understand the risks it was supposed to be policing.
As a result, the NAO placed a qualification over the HMRC accounts for 2020 and HMRC had to plan for substantial and urgent improvements.
Significant amounts of fraud and error were suspected to be at the root of the problem, and HMRC is known to have bolstered its R&D team with the addition of 100 new inspectors which has resulted in tax fraud investigations being opened into over 1,500 R&D claims.
Whilst fraud and error are undoubtedly a significant problem (HMRC’s own estimate is that 4.9% of the overall cost to the Exchequer of R&D tax reliefs is attributable to error and fraud) it still didn’t explain such a large discrepancy. The political pressure has been firmly on HMRC to explain why its figures have grown so far apart from the ONS.
Unexpectedly, HMRC announced last week that the ONS has found a solution to the variance:
“Following interim methodological improvements to better represent small businesses, the value of expenditure on R&D performed by UK businesses according to ONS’ BERD survey were £15.0 billion, £15.6 billion, and £16.1 billion higher in 2018, 2019 and 2020 respectively than previously estimated; this brings the ONS estimates closer to the HMRC statistics”
At a stroke, the ONS has added at least £15 billion to its annual estimate of R&D being undertaken by businesses in the UK.
This revision has potential implications for R&D Tax Credits because the ONS figures feed into the estimated UK Gross Domestic Expenditure on R&D.
The UK government had set a target to increase the proportion of GDP being invested in R&D from 1.74% in 2018 to 2.4% by 2027. However, the ONS revisions announced last week suggest that GDP for 2018 was partially calculated using a figure that was £15 billion lower than it should have been.
Rather than being a perennial R&D laggard amongst developed countries, it turns out that the UK has already been meeting the 2.4% R&D target for several years!
There is no doubt that the ONS revision is incredibly convenient for the Government in that:
- The UK is now only slightly behind the OECD average of R&D performed as a proportion of GDP;
- The total value of R&D Tax Credits now matches the ONS estimate, correcting a major statistical anomaly;
- The amount of estimated R&D Tax Credit fraud and error (believed to be £469m in 2021-22) no longer looks much of an underestimate, and
- R&D Tax Credits appear to have delivered value for money rather than being “a costly failure”.
However, the Treasury could have an even bigger bonus in mind.
With the 2.4% “R&D as a proportion of GDP” figure appearing to have been achieved several years early, the government might see an opportunity to reduce the generosity of an R&D Tax Credits regime that costs the Treasury around £8 billion per year.
With this revision, the Treasury could go one of two ways.
1. Reduce the value of R&D Tax Credits
Providing businesses, and particularly SMEs with exceptionally generous R&D reliefs was part of the agenda to achieve the 2.4% R&D target, therefore the Treasury could now declare “mission accomplished” and reduce the rates at which companies benefit from R&D Tax Credits, potentially saving billions of pounds in tax.
When compared with similar schemes worldwide, the payable R&D Tax Credit for SMEs is amongst the most generous so with a Truss government retaining a lower Corporation Tax rate (19%) for all businesses rather than the higher rates (up to 25%) with targeted reliefs favoured by Rishi Sunak, we may well see the payable SME R&D Tax Credit rate of up to 33.35% reduced.
Such a move could form part of an integration of the SME and RDEC schemes which would save the Chancellor from the negative publicity of having to announce specific reductions to the SME rates on Budget Day.
Another option could be to restrict certain R&D cost areas, such as Qualifying Indirect Activities, or to re-introduce a minimum R&D spend similar to the one in place before George Osborne removed it in his 2011 Budget (a move which led directly to the large amount of highly dubious low-value R&D Tax Credit claims currently being submitted).
2. Maintain or enhance the value of R&D Tax Credits
Alternatively, the Treasury could double-down on R&D incentives to help achieve the economic trend (GDP) growth of 2.5% targeted by the new Prime Minister and her Chancellor.
This could be aided by increasing the 2.4% target for R&D spending as a proportion of GDP, perhaps towards the levels seen in countries such as Germany (3.2%) and the US (3.1%).
In this scenario, R&D Tax Credits would remain a key component of the government’s growth agenda as it seeks to both “cement the UK’s position as a science superpower and innovation nation” as well as attracting inward investment into the UK from around the world.
After more than 20 years of operation, R&D Tax Credits are far too embedded in the UK innovation ecosystem to be abolished altogether and such a move would send a terrible signal to prospective investors in the UK.
Whilst abolition would seem inconceivable, a significant downgrade of generosity may be on the cards.
Content by Rufus Meakin.
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