The low hanging fruit of R&D tax credits

Even though recent figures from HM Revenue & Customs (HMRC) reveal record levels of spending on Research and Development (R&D) by UK companies, it remains clear that many who could claim are not doing so.

According to the latest statistics, spending reached £47bn, resulting in R&D tax relief claims of £7.4bn in 2019/20.

This is a rise of around 20% on claims for the previous year, and was dominated by the manufacturing and information technology sectors.

R&D tax credits reduce a company’s tax bill by a percentage of its qualifying R&D expenditure. This can also result in a cash tax credit when the company suffers a tax loss, helping to provide further funding for more investment.

Small and medium-sized companies (SMEs) accounted for £4.4bn of R&D tax credit claims in 2019/20, up from £3.5bn the year before. They make up most of the claims made (90%), with an average claim for 2019/20 of just over £57,300 (up 7% on the prior year).

The manufacturing sector invested the most in 2019/20, spending £14.1bn, up 8% on the previous year. The IT sector was next with spending of £7.7bn in 2019/20, up 26% on the prior year.

Third place was taken by the wholesale and retail sector with spending of £2.7bn, up 11% on the previous year.

There are regional differences too, with London and the South East having the largest slice of the cake. The Midlands and the South West come much further down the table of claims made, which suggests there is more to claim by companies in those regions.

Encouraging Innovation

R&D tax credits are a key tool of the UK government to encourage innovation to help the economy grow and to make the country more competitive, particularly as we build back after the pandemic and find our economic feet in the post-EU landscape.

An increase in R&D spending indicates that businesses are investing for the future, although not as much as the government would necessarily like. Faster growth helps the economy and reduces the government’s need to raise taxes or increase borrowing.

Britain has the stated ambition of spending 2.4% of GDP on R&D in the coming years (up from its current 1.7%), but we are way behind other countries such as South Korea that is already at twice that level.

Although companies are claiming, there are undoubtedly many who have yet to do so. There continues to be a lack of awareness by businesses that they can claim, or for what they could claim.

HMRC has made the R&D landscape less clear following its controversial change of view on the definition of “sub-contracted” R&D. In addition, recent reports of its greater scrutiny of claims to reduce errors or fraud, particularly in connection with Covid-19 funding, may be putting companies off from claiming.

Engaging the right professionals to prepare R&D claims is essential to ensure a smoother passage through HMRC’s audit process.

It is possible that we may see further reforms to the R&D tax credit regime in a future Budget. Any reforms that simplify the claims process would be welcomed by companies.