Across a series of stories this Future Shapers investigation has looked at how the UK’s Research and Development (R&D) Tax Credit scheme is being used and applied for. It looked to shine a light on the holes that indicate an industry making money off entrepreneurs while taking no responsibility, often at the expense of the government and the entrepreneurs themselves.
The government has set itself the target of raising total investment in research and development (R&D) to 2.4% of UK GDP by 2027. At the Spring Budget 2021, chancellor Sunak announced an extensive review of the R&D tax relief system “with the objective of ensuring the UK remains a competitive location for cutting edge research, that the reliefs continue to be fit for purpose and that taxpayer money is effectively targeted”.
The review is wide-ranging and broadly will consider whether the definition of qualifying R&D should be expanded and whether the existing two separate systems of reliefs for larger and smaller businesses should continue. It will also consider whether changes should be made to how the system is administered and whether territoriality requirements should be introduced.
The UK government has recently completed its information gathering phase of its third consultation in two years on what to do with the R&D Tax Credit Scheme. The lens of the latest consultation appears to have moved away from curbing misuse to one which goes long on the UK government target of 2.4% of GDP by 2027.
At this stage it is difficult to draw any conclusions as to what the consultation may ultimately mean for R&D intensive businesses. There is currently no clear indication of the route any future reforms may take. However, if evidence obtained through the consultation indicates that changes to the regime could translate into increased investment in innovation, and particularly if it supports the UK’s post Covid-19 recovery, it is likely that the government will be keen to act swiftly and introduce reforms at pace.
Targeting record levels of R&D in the UK
The recent consultation coming off the back of the Budget announcement by the Chancellor, Rishi Sunak, emphasises that the primary target, initially set in 2017, was to reach 2.4% of GDP by 2027.
In the UK in 2018, total expenditure on R&D was £37.1 billion, £558 per head, or the equivalent of 1.7% of GDP. R&D investment has risen steadily over the past few decades, from £20.0 billion in 1986 to the current total of £37.1 billion (in 2018 prices). This is a real terms increase of 94%.
Increasing expenditure on R&D to the equivalent of 2.4% of GDP would lead to a record level of R&D investment in the UK. At 2.4% of GDP, R&D expenditure in the UK matches the current OECD average.
Putting this in an international context. UK R&D investment equivalent to 1.7% of GDP in 2018 is below the EU28 average of 2.0%, and below the OECD average of 2.4%. UK has a lower level of R&D investment than competitor countries such as France (with R&D investment equivalent to 2.2% of GDP), the US (2.8%) and Germany (3.1%).
Given the increased tensions and competitiveness wrapped into the UK’s Brexit decision one could legitimately expect to see no real curtailment of R&D service-related business however questionable their business operations. This increase and subsequent by-products with regards volume and value of claims as well as the accompanying specialist service providers was unpacked in previous parts of the investigation.
The UK definition is more tightly drawn than some international competitors. Some stakeholders have suggested that areas such as pure mathematics, the creative industries or social sciences should be brought within the definition and allowed to qualify for tax reliefs. These areas are not generally within scope for R&D support internationally, although Canada allows claims for mathematical analysis.
If, as is indicated as part of the latest consultation, the government sticks to the main change to the process that came out of the first two consultation on misuse of the R&D Scheme, to limit the value of a claim for an SME to £20,000 plus three times the company’s total PAYE and national insurance contributions’ liability per year. The knock-on impact of the potential 40% increase to 2.4% of GDP will flow through to produce over 200,000 claims a year. At these types of projected volumes of over a 300% increase, the strain on UK HMRC operations teams could well be substantive.
Given the previous challenges to the operations at the lower volumes when claims had been known to take up to 9 months to process, the pressure to call on the services of a specialist that will and currently do promote themselves as a fast—track for the process that will take all the issues off your hands will only grow. Also given the existing levels of non-payment for claims being only 0.3%, it may be that specialist agencies make the decision to pay claims to clients in advance of receiving funds from HMRC.
This would be quite a change in business model, as at present the specialist agency can receive up to 40% of the value of claim over a multiyear contract without having any liability for a false claim. This “boundary pushing” on behalf of the specialist agencies with their no-win no fee model, whilst called out in the consultation, seems to have been pushed to the long grass and deprioritised with the indication that a wider definition of R&D and subsequent eligibility of costs is desired to be part of the mechanism to reaching the 2.4% target.
The wider consequences of a further potential £250bn flowing into the innovation ecosystem certainly has the scope to act as catalyst for an increased number of propositions supporting an end-to-end service for intellectual property from idea to industrialisation from the innovation management software providers to the IP intelligence platforms as they look for further wallet share in the sector.
Dangers of unregulated
The allure of these innovations and new propositions will come with some downsides. The potential for abuse from specialist agencies, as the sector is unregulated is high. Not wishing to cast any aspersions on the well established players in the innovation community, but with new entrants coming to market everyday and offerings spinning up from contractors, freelancers and seemingly unrelated providers the learning and guidance seems to be, do your due diligence.
This scenario has echoes of the challenges which came out of the self assessment mortgage scheme that was part of the lead up to 2008’s global financial crisis, the Icebreaker tax scheme and the Employee Benefit Trusts (EBT) scandal from the early 2000’s. Employee Benefit Trusts, or EBTs, have been in existence for several decades, and are used to provide benefits to existing/former company employees and their families. An EBT is set up in the same way as a discretionary trust, with independent trustees being appointed to administer it. These types of trust were established both offshore and also in the UK, and in recent years have been targeted by HMRC that claim they can be a form of disguised remuneration scheme and can be easily misused. The government believes that, in many cases, the overriding motivation for setting up an EBT was tax avoidance, and so introduced legislation to deter their use. With EBTs, an employer pays money into a trust and that money is then paid out to the beneficiaries in the form of loans. These loans are not subject to income tax and in some cases, aren’t taxed at all. However, for an EBT to stay legal, these payments cannot be made on a contractual basis, because this would therefore make them wages and therefore, subject to usual tax deductions.
In many cases organisations, potentially on advice of specialist service providers that at the time carried no liability for the decision, ended up pushing the boundaries with the results ending up being considered tax avoidance.
HMRC ended up proposing a settlement agreement process to unwind and resolve outstanding enquiries. These arrangements seek to minimise the Income Tax and National Insurance charge on remuneration to employees and directors and may also generate a claim for Corporation Tax deductions for payments into the trust. The Finance (No 3) Bill 2011 published on 31 March 2011 introduced new legislation to put beyond doubt that such arrangements or schemes don’t work.
HMRC are still working through the costly process of winding the false claims and mistreatment that organisations carried out on the advice and guidance of the specialist agencies, management consultants, accountants and lawyers at the time. This group of rogues and charlatans benefitted from the feeding frenzy of commissions and management fees without facing the liability for an erroneous claim.
When the music stops?
The similarities between the various tax benefit schemes are strong. However, given the current government enthusiasm to push for the 2.4% of GDP target, they clearly have made the decision to keep the bandwagon playing. But be cautious that this doesn’t turn into a painful R&D equivalent of musical chairs.
As regulations and additional oversight comes into focus as it will inevitably do as a result of the outcry to excessive leakage from the boundary pushing specialist agencies or a change in flavour of government. Be careful that when the music stops you are not left standing without a chair and a hefty bill for an R&D claim that you followed because it seemed too good to be true.
Given the size of this sector and implications for the innovation ecosystem The Future Shapers will continue to keep a watching eye on the changes and will continue to report back on how they play out.