The Institute for Public Policy Research (IPPR) published its ‘Industrial strategy - Steering Structural Change in the UK Economy’ this month, calling for R&D and Patent Box schemes to be phased down and ultimately largely abolished.

The IPPR acknowledged the importance of R&D tax credits in driving ‘long-run productivity improvement’ and keeping ‘the economy at the frontier of globally competitive sectors’. However, they argue:

A small number of large corporations reap 95 per cent of the patent box and 80 per cent of R&D tax credits. We estimate that between 57 and 80 per cent of R&D tax credits are deadweight, subsidising spending which would have happened anyway, at an annual cost of £1.8–1.9 billion.

We believe that the advantages of the scheme for SMEs is irrefutable, and to dismantle the scheme would be harmful to the UK economy. 

If we examine the ONS data released last month the picture looks slightly different, to the one painted by the IPPR.

In 2015-16, Small and Medium Enterprises (SMEs) submitted a total of 23,645 R&D claims compared with 2,610 by Large Enterprises (LEs).  In the same period SMEs benefitted from £1.165billion in tax credits.  As expected the LEs spend more on R&D on average and received a larger share at £1.43billion. But this doesn’t equate to the 80% of potential tax credits for LE’s quoted by the IPPR.

·        SMEs benefitted from £1.165billion from the R&D tax relief scheme in 2015-16.

Indeed, the number of SMEs claims in 2015-16 grew by 34% compared with only an 8% increase of claims made by LEs.

The original purpose of the scheme is to support SMEs, which it continues to do. So, are LEs to blame for the ‘deadweight’ having taken advantage of the scheme?  Is removing the scheme for the answer?

LEs using the RDEC scheme

It should come as no surprise that LE spend the most on R&D, but the IPPR have said that they would spend that anyway.

LEs can only use the RDEC scheme which currently gives a net benefit 8.91% on their investment, compared to a maximum of 33.35% for SMEs.

However, many LEs and Multi-National Corporations are closely scrutinising the cost of being in the UK. A deal for Brexit is still to be finalised and if the R&D scheme is scrapped the grass might start to look greener elsewhere.

A closer look at Corporation Tax

The main rate of corporation tax has gradually reduced since 2010 in line with the small profits rate so the UK is an attractive place for companies. This means the largest companies now pay the same rate of tax as the smallest.  This does not explain why LEs get more value out of the R&D scheme but does show the advantage that the larger companies have been gaining over the years.

Targeting R&D tax relief is not the only means of increasing productivity, and we think it’s counter-intuitive.  The IPPR even suggest this in saying that a 1% reduction in corporation tax for SMEs would boost productivity. 

So maybe rather than look to abolish R&D tax relief, which is now established and well used across the UK, the Government could look to revise it’s standing on corporation tax to level the playing field.

Only for the young?

IPPR conclude that the R&D schemes should be abolished save for SMEs younger ‘say, five years old’.

Piers Pye-Watson, our Tax Manager thinks that this would discriminate against older struggling business who might want to innovate:

‘Our experience is that truly innovative SMEs have benefitted significantly from the scheme irrespective of their age.  Start-up have enjoyed tax credits when undertaking their R&D before the benefits of their trade have come in.  At the same time, highly skilled, experienced and market-leading but small manufacturers manage their cashflow on the basis that they will receive a smaller corporation tax bill or tax credit.

‘We have a client who needed to cut costs to keep trading during a dry spell and was considering staff redundancies. The payable tax credit under the SME scheme gave vital cashflow that saved their workforce until their new products provided the expected return.’

Improving UK productivity

UK productivity should be targeted and improved, but not at the cost of helping companies, especially SMEs, invest in R&D.

We can see that a fine balance must be struck.  The UK government must boost innovation and productivity with SMEs whilst keeping the UK attractive for LEs and Multi-National Corporations.

Where funding is available, the concept of a National Investment Bank, posed by the IPPR is a positive and direct move that could bolster the UK’s R&D.  However, setting up a new system would incur costs, when HMRC already have systems in place to provide the existing tax reliefs.

Philip Hammond gives his Budget this Wednesday, 22nd November 2017 and we will learn more about how the Government plans to tackle the challenges of increasing the UK’s productivity and R&D.

Read The Institute for Public Policy Research ‘Industrial strategy - Steering Structural Change in the UK Economy'