SMEs reeling from slashed R&D tax reliefs, experts say

Small businesses in the UK are likely to be feeling the sting of reduced reliefs and disorienting policy shifts in the nation’s Research and Development (R&D) tax credit regime, according to market participants.

The latest in a string of changes to R&D in the UK saw the deduction rate for the regime’s SME scheme reduced from 130% to 86%, and the credit rate cut from 14.5% to 10%.

In contrast, the R&D Expenditure Credit (RDEC – the reliefs infrastructure for higher turnover businesses) scheme was handed a 7% boost (from 13% to 20%).

“It does feel as though, if you’re in the SME space, that money has been taken away and put into the pockets of larger international businesses,” says Catherine Hall, international tax partner at Mazars.

“The initial reaction in our client conversations was ‘how am I going to plan and manage my cashflow, especially while everything is becoming more expensive?’”

Announcing the changes as part of the Autumn Budget statement in November 2022, Chancellor Jeremy Hunt argued that “concerning reports of abuse and fraud” were the impetus for the new rates.

He added that the government will “work with industry” ahead of the next budget to understand what further support R&D-intensive SMEs may require.

But according to Hall, the government has passed up the opportunity to implement fairer, more effective measures such as narrower definitions of qualifying expenditure and further investment in compliance resources.

“There are other ways of tackling the fraud that would be more effective. It feels counterintuitive to be saying we want to support with one hand and yet turning off the tap with the other,” she comments.

“It’s probably a bit of a sledgehammer to crack a nut.”

‘Spurious’ R&D claims

The Chancellor’s measures are thought to have been spurred by a sharp uptick in the number of bogus R&D claims in recent years, particularly among the SME community.

According to research by national accountancy group UHY Hacker Young in April, it is estimated £725m in R&D tax relief was overclaimed in the 2020-21 tax year. This represents a 16% jump on the £623m suspected to have been overclaimed the year before.

But Hall’s skeptical view is echoed by Jenny Tragner, director and head of policy at R&D consultancy ForrestBrown, who argues that the fresh reductions will leave many SMEs feeling “quite hard done by”.

“Some of our clients are precisely the types of businesses that the government wants to be pointing these incentives towards, and are now facing the same reductions in relief rates as spurious R&D claims.

“Reducing the rate for everyone is not a direct way of targeting error and fraud – lots of things could do that in a more targeted way.”

However, Tragner also acknowledges the value of incentivising R&D expenditure among larger corporations, noting that “there’s good economic policy reasons why you would want to support those types of businesses, but not at the expense of R&D-intensive SMEs”.

But Hall, contrastingly, argues that there’s no guarantee that the intellectual property of such businesses will stay in the UK long-term due to them being more internationally mobile.

“Something we’d quite like to see is more support around the longer lifecycle of a business. The incentives are more based around those earlier stages, and less around taking that business through to full fruition and making it profitable.”

‘A real clear policy direction’

Hall also goes on to lament the complex and erratic nature of R&D policy in the UK, arguing that this will “absolutely hit SME businesses hardest”.

“In a time of economic uncertainty, a number of our clients have expressed their desire to be able to plan and understand the landscape – particularly when you’re looking at investing in R&D activity that might take place over a number of years.”

This is echoed by Tragner, who argued that the industry had barely digested previous adjustments to the R&D regime when the Chancellor announced his latest raft of measures.

Just four months prior to the 2022 Autumn Budget statement, HMRC published draft legislation proposing an expansion of qualifying expenditure to include data licenses and cloud services, in addition to extending the scope of relief to cover mathematical advances.

And as part of the Autumn Budget statement in 2021, then-Chancellor Rishi Sunak announced that relief for subcontracted and externally provided work for overseas activity would be excluded from the regime.

“One thing that’s really critical in an incentive that’s designed to inform behaviour and investment decisions within businesses, is a level of stability and certainty that the relief will still be there,” Tragner says.

“If you keep making changes, it’s going to create uncertainty, and that uncertainty is bound to affect investment decisions.”