‘A fundamental error by the Government’: why the R&D Scheme is still far from serving SMEs

Changes made to the R&D Tax relief scheme as part of the latest budget announcement will complicate access to tax relief by SMEs conducting R&D.

The Chancellor announced the enhanced deduction SMEs could claim for qualifying R&D expenditure will reduce from 130% to 86%.

For SMEs who are heavily involved in R&D, the repayable tax credit will remain at 14% if 40% of their total expenditure is R&D related.

By contrast, the Research and Development Expenditure Credit (RDEC) for large companies will increase from 13% to 20% of qualifying expenditure. As a net result, tax relief has favoured large enterprises and has reduced for SMEs.

Under these new rules, for every £100 that an SME invests in R&D, only £18.60 will be returned as a repayable tax credit. This means companies will be £14.75 worse off than under the previous tax regime. Although SMEs heavily involved in R&D are better off than the average small enterprise, they will still incur a loss of £6.38 for every £100.

The end of the Silicon Valley dream?

When explaining the changes, the government stated “R&D tax reliefs have a key role in incentivising R&D investment by reducing the costs of innovation.” Innovation is at the heart of the chancellor’s mission to transform the UK into a quasi-Silicon Valley. Yet, changes to the R&D scheme imply an unwillingness to offer the necessary support to SMEs.

Mike Dean, Co-Founder and Managing Director of R&D tax claims startup Whisper Claims is not impressed.“My personal opinion is that this is driven by the Government’s desire to have a more easily managed scheme, and has nothing to do with the potential impacts on businesses,” he tells Startups.

“The smallest of businesses are those that require most help and support yet all of the recent changes are balanced against them – this seems like a fundamental error by the Government.”

Sarah Barber, Jenson Funding Partners CEO, echoes similar concerns. “This will have a significant impact on early-stage tech businesses and Britain’s research capabilities, especially those that cannot devote 40% of their total expenditure to R&D investment.”

Although the emphasis on preventing fraud and neutralising rogue consultancies taking advantage of the scheme is reasonable, gaps remain. “If anything, the announcement regarding R&D intensive SMEs has the potential to make the matter of ‘pushing the boundaries’ of the scheme even worse as advisors look to push claims over the 40% threshold in order to maximise claim sizes and fees,” explains Dean.

In addition to these misplaced incentives, the changes have failed to implement a stronger policing system for the scheme as proposed by a recent House of Lords enquiry. By design, the scheme has symptoms of financial leakage despite attempts to plaster them up.

Whilst the UK Government has committed to expanding R&D spending to £20 billion a year by 2024, reaching 2.4% of GDP by 2027, the distribution of funding based on the changes will be skewed towards larger enterprises.

Flawed by design

A recent study reveals that the issues with the R&D scheme are long drawn and do not simply stem from recent budget alterations.

Over the last 18 years, £293 million of funding (5% of the total) was committed to 2,270 companies that have since dissolved. £1.05 billion was invested in 2,630 companies identified as being at high risk of dissolution (18% of funding to commercial entities).

Robert Garbett, CEO of global drone consultancy Drone Major Group, is adamant that the longstanding R&D strategy is fundamentally flawed. “Many of the innovation funding organisations that distribute much of this funding are private companies whose entire business is based on bidding for and expanding Government money,” he explains.

“This has resulted in the emergence of a self-perpetuating industry focused almost entirely on handing out taxpayers’ money, without a proper strategy for how to bring important emerging technology to market.”

The lack of a robust commercial strategy, in Garbett’s view, is making it harder to bring emerging technologies into the mainstream and is corroding the R&D Tax relief with short-termism.

An R&D Scheme that makes Startup Britain a reality

Although the numbers could encourage risk aversion for investments, Dean highlights that by definition R&D is high risk. “This is an area where there will always be a high risk of failure, particularly with start-ups, and this should not be a reason to withdraw funding – if anything it should be the opposite.”

Whilst the numbers seem alarming, they are symptomatic of both the lack of more structured support for recipients of the R&D scheme and the fact that R&D is inherently risky.

That said, Garbett believes there are reasons for optimism, not least the creation of the new Department for Science, Innovation and Technology. “What’s needed is a ‘commercialisation programme with a clear focus: to help attract investment targeted at delivering commercially-viable services to the industry, ” he emphasises.

“Research and development initiatives could then be funded to optimise benefit to the UK economy, resulting in tangible socio-economic benefits including investment growth and job creation, creating a genuine return on investment both for the taxpayers and the UK economy.”

Whilst Startup Britain may not be an overnight reality, establishing concrete and structured support systems to guarantee R&D at all stages of company growth will be a sound step forward.