R&D Tax Reliefs: Consultation
We welcome the opportunity to respond to the Government’s consultation on various aspects of the R&D tax schemes. We are a firm of specialist advisers on R&D tax schemes founded in 2006 and a member of the R&D Consultative Committee.
We present our responses below.
Question 1 – Do you consider your company to be a research-intensive firm? How does your business benefit from the R&D reliefs (e.g. cashflow, reduced tax liability)? If your company is an SME that claims under both the SME tax relief and RDEC, what is your experience of using each scheme and how do they compare?
Within our client base the R&D intensity varies considerably. In some start up companies, it can be close to 100% whilst it can be as low as 3% of turnover in more established businesses where qualifying activity is an ancillary activity to everyday operations.
In some industries such as automation control, R&D takes place on many customer projects as each situation is different, requiring a novel technological approach and here the level can be over 50%. The benefit can take the form of an annual cash injection through the R&D tax credit scheme, reduced (or even eliminated) corporation tax liability or the ability to factor the R&D tax benefit into project costing decisions.
Many SME claimants find the distinction between SME and RDEC claims confusing such as not being able to claim limited company subcontract costs in the latter or having to restrict them to 65% for payments to individuals in the former but not for the latter.
We also find that the operation of the RDEC scheme is not generally well-understood among small accounting firms advising SMEs having to claim under it for grant-funded or subcontracted R&D projects.
Question 2 – Is there a case for consolidating the two schemes into one? What do you value about the design of the current schemes that might be lost if they were unified?
As mentioned above SMEs often have difficulty understanding the different rules and operation of the SME and RDEC schemes.
This comes into play when an SME has a mixed claim for own-account and subsidised or contract R&D expenditure. Rather than amend the RDEC scheme wholesale we would suggest looking at a modified version of the SME scheme for such situations, delivering a lower benefit roughly in line with the existing RDEC but operating in the same way as the SME R&D tax relief.
Question 3 – What do you think explains the difference in additionality between the two schemes? How could the schemes be improved to incentivise the R&D your business does or might consider doing? Can you give evidence to support your suggestions?
Perhaps the differences in additionality might be explained by other factors and not necessarily a causative relationship between the R&D tax scheme and investment. An option that might more closely tie the benefit to R&D would be for claimants to be required to state what it might be spent on and how that might benefit the business.
Question 4 – To what extent do the rates of relief available to you impact your investment decisions and/or your choice of location? Is the balance of relief between the two schemes appropriate? Is there any evidence of significant deadweight where investment decisions would proceed without relief?
Based on our experience, the availability and rate of any R&D tax incentive is just one factor influencing decisions on where multinational groups locate their operations, among aspects such as workforce skills, cost base and overall tax environment. However clients view the two UK schemes as generous and relatively straightforward in terms of structure and administration.
Question 5 – Would a departure from the ordinary Corporation Tax self-assessment system be justified? Should more information and assurance be required from companies at the point of claiming? Should a company providing more information upfront be treated differently?
The interaction with the corporation tax system provides both a legislative and administrative framework for the R&D schemes’ operation. Additionally, being part of the corporation tax sphere enables regulation and ongoing professional standards to be more easily maintained. We would therefore not be in favour of decoupling the claim process from the corporation tax return system.
At present it is not mandatory to provide supporting information with a claim made in a return but most advisers do so as a matter of best practice. Whilst we would not want to see a mandatory report format that was too restrictive we would be in favour of a requirement to supply a certain level of supporting information to encourage disclosure.
Question 6 – When did you first claim, and what prompted you to do so? Do you use an agent? If so, why? What is your experience of how agents’ fees are structured? How could the expertise and specialist knowledge of agents assisting with R&D claims be improved?
We have seen a number of small companies prepare claims in-house but the need for specialist knowledge and experience of the scheme and tax in general often results in claims prepared in-house being challenged.
Our philosophy on fees has always been that there should be some reflection of the actual work involved – whereas we have heard of some less reputable advisers abusing the scheme in order to generate enormous and disproportionate fees.
As passionate supporters of an innovation-led economy we strongly believe the R&D tax schemes should exist to primarily reward businesses performing R&D, not their advisers.
There has been a recent push to formulate a set of standards for R&D claim work with the Professional Conduct in Relation to Taxation initiative, which we support and adhere to. HMRC could raise awareness of this to help companies can choose a reputable adviser.
Question 7 – How can the responsibilities of HMRC, agents and the company be better reflected in the claims process?
Question 8 – What other changes might help claims to be dealt with more smoothly, while ensuring better compliance? Is there a way HMRC and advisers can work more effectively to improve the quality of external advice available to companies? If you claim R&D tax reliefs in other countries, how does the claim process differ and what are your views on this?
The introduction of the R&D tax units in 2006 was a major step in the administration of the reliefs, with dedicated, regional specialists providing a more consistent approach and local contact.
Since then the units have undergone considerable and regular reorganisation which we feel has not been wholly helpful.
Although the R&D schemes operate within the self-assessment system it is very important that when a claimant company receives a payment (whether an R&D tax credit or a repayment of corporation tax) it is confident HMRC will not subsequently ask for it back, sometimes long after it has been spent.
We understand that repayment claims do receive some level of inspection before monies are paid out which gives some level of assurance but we would welcome some form of confirmation that the claim has been accepted, with any caveats if necessary.
Even if HMRC had the resources, we would not like to see audits occurring in every case. Anecdotal evidence suggests the US system is adversarial in nature and indeed before the introduction of the R&D units in the UK a similar atmosphere existed then, which had the effect of undermining confidence in the claim process. Instead we would support more training being available to HMRC to enable staff to identify claims that might warrant further enquiry.
Question 9 – Is there evidence to suggest areas of activity other than those currently covered by the R&D definition drive positive externalities which should be recognised by the tax system?
One area that would benefit from being included is the field of mathematics.
Paragraph 15 of the Guidelines excludes work in mathematics unless it is part of a wider project of a technological nature. However the distinction is blurred in practice as work on computer software forms a large part of projects in the field of mathematics. Also, the work in the area is no less ground-breaking and creative so we see no real policy reason for the distinction.
We would also suggest the inclusion of work on applying for patents.
Question 10 – Do you think R&D tax reliefs could better incentivise R&D with specific social value, for example developing green technology? Could R&D tax reliefs be used to disincentivise R&D in certain fields?
We would be supportive of a flexible approach to the levels of relief available in certain sectors enabling the government to increase support in particular fields as part of wider policy aims which may change over time.
Question 11 – What is your experience of conducting R&D in different regions across the UK? How do R&D tax reliefs benefit these activities, and how could the offer be improved to better support these activities?
Although based in Cambridge we serve a national client base. It is certainly our experience that the majority of claimants are located in the South East and East. This could partly be due to the “snowball” effect whereby the initial wave of claims in the early days of the relief were in those areas, leading to local advisers promoting R&D services.
Question 12 – Are there any other areas of qualifying expenditure that should be included within the reliefs? How would this influence your investment decisions?
Question 13 – What proportion of your R&D expenditure is treated as capital for the purposes of corporation tax? What would be the impact on your R&D activities of increased relief for capital expenditure?
Clients commonly ask whether capital expenditure qualifies for R&D tax credit or RDEC since they are often incurring spend on computers or specialist hardware or dedicated plant and machinery. It would make sense to extend the relief to capital spend in order to more closely tie the benefit to expenditure invested in R&D.
As mentioned above, one other cost that clients are often disappointed does not qualify is that of applying for patents.
Allowing such costs would help incentivise companies to take out patents alongside or in many cases instead of the existing patent box regime, which, particularly for SMEs, is seen as complex and only worthwhile for companies with a very large proportion of qualifying income.
Question 14 – Do you currently claim RDAs? If not, why not? What do you like and/or dislike about RDAs?
In our experience very few companies actually claim RDAs. For many companies their capital spend level is such that the existing 100% Annual Allowance already gives the same level of relief. Where the RDA does tend to come into its own is where spend not normally attracting any capital allowances – buildings mainly – is incurred, providing an absolute tax saving. The most common problem is determining an appropriate proportion relating to R&D where usage tends to fluctuate year on year.
Question 15 – How much of the activity in respect of which you claim R&D in the UK is undertaken outside of the company, and how much of that is not undertaken in the UK? What are the benefits and drawbacks of subcontracting, whether overseas or domestically? What are your commercial/other reasons for carrying out work overseas rather than in the UK?
Question 16 – How could the government distinguish between work that needs to take place abroad and which benefits the UK, and that which doesn’t?
Companies use subcontractors (or externally provided workers) outside the UK primarily on grounds of cost. The differential between the UK and, for example, India or Eastern Europe can be substantial. In our view companies would continue to outsource work to locations such as these instead of the UK irrespective of whether R&D tax relief were to be available as the cost saving would outweigh any tax relief benefit.
In our view attempting to classify overseas work into “good” and “bad” would be difficult to define, lead to increased compliance costs and have little effect in incentivising companies to use UK-based suppliers.
Question 17 – How can we identify the supporting activities which are most valuable for R&D, while providing a clear boundary to assist companies in claiming and HMRC in administering?
We feel that the range of Qualifying Indirect Activities currently within the scope of qualifying cost are a reasonable reflection of the supporting roles that should be included. Restricting these to a limited range of activities would introduce unwelcome complexity.
Once again we thank HM Treasury and HMRC for the opportunity to provide input to future thinking on the R&D tax schemes. If there are any responses to which you would like further clarification, please contact us.
Director, Pronovotech Ltd