In 2019, we prepared a piece on how does the UK compare with neighbouring countries regarding R&D Tax Credit programmes.

The landscape has changed considerably since then, so we thought we would update this information piece.

Very roughly 32 of 38 OECD countries give preferential tax treatment to business R&D expenditures. These programmes are generally well used and popular as R&D Tax Credits are typically part of a country’s tax act. Therefore generally all companies are potentially eligible if they meet the criteria. As opposed to R&D grants where such programmes have a budget such that only a small portion of the companies that apply successfully receive an R&D grant. Under most R&D tax credit programmes worldwide, there is no budget limiting the availability of R&D tax credits to companies. As a result, R&D tax credit programmes tend to be much larger in scope and government spending than any complementary R&D grant programme.

Why do countries have R&D Tax Credit programmes?

The UK heavily relies on trade with the rest of Europe. At the heart of trade lies innovation and the introduction of new products and services to the market for competitiveness not just in Europe, but also in global markets. For the UK, to continue to succeed in trade, devising policies that facilitate and strengthen its innovation ecosystem will become ever more paramount.

So while innovation is important, there is also another important element which is talent.

Talent is the engine of any innovation ecosystem. So from a competitive standpoint, there is always competition for the right talent. Key European economies compete with the UK for tech talent, a competition that is compounded in post-Brexit Europe. These economies are:

• Ireland
• France
• Germany
• Netherlands

Another factor complicating the business environment is the geopolitical impact of the United States turning inward and detaching itself from certain aspects of the global economy by adopting a more nationalistic approach to global trade. While the latter puts many American businesses at a disadvantage, it certainly provides an opportunity for other countries to attract talent and gain a greater share of world markets; all at the expense of American businesses.

Therefore, many businesses that intend to sell to global markets factor in the above dynamics. These dynamics impact their decisions in terms of selecting which countries to operate in.

Hence the significance of R&D Tax Credits to countries that want to remain competitive, attract and foster the right talent and create a funding platform for businesses to de-risk their R&D initiatives

What Makes a Good R&D Programme?

A good R&D tax incentive programme:

1. Incentivises businesses to spend more on R&D than they would otherwise
2. Creates more skilled employment and
3. Assists businesses, especially small businesses, in reducing the risk inherent in innovation and
4. strikes a balance between compliance checks carried out by government authorities to ensure the programme is not abused while making the application process sufficiently manageable and cost-effective for SME’s and large companies. 

There have been many econometric studies regarding the contribution of R&D tax credit programmes to the economy, however many have resulted in conflicting results.

In 2023, some of the specific findings and themes from recent econometric evaluations include:

• Increased R&D Investment: Many studies confirm that the Tax Credits have been successful in encouraging increased R&D investment by firms, particularly small and medium-sized enterprises (SMEs).
• Disparities in Impact: There is evidence that the benefits of the R&D Tax Credits can vary significantly across different industries and company sizes. For instance, tech-focused sectors might see more direct benefits compared to others.
• Innovation Outcomes: While there is a general positive correlation between R&D spending and innovation output, the direct causal link between Tax Credits and specific innovation metrics (like patents) can be more complex and less straightforward.
• Economic Impact: Some evaluations suggest that while the R&D Tax Credits are effective at stimulating investment, the overall economic return on the government’s investment in the programme can vary and depends on the efficiency of the implementation and the characteristics of the recipient firms.

How Does the UK R&D Tax Credit Compare?

The table below compares the R&D Tax Credit incentives in Ireland, the US, France, Germany, and the Netherlands to those of the UK.

Table 1: A Comparison of R&D Tax Credits between Selected Countries

Some key points are that:

• The statistics for each country are taken from the 2022 tax year, with the tax credit rates updated to 2024 where changes have occurred
• The UK went through a number of tax rate changes between 31/03/2023 and 31/03/2024
• A table outlining these changes is at Table 2 below
• Under the new UK-merged R&D Tax Credit scheme for years commencing after 1st April 2024, all companies, both large and SME’s, with the exception of loss-making R&D-intensive companies, will have a R&D Tax Credit headline rate of 20%. However, this rate is immediately taxed to bring the effective R&D Tax Credit rate down to a range of 15% for most companies and to 16.2% for small SME’s
• Currently, loss-making R&D-intensive UK companies (those whose R&D expenditures are more than 30% of all expenditures incurred in a year) earn a R&D Tax Credit rate of 27%
• The R&D Tax Credit for Ireland, France, and the Netherlands is roughly 30%, and Germany is 25% (note Ireland increased the R&D Tax Credit from 25% to 30% commencing 2024). The R&D Tax Credit rate in the Netherlands is usually around 32%
• There is a wide discrepancy between countries as to the type of expenditures that qualify as R&D. All countries permit salaries and contract fees incurred in that particular country. This reflects the importance of driving talent and skilled employment as a government policy. Ireland has the widest range of expenditure, which also includes materials, plant & machinery, and buildings

Effective for 2024, the UK R&D Tax Credit incentive is now far below that of neighbouring countries.

Table 2: R&D Tax Credit Rate Changes – UK

* The R&D tax credits earned are subject to tax. The post-tax RDEC/Merged scheme rates from 1 April 2023 will vary. Which will depend on the level of the taxable profits a company has. Plus the corporation tax rate is applied to those profits. The Net RDEC tax benefit is 15% (after reducing the 20% R&D tax credit by the main rate of CT of 25%). For SMEs, the net tax benefit is 16.2% (after applying the deemed corporate tax of 19%) and for companies paying tax in the marginal rate band, the net benefit is 14.7% (after applying the corporate tax rate of 26.5%).

**The SME loss-making R&D-intensive companies are those whose qualifying R&D expenditure is at least 40% (from 1 April 2023) or 30% (from 1 April 2024) of the total expenditure (splitting accounting periods, as required). The Total expenditure for this purpose will be calculated from the total expenses figure in the profit and loss (P&L) account subject to some adjustments. When the final law is passed, we will comment further on this.

Compliance

A large part of the success of an R&D Tax Credit programme is how the programme is administered. The tax authorities must carry out sufficient reviews of R&D Tax Credit claims made to keep the programme compliant and free of abuse.

However, some programmes have the reputation of being overly harsh in their compliance checks or reviews of R&D Tax Credit claims such that would-be-eligible companies are reluctant to make a claim.

There is a balance between encouraging eligible companies to make an R&D claim while warding off those companies that intend to abuse or take advantage of the programme or simply file a claim in error.

While it is conjecture on our part we believe between 10% to 20% of all R&D claims made in a year should be scrutinized by the tax authorities. If a programme is deemed compliant by the tax authorities, the lower end of the range at 10% is the minimum compliance check rate. If the programme is receiving too many ineligible claims, 20% appears to be the correct compliance check rate to stifle abuse of the system.

Until recently it appears that HMRC carried out compliance checks on well less than 10% of all claims filed in a year since the inception of the programme in 2000/2002.

As a result…

The number of R&D Tax Credit claims in each year increased substantially to the point in 2023 that HMRC became concerned and reported to the House of Commons that it is likely up to one-half of all R&D claims were made in error.

To combat this compliance problem HMRC hired additional inspectors and substantially increased their compliance checks.

One nuance between the UK compliance checks and the compliance checks in other countries is that the other countries listed in this report either hire or engage their subject matter experts to assess the eligibility of the R&D project itself. In other words, these tax authorities have their own computer science specialists, engineers and life science professionals to assess the project eligibility. In the UK the tax inspector makes this judgment call.

As it has been reported in UK tax court cases, HMRC sometimes can lack credibility or have difficulty articulating their position that a particular R&D tax credit claim does not meet the definition of R&D for R&D Tax Credit purposes. This was particularly evident in Get OnBoard Ltd vs HMRC, where the courts felt HMRC fell short of specifically stating why the particular technological uncertainties and advances as set out by the company did not meet the criteria.

Conclusion

Overall, the UK R&D Tax Credit programme now compares much less favourably to other surrounding and competing countries for the following reasons:

• The current R&D Tax Credit rate in the UK  is substantially lower, 15% to 16% for all companies except SME loss-making R&D intensive companies, which have an R&D tax credit rate of 27%
• This is compared to R&D Tax Credit rates of 25% to 30% in other competing countries.
• The compliance procedures in the UK are in a state of flux.

Other relevant comments are as follows:

1. While France has a larger Tax Credit, the refund takes much longer to obtain. There is also a great deal of concern over the audits by tax authorities. However, companies can factor their R&D tax credit with certain financial institutions.
2. Ireland has comparable tax credit rates. But the risk of a revenue audit is high, with significant potential reductions in R&D Tax Credit claims.
3. The Netherlands have a higher R&D Tax Credit. But the eligible R&D costs are restricted to only full-time salaries; contract fees are not eligible. In addition, the credit is only applied against payroll taxes.
4. Ireland permits the widest categories of costs to be claimed for R&D Tax Credits. This includes salaries, contractors, materials, equipment, overhead, buildings, and agency staff.

The OECD, which monitors the effectiveness of R&D Tax Credit programmes in countries that have such programmes in place, recommends against frequent policy reversals in R&D Tax Credit as they can minimize the impact of such policies on private R&D expenditure. To minimize uncertainty, it is therefore important that governments not tinker with such policies.

While it was a step that was necessary to take, the UK has made some significant and frequent policy changes over the past 2 years. As a result, the programme uncertainty will surround the programme until compliance levels are satisfactory to HMRC.

How Can the UK’s R&D Tax Relief Improve?

Most businesses in the UK are aware of the R&D Tax Credit programme. There are now over 90,000 companies making claims, so the programme has gained sufficient awareness.

If HMRC believes 50% of R&D claims are in error, then considerable work needs to be done to bring the programme in line.

HMRC’s initial response has been to cut the R&D Tax Credit rate for SMEs which comprise over 90% of all claims and increase the number of compliance checks to cull out ineligible claims.

HMRC tax inspectors are in a difficult position to assess R&D project eligibility given their lack of technical background in the claims they assess. In this regard, HMRC should consider hiring technical experts to make this assessment.

In the Netherlands and Germany, these technical assessments are made by other government departments but the (limited) level of competence of government ‘experts’ can be problematic. Ireland engages outside experts, typically from universities, to assist with assessments.

Once HMRC believes the level of compliance is acceptable, consideration should be given to increasing the R&D Tax Credit rate for SMEs, by at least 25% to be competitive with neighbouring countries.

Brian Cookson is the President and Managing Director of RDP Associates.

For a complementary assessment of your eligibility for R&D Tax Relief and government funding, please contact us on 0208 214 1341 or email Jenni at [email protected].