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R&D Tax Incentives in the UK

July 6, 2021

UK Aims to Update R&D Tax Incentive Regime  

The UK government has announced an initiative to improve its R&D tax incentives and boost R&D investment in the UK. The aim is to increase R&D to 2.4 percent of UK GDP by 2027. With the R&D tax relief regime playing a key role in incentivizing the sought-for investment, the government is evaluating whether the current R&D regime is competitive and up to date. 

In March 2021, a consultation document sought input from the public on potential changes. The UK is considering consolidating the current bifurcated R&D incentive regime into a single credit, modifying the types of expenditures that qualify, and distinguishing between R&D that takes place in the UK versus abroad. 

Consolidating R&D schemes 

Unlike many countries, the current UK R&D tax relief regime is based on two separate provisions. The R&D Expenditure Credit (RDEC) is available as an above-the-line credit equal to 13 percent of qualified R&D costs. There is also additional R&D tax relief in the form of a deduction that is available for small- and medium-sized enterprises (SME scheme). 

The consultation document suggests that the government is interested in eliminating the SME scheme. It notes that while SME businesses have reported that the scheme is valuable, it has also received reports that the RDEC is preferred because it is simpler and operates as a credit rather than as a deduction. 

The UK consultation further notes that having two R&D provisions complicates processes because it means having two sets of rules. Moreover, when the government has previously expressed its interest in simplifying the R&D claim process, stakeholders have suggested switching to an “RDEC for all,” potentially with a higher rate for SMEs.  

The consultation document also notes that studies of the “additionality” of the two schemes (a measure of how much extra private R&D expenditure is gained per £1 of public support) indicate that the RDEC is the more effective of the two. 

The document adds that this seems to be the case even though studies show that small- and medium-sized enterprises are more responsive to R&D incentives in general.  

Accordingly, the consultation document seeks input on businesses’ experience using the two schemes, the potential benefits of consolidating them, and what might be lost if they are unified.   

Expanding and targeting qualified expenditures 

The UK government had undertaken an earlier consultation on whether the scope of the expenditures that qualify for R&D tax credits should be updated. The outcome of the earlier consultation, which was published alongside the launch of the new R&D consultation, showed support for including data and cloud computing as qualifying expenditures.  

The new consultation document states that the government recognizes the case for expanding the scope of qualifying expenditures to include data and cloud computing. It’s considering this amendment alongside broader changes. 

The document notes that the UK’s current definition of qualifying expenditures is narrower than some international competitors. Canada, for instance, allows claims for mathematical analyses. Some have also suggested adding new areas, such as creative industries or social sciences, although these areas are not generally supported internationally. The document seeks input on the economic value of expanding the scope of the tax incentive to include these additional areas.  

The document further asks whether the R&D incentive should be tailored to better incentivize specific types of R&D. It notes that some counties–such as the U.S., Spain, and Portugal–vary rates for different activities.

It asks specifically, for instance, whether R&D reliefs should better incentivize activities with social value such as green technology. The document also requests comments on whether capital expenditures should qualify for R&D tax relief, as they do in Ireland, Austria, and Portugal, which permit expenditure for plants and machinery to qualify.  

The government is not only interested in expanding the scope of qualifying expenditures but also in making the definition more targeted. It seeks to know more about expenditures that qualify for the credit but that do not really contribute to genuine innovation. 

In this respect, it highlights certain qualifying indirect activities such as administration and finance. It acknowledges that certain industries might be negatively impacted by restrictions on the qualification of such activities and wants to hear more about what types of these activities are essential enablers of R&D. 

R&D in the UK versus Abroad 

The UK R&D tax regime is unique in that it does not require the expenditure to take place in the UK, while almost all other countries have rules limiting overseas spending. 

The government suspects that the spillover benefits to the UK are greater where the R&D takes place within the UK and wants to ensure the relief it is granting is targeted to provide the most benefit. To this end, the document states that the government wants to hear more about the necessity for certain R&D being carried out abroad and how the government could distinguish between R&D work done in the UK versus abroad.