The government is keeping faith with R&D tax credits. Why?
What connects Chelsea Football Club, a pub that changed its menus, and a window cleaner who invented a new way to hold a bucket? According to the Guardian they have, along with fitness centres, care homes, and dental clinics, made use of the government’s R&D tax relief scheme.
The scheme is designed to encourage activities that “seek an advance in a field of science or technology.” It turned out that Chelsea were not the only ones at it, with a number of other Premier League clubs having taken advantage of the scheme. Scottish club Dundee United were careless enough to have their advice passed on to Tax Policy Associates who illustrated how Dundee claimed 24 per cent of their players wages as tax relief. As the tax think tank wrote at the time:
“24% of their players’ wages – as if the players were carrying out scientific/technical research. That is a huge amount of money, and in our view is indefensible. Even if the R&D projects were real, and qualified for relief, the players would be the subjects of that research, and their wages would not qualify for relief.”
It isn’t just football teams that seemingly struggle with the definition of research. According to HMRC’s latest annual report there was nearly £1bn lost to error and fraud in their last two accounting years. Within this £1bn there will be some genuine error and some genuine fraud – but this is public money that was designed to support legitimate R&D activity.
Now, some of the historic examples of fraud referenced above are, supposedly, a thing of the past. HMRC’s annual report also highlights how error and fraud rates are down steeply from 2021, ascribing this in part to the introduction of additional information requirements as well as significantly increased resource dedicated to enforcing compliance.
But given all this, it was still something of a surprise to see the Chancellor of the Exchequer announce plans to simplify and streamline the system in this week’s Budget – and in doing so spend an estimated £300m more on this form of tax relief over the next six years.
What is R&D tax relief?
In simple terms R&D tax relief is a rebate on the money a company spends on research and development. HMRC provides a range of qualifying criteria that was most recently updated this year.
Historically there have been two main R&D tax relief schemes. The SME R&D scheme which was first introduced in 2000. Under this scheme a company could claim a deduction on their corporation tax liability. If the company was loss making they were eligible to claim an enhanced rate. In 2013 the government introduced the Research and Development Expenditure Credit (RDEC). This relief applies to qualifying R&D expenditure and closed in 2023 along with the SME R&D scheme. These schemes merged into a single scheme which provides a taxable expenditure credit at 20 per cent for qualifying R&D expenditure.
The more a company spends on R&D the more relief they can claim. This is meant to encourage genuinely new activity, rather than simply allowing tax relief on business as usual.
In theory this is all straightforward. Governments want businesses to spend money on research, so they make it cheaper for them to do so by offering a tax incentive. The challenge, or at least where enterprising tax advisors are making money, is that the definition of R&D is contestable.
It relies on guidance issued by the Secretary of State for the purposes of section 1006 of the Income Tax Act 2007:
“R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology. The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D. Certain qualifying indirect activities related to the project are also R&D. Activities other than qualifying indirect activities which do not directly contribute to the resolution of the project’s scientific or technological uncertainty are not R&D.”
But within these statements lies a pool of complexity. To build on only some of the illustrative examples, it is not easy to pinpoint where research ends and everyday activity begins, where the difference is between planning and application, or the point at which uncertainty is resolved and therefore research ends.
Despite the confusion, it is difficult to see how paying footballers wages advances science, resolves technological uncertainty or, crucially, provides an overall advance in knowledge capability beyond that of the company receiving the relief.
One of the consequences of some of the more egregious claims is that HMRC has, rightly, tightened its approach to approving R&D claims. A possibly unfortunate consequence is that data within HMRC’s annual report, highlighted by the Times, suggests the crackdown has reduced the number of legitimate claims. This does not necessarily suggest that companies are doing less R&D, but there are fewer claims being made. If there was genuinely less R&D activity going on this would be a blow to a scheme designed explicitly to encourage more R&D activity.
Now, it is true that fewer SMEs in particular are claiming tax relief than was the case a few years ago – but the average claim value is rising and large firms are making more claims. The total amount of foregone corporation tax continues to rise:
The £8.2bn price tag of R&D tax credits in 2024–25 is a steep one. For comparison, UKRI invested £77m in the Arts and Humanities Research Council in the same year. Innovate UK’s whole budget allocation was around £1bn. Collective talent programmes across UKRI saw about £700m put in. And yet the amounts spent on this particular form of business R&D incentive remain demand-led and enjoy continued growth – and this week’s Budget has doubled down on the approach.
What happened at the Budget?
From April 2027, the government is going to remove the R&D tax credit claim notification form, the submission that lets HMRC know a business intends to claim tax credits. It is also going to simplify the additional information form – as noted above, HMRC has highlighted this extra information requirement as a reason for the (relatively) lower error and fraud in the last few years.
This bureaucracy blitz is predicted to encourage more businesses to put in claims. Trying to predict exactly how this sort of measure will affect firm behaviour is very much “finger in the air” forecasting – but the important thing to note is that the Treasury has been willing to find more than £300m to meet the supposed growth in take-up:
The benefits of such schemes are contested. It is never entirely clear whether this R&D activity would have happened anyway – after all, companies use R&D as a means to increase their profits, or whether it is genuinely incentivising new work. A 2020 evaluation of the SME R&D scheme found that there were low levels of additionality to the Exchequer, and that every £1 foregone in tax revenue “stimulates between £0.75 and £1.28 of R&D expenditure” – hardly a barnstorming result. The evaluation also concluded that there was evidence of a negative knock-on effect on the turnover of other businesses that undertake R&D in the same sector.
The demand-led nature of this particular tax relief also feels like an odd fit with how Labour is conducting policy elsewhere. Tax credits are place-blind and not linked to the industrial strategy except by happenstance, and fail to translate well to important UK economic sectors such as the creative industries.
Despite the lack of conclusive supporting evidence and the seeming inevitability that a not insubstantial part of the relief granted will be either error or fraud, the Treasury has chosen to keep faith with R&D tax credits as a mechanism. When the sums involved dwarf the government’s ever-more-stretched investment in other areas of the research and innovation system – ones for which the evidence of improving society, increasing the stock of knowledge, and generating economic growth is well proven – it becomes increasingly hard to see why.