With concern mounting about a downturn in investment by UK businesses as a result of the Brexit uncertainty that characterised 2019 and looks set to continue into at least early 2020, attention has turned to the various ways in which the UK tax regime can support and incentivise innovation.
The tax regime offers a number of carrots in the form of both tax credits and tax reliefs to encourage businesses to continue to invest in research and development, many of which are widely available and currently under-utilised.
The three main tax incentives for R&D in the UK are research and development tax relief, research and development capital allowances, and the patent box. The first, R&D tax relief, seeks to make R&D easier for small companies by offering relief on corporation tax that can reduce a company’s tax bill or even result in a payable tax credit. Not available to individuals or partnerships, the relief defines R&D as a project that seeks to achieve an advance in overall knowledge or capability in a field of science or technology, with quite detailed guidance available from HMRC on what qualifies.
There are two schemes through which R&D relief is calculated, with the scheme for small and medium-sized companies allowing a company to get 230% relief on qualifying R&D costs and allowing loss-making companies to – in certain circumstances – surrender their losses in return for a payable tax credit. The alternative scheme for larger businesses with more than 500 staff or turnover above €100m is the Research and Development Expenditure Credit, makes a taxable credit available at 11% of R&D expenditure, with that tax credit fully payable for loss-making companies. Nathan Williams, tax partner at Trowers & Hamlins, says:
"For SMEs, that means that if you are employing individuals to develop a piece of software or a new vaccine, then you can claim a relief equivalent to 230% of the expenditure you are incurring.
(although this may change in the forthcoming March Budget). There does have to be an element of future exploitation and expanding knowledge, rather than just reinventing the wheel.”
Guidelines from HMRC say that qualifying projects can include creating new processes, products or services, making appreciable improvements to existing ones and even using science and technology to duplicate existing processes, products and services in a new way. But pure product development in itself does not qualify, and HMRC recommend getting them involved early when judging whether projects and activities will qualify.
“We see this as a benefit but it’s very complex and has been abused in the past,” says Williams. “There are a considerable amount of pitfalls. HMRC will look for and request evidence of innovation, so you will need to demonstrate how you are expanding knowledge with what you are doing and incurring that expenditure. It’s a hard-won relief but there are opportunities there for companies that qualify.”
Research and development capital allowances provide for a deduction on capital expenditure on R&D, on assets used for R&D purposes, or on providing facilities for carrying out R&D.
Meanwhile, the patent box was introduced in the UK in 2013 as a tax incentive for businesses that are generating income through the exploitation of patents, by reducing the tax paid on that income to an effective corporation tax rate of 10%. “Again, the devil is in the detail,” says Williams. “The scheme hasn’t been as successful as HMRC thought it would be in terms of attracting that base of exploitation and creation of patents in the UK.”
A company can qualify for the patent box scheme if it is liable for corporation tax, makes a profit from exploiting patented inventions, owns or exclusively licenses the patents and has undertaken qualifying development on them. That means the company must have made a significant contribution either to the creation or development of the patented invention, or to a product incorporating the patented invention.
Williams says: "People with patents will typically be aware of the patent box and have it on their radar. When it comes to R&D tax credits, however, small businesses and technology start-ups are not always aware of what is qualifying expenditure and what isn’t."
“What is sometimes missed is the opportunity to claim cash back from HMRC in surrendering a loss, which can be valuable in those first few years that are particularly cost heavy.”
One other aspect to keep in mind, particularly when looking to raise investment, is the Enterprise Investment Scheme (EIS) which offers tax incentives for individual investors seeking to invest in companies. The EIS has a category of ‘knowledge intensive companies’ (KICs) which allows companies undertaking research, development or innovation to raise EIS investment more flexibly than non-KIC companies.
In addition to funding and investing in R&D, it is also imperative that companies put innovation at the heart of their business strategies, and particularly micro-innovations, which are small but highly effective changes that drive forward company growth. If R&D is the work that is done to increase knowledge and create new applications, then innovation is the implementation of those processes or practices. Most companies recognise weaknesses in their ecosystems that can benefit from innovation but many focus on large-scale advances rather than smaller, everyday improvements and practical ideas.
“It is often said that companies need to prioritise innovation at board level,” says Tim Nye, corporate partner at Trowers & Hamlins. “The business strategy needs to put the customer front and centre and encourage innovation at every level, which often means building a no-fault and no-mistakes culture. Not every idea is going to work and in order to bring ideas to the fore, people need to feel free to fail and not expect to be criticised.”
While tax credits will apply to the initial R&D, the intangible costs of implementing change must also be taken into account.
That means embracing the implementation of change from the top down and championing innovation from the C-suite. “Creating and developing cross-departmental teams can be very effective,” says Nye. “That can bring out new ideas by putting together different concepts, encouraging people to think outside existing silos and integrate in order to come up with new suggestions.”
One final consideration for companies investing in R&D is the need to think at the beginning about how inventions will be protected and who will own any resulting intellectual property. This is a particular issue where R&D is conducted in partnership with another organisation that might become a competitor in the future, or when partnering with a university to undertake commercial research.
Caroline Hayward, an IP partner at Trowers & Hamlins, says: “If there is any form of collaboration, you need to think very carefully at the outset about what rights you actually need and want.
"Often, we see R&D agreements that are thrown together and provide for joint IP ownership, and that is actually very restrictive and does not mean both parties can do whatever they want.”
Applying for patents is an expensive process but has to be done to secure protections, so thought should be given to who will apply for the patent, as well as to what licensing rights will apply.
“You have to really think ahead when you embark on R&D,” says Hayward, “and assume that the R&D is going to be fantastically successful and then think about what you want to do with the results. Are you happy to only sell the product in Europe and allow someone else to sell it in the US, for example? The key message is to think all of that through at the very outset.”
The most recent figures available show that the UK spent £34.8bn on R&D in 2017, up £1.6bn on the year before, with R&D representing 1.69% of GDP, well below the European Union figure of 2.07%. The UK ranked 11th of all EU countries for R&D expenditure as a percentage of GDP in 2017, and the government’s industrial strategy includes a target to significantly increase that investment to 2.4% of GDP by 2027.
