R&D Tax Credits for UK SMEs is in the spotlight

Earlier this month, the Office for National Statistics (ONS) published a blog outlining changes to their methodology for estimating business Research & Development (R&D) spend in the UK. 

This might not usually cause a stir beyond a small group of economists. But it turns out that business R&D investment is over 50% higher than previously estimated, that is around an additional £15bn a year, or a little under 1% of GDP. That’s a big change!

The CBI has explained what this might mean for UK innovation policy.

What’s changed?

In short, ONS updated their approach to better account for the significant SME investment in R&D. This has led to large uplifts in estimates of total R&D expenditure.

This work was originated because there was a large difference in UK statistics between the official ONS estimates of business R&D spend (according to the Business Enterprise Research and Development Survey (BERD)) and HMRC’s figures on R&D spend used to claim R&D tax credits. 

There are several possible reasons for such a gap – e.g. such as different timelines, (ONS uses a calendar year while HMRC use tax years); definitions of R&D used are slightly different; overseas R&D included in HMRC claims but excluded from BERD and the sectoral coverage of BERD is limited. HMRC assumes a level of fraud and error in R&D tax credit claims but the ONS does not.

ONS has now confirmed most of the difference appears to be caused by the sampling approach they used. The ONS approach had very limited coverage of SMEs, but, in recent years, SME claims are an increasing proportion of R&D tax credit claims. Improvement in the ON’s approach, to better cover these SME businesses, has led to significant increases in their estimates. For 2020 the ONS estimate of business R&D investment has increased from £26.9bn to £43bn. HMRC’s estimate for 2020-21 (which covers 9 months of the same period) is £38.1bn

What does this mean for the UK’s 2.4% target?

Reaching ‘2.4% of GDP spent on R&D’ has been a flagship UK innovation policy, with cross-party support, since 2017. Figures aren’t finalised yet but it already appears the UK has already met, or maybe even surpassed, this figure.

So, what next? Should the UK go for a 3% target, or aim for over 4% like R&D leaders South Korea and Israel?

The story of the 2.4% target certainly highlights the risks of setting input-based targets. However, setting an ambitious target that government, business, academia, and the broader research sector can rally around has certainly been helpful. Business R&D spend has increased steadily since the target was set.

The CBI is keen to hear your thoughts on what a UK R&D target should look like going forward. Contact Jayne at the MIA who will feed in your views to the CBI.

What does this mean for UK innovation policy?

The updated data means government support for R&D, through public R&D funding and R&D tax credits for example, has been more effective at leveraging private R&D spend than originally thought. And we know that business innovation investment will be core to driving long-term sustainable economic growth. 

So it is essential that the government doubles down on these measures, which are unlocking business R&D investment in the UK. For example, the government should maintain its commitment to increasing public R&D spend to £22bn by 2027 and ensure that, in the case that we can’t associate to Horizon Europe, all committed funding is ringfenced for UK research and innovation.

However, the update to the ONS data raises interesting questions about innovation policy beyond R&D support. If R&D spend is higher than initially thought but the UK’s productivity gap remains, what other factors need to be focused on? 

This includes the adoption and diffusion of technology, an area where the UK lags behind other countries. A recent survey, for example found that only 33% of UK organisations have accelerated their use of AI in the past two years, compared with 57% and 56% businesses in Italy and Spain, respectively.

The CBI would like to see Made Smarter, a programme focused on supporting manufacturing businesses to take up new technology, expanded nationally and into other sectors. 

What does this mean for R&D tax credit policy?

ONS and HMRC figures for business R&D spend are now broadly the same which is as it should be. 

The government should, of course, apply proportionate measures to ensure compliance with the tax credit schemes. This new data gives HMRC and Treasury a chance to take a fresh look at their approach.

HMRC and Treasury should look again at assumptions about fraud and error in the R&D tax credits scheme, the affordability of the schemes and their value to the UK economy – and recognise SMEs’ impressive contribution to UK innovation. Any further changes to the R&D tax credit schemes need to take this into account.

The CBI is keen to hear your thoughts on what proportionate compliance around the R&D tax scheme looks like for all businesses. Pass your comments onto Jayne at the MIA who will make them available to the CBI.