New R&D tax credit is ‘missed opportunity’


Russell Hampshire, KPMG


Six months on from what seemed a significant move, it is now clear that the UK government did not go far enough when it announced a new research and development (R&D) incentive for large companies. Analysis of the fine print reveals that the UK guidelines neither represent particularly good news for hard-pressed technology companies nor do they compare favourably with regimes elsewhere in Europe and North America. This threatens to scupper the British chancellor’s hopes of re-establishing the UK as an R&D centre of excellence.

Under the new guidelines, large companies receive an additional tax deduction equal to 25% of the qualifying expenditure – essentially staff costs and consumable stores – incurred each year on R&D. This has been widely welcomed by the business world and, indeed, for many industries it is likely to be an extremely valuable new relief, equating to a cash contribution of up to 7.5% of qualifying expenditure. But it is not as generous as the relief introduced for smaller companies in the UK two years earlier, which gave a 50% credit and allowed a cash repayment if the company was loss-making.

That is not all. The new guidelines disqualify a large number of activities that IT companies might legitimately consider to be R&D, including “adding user functionality to application programmes”, “debugging of systems” and “adaptation of existing software”.

Indeed, the wording of the guidelines raises questions about the London administration’s understanding of the wide variety of activities that occur within R&D in the software sector. The main focus of the guidelines is on the ‘R’ element of R&D – whereas the majority of software R&D activity falls squarely under the experimental development heading.

What all this means is that companies involved in software R&D that may have given the UK initiative an initial thumbs-up may now be feeling a mixture of confusion and disappointment.

The British initiative was designed to encourage big businesses to carry out more R&D activity in the UK – thereby increasing the number of people employed in this highly skilled and generally well-paid sector. But many tax regimes elsewhere already offer generous incentives.

In Europe, the most common form of incentive is a credit-based system that is usually based, to differing degrees, on the increase in R&D spend over prior years. Spain, for example, has one of the most generous regimes, offering credits between 30% and 50%. At least the UK is more generous than some European countries on the matter of credit ceilings – there is none in the UK, unlike in France for instance, where the credit is limited to EU6.1 million a year, or in the Netherlands where the annual ceiling is set at EU7.9 million.

Outside Europe, the country with the most admired regime is Canada. There, incentives for R&D have been in existence in some form or another since 1944. Although the credit for large companies is only 20%, the tax authorities employ large numbers of science advisers and technical consultants who review every claim and offer advice to taxpayers. This makes the claim process run smoothly. The Canadian authorities are also said to be very generous in interpreting which activities qualify as R&D.

Bearing in mind this global competition, the UK government’s plans to encourage more investment in the UK may fail if the tax authorities aggressively challenge R&D tax claims. This is a particular risk in the software sector, where the guidelines could be used as a weapon to argue against all but the most groundbreaking research in a claim.

I am aware that the UK tax authorities are concerned about the unsatisfactory state of the guidelines for software R&D. Officials are talking to industry representatives with a view to clarifying which activities qualify for a claim. But while additional guidance is welcome, I do not believe this move in isolation will go far enough. With this in mind, the IT industry should employ experienced advisers while continuing to lobby for changes to the guidelines.

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Ben Rossi

Ben was Vitesse Media's editorial director, leading content creation and editorial strategy across all Vitesse products, including its market-leading B2B and consumer magazines, websites, research and...

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