The UK needs to overhaul its R&D tax credits system in relation to startups

R&D tax credits for startups — the UK government has a number of schemes and programs dedicated to fostering tech startups — after all, innovation is needed to propel the country into the digital economy and the government knows this.

In particular, startups (tech or otherwise) are reliant on the UK’s R&D tax credit scheme. It’s an initiative that’s crucial in helping startups succeed in a merciless business landscape. However, according to the latest report from Coadec — Credit where credit’s due — it could be improved.

The report concludes that in order to improve, the R&D tax credit scheme must remove the ‘bureaucracy that stops startups claiming, while making sure that the policy covers everything that startups actually do as part of their R&D process (not just what’s covered at the moment),’ writes Dom Hallas, executive director at Coadec.

Summary of recommendations

Improving policy

1. Allow the purchase of data sets for tech development 

Because data isn’t classed as a consumable in the R&D process, the cost of data sets can’t be claimed under R&D tax credits. But it’s integral to R&D projects of many tech startups, including AI and machine learning. Let’s include this cost in the tax credit, providing greater incentive for cutting-edge innovation.

2. Allow the full inclusion of cloud services costs

Cloud services are used by the overwhelming majority of tech startups/scaleups. You can’t work with large data sets, train new algorithms, or deploy sensors at scale without the cloud. But our research tells us that there is a great degree of variation in whether these costs are included or accepted in tax credit applications. We need to make sure that startups have access to the compute they need to build world-beating products and services.

3. Allow full claims for UI/UX development work

Over 80% of startup respondents to our survey said they undertook significant amounts of UI/UX which they considered a vital part of their R&D processes. Right now, startups aren’t able to claim fully for the costs they incur building innovative solutions to the front end of their product. Tech firms won’t have a product unless it’s been tested properly with users; they need a clear understanding from HMRC that UI/UX work is critical R&D work, and should be included in the credit.

Tackling bureaucracy

4. Providing better feedback on claims and ensuring that there is clarity in the system

What is true for all business life is true for tax credit applications: certainty is everything. Our members tell us feedback from HMRC on rejected or questioned claims is unclear. Whatever happens with the credit in the future, the ability to provide clarity about what it wants to see in tax credit applications will be crucial.

5. Continuing to develop tech expertise at HMRC to help rule on claims relevant to the sector

If R&D tax credits are to become more relevant and more effective for tech startups, HMRC’s expertise will have to catch up with the fast-moving pace of the tech sector. We are aware that HMRC is working on this. The further up the agenda, the better.

6. Support the creation of a new self-regulatory body to set minimum service standards in the R&D tax credit claim market

The tax credit adviser market can be a minefield for any company, but especially for startups who may be low on staff and undertaking the application for the first time. A self-regulatory body would give all actors the confidence of minimum standards of service to be accepted, and mitigate the other uncertainties of the process.

7. Proactive promotion of the credit

Too many companies still don’t know about the credit, or find it hard to access information on how to claim. The Government has committed to boosting the UK’s R&D spend – championing the R&D tax credit should be front and centre of this objective.

Expert comment from Mark Smith, partner — Finance and Innovation at Ayming, the specialist R&D consultancy

“The report from Coadec is spot on. The need for more R&D spending is clear. The UK is simply not hitting its self-imposed targets.

“We can, in most cases, put this down to start-ups simply not being aware of what activity they can claim for. Our clients are often surprised at the extent to which they have been missing opportunities. The Government would do well to set up a specific task force aiming to educate start-ups on the UK’s R&D credit system to really help foster that innovation. The UK already has a good foundation for having a dynamic and innovative economy. This year, for example, has seen record funding into UK’s fintechs, for which we are undoubtedly a hub.

“Relatively speaking, the UK does have an easy application process but start-ups very often don’t have the resources to go through long application processes. Supporting by guiding these start-ups through the process more would make a huge difference and free up capital for the country’s innovators.”

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Nick Ismail

Nick Ismail is the editor for Information Age. He has a particular interest in smart technologies, AI and cyber security.