Proposals to fundamentally change the R&D tax credit regime shows the Treasury has understood the importance of R&D to sophisticated manufacturing.
On Friday June 10, the Treasury published consultation documents on the Patent Box and R&D tax credit, as part of its stated plans to make the UK’s tax system more competitive for business.
The consultation is robust, driven by a desire to know the true economic impact of these credits, that is, how they will actually affect decisions to invest in R&D.
On the Patent Box, HMRC decided it would not extend tax relief beyond patents to other types of intellectual property. Now the focus is on understanding some of the technical issues, such as how you determine the embedded profit attributable to a part within a large assembly that is due to that particular patent.
The common perception is that the Patent Box only really benefits big pharma and companies with many patents like biotech firms.
But Tom Woodrow, a tax partner at business advisors Hazelwoods, who runs the Advanced Engineering practice at the Motorsport Industry Association, says smaller companies should not be so hasty to dismiss the Patent Box. “Engineering SMEs should not think that the Patent Box has nothing to do with them. Companies, such as [motorsport engineering firm] Ricardo, are increasingly looking at IP as an asset to exploit and are restructuring their businesses accordingly. If you can sell a product or service at 10% rather than a final assembly at 28%, it is good business sense.”
Carmen Aquerreta, a tax partner in the R&D and Patent Box team at Deloitte, says that it’s actually easier to list the types of industries that wouldn’t potentially qualify for the Patent Box.
The proposed changes to the R&D tax credit were genuinely exciting.
“Many people were clamouring for a wider definition of R&D that encapsulates more of the industrial development process in taking technology to market,” says Jeegar Kakkad, senior economist at EEF. “Although the definition of R&D will not be redefined or updated to explicitly include a wider range of development costs, the changes proposed are important.”
The three key proposals will, however:
1) Provide updated guidance on what activities are defined as technical uncertainty. Companies can only qualify for R&D tax credits if what they do addresses some sort of scientific uncertainty. “The new guidance could, we hope, reflect more modern types of R&D processes,” says Mr Kakkad. EEF hopes that this will be published by mid-July.
2) The big benefit: Consulting on whether to take the tax credit above the line. Currently companies get the R&D credit against their corporation tax only. “There is a disconnect between the tax credit they get and the incentive in terms of lower taxes, and the R&D team doing the actual research,” says Kakkad. “Making it above the line means you would be able to offset some of this on your P&L before you get to pay corporation tax, offsetting it against taxes like NICs and PAYE contributions for that R&D team. That is, the real cost of the R&D team in payroll, will drop significantly.”
Small companies too will benefit from this change, but as EEF points out, large companies will really cash in. Jaguar Land Rover, for example, was in a tax-loss position – while profits are super-strong today, the company doesn’t pay corporation tax because of losses built-up during the recession. So a company doing vast amounts of R&D is ineligible to claim an R&D tax credit. Taking it above the line would make those credits eligible, which would imply huge previously inaccessible tax relief.
3) Small companies have often shied away from claiming the R&D credit – the process might be expensive and there was no guarantee of success. The third main benefit is HMRC’s pilot scheme for small firms and start-ups which says that, providing the claim qualifies in Year 1, claims in subsequent years will be automatic. “It’s a risk-based approach, where HMRC says ‘you’re a good company, have the R&D credit and we’ll talk to you again in five years,” says EEF’s Kakkad.
The proposals, if enshrined in legislation, will make a real difference to companies involved in any kind of R&D and might affect how they define their products – prompting them to think more about the commercialisation of their IP and transferring the relief from a tax on profits to taxation on wages or running costs, which should improve cash flow providing the claims are processed quickly and efficiently.
All these changes remain mere proposals, but the potential combined effect of these changes, if actionned, demonstrates that HMRC has sought to really understand the business process, and economic benefit, of doing R&D, and it will represent a significant improvement in the treatment of R&D for tax.
A further explanation of these benefits will appear in The Manufacturer soon.
