Sunak plans overhaul of ‘generous’ R&D tax credits

Rishi Sunak is planning an overhaul of the UK government’s “flagship industrial policy”, as he looks to redesign a misfiring £7.7bn R&D tax credit system to boost sluggish business investment.

The chancellor, who will present a spring financial statement on March 23, believes that in spite of spending “huge and rapidly growing sums” on the tax credit, it is not doing enough to boost growth.

Sunak has been inspired by a Cambridge university report which asked: “Is the UK’s flagship industrial policy a costly failure?” The chancellor is looking at whether R&D tax credits can be better focused on larger companies, rather than an increasingly costly programme aimed at small and medium-sized businesses, government insiders said.

Sunak has set himself the target of boosting Britain’s sluggish growth rate, as the opposition Labour party and the CBI employers federation claim he presides over “a low growth, high tax” economy.

The R&D tax credit system is in his sights, following a report last year by David Connell of Cambridge’s Centre for Business Research which showed it delivered poor value for money.

The Office for Budget Responsibility has estimated that the cost of the reliefs will increase from £7.7bn in 2021-22 to £11.9bn in 2026-27, but studies show that parts of the scheme aimed at SMEs appear to do relatively little to boost investment.

In his Mais lecture last month, Sunak criticised what he called “one of the most generous tax regimes for R&D investment anywhere in the world, measured by how much we spend on it compared to other nations.” He added: “But in spite of spending huge and rapidly growing sums, clearly it is not working as well as it should.”

He said spending by British businesses on R&D was four times the value of the tax relief, compared with the OECD average of 15 times.

The chancellor plans to address that by introducing tax reforms to boost investment and encourage companies to spend on training and R&D. Government insiders said Sunak wanted to get more “bang for his buck” and that reforms to the tax credits would go beyond some preliminary measures announced in last October’s Budget.

On that occasion Sunak unveiled plans to end a system where tax credits helped to fund “billions of pounds of R&D that isn’t even happening here in the UK”. He also plans to extend the reliefs to cover data purchases and cloud computing costs.

The Connell report, which Sunak cited in his Mais lecture, found that self-funded business investment in R&D was between 10 and 15 per cent lower than before the tax credits were introduced in 2000.

Evaluations by HM Revenue & Customs found that the relief aimed at SMEs offered relatively poor value for money, even though it was expanding quickly and now cost more than the tax credits offered to bigger companies.

It found that the Research and Development Expenditure Credit aimed at larger companies generated £2.40 to £2.70 of additional R&D expenditure for each £1 of tax relief claimed, while the SME scheme generated £0.60 to £1.28. 

Sunak argues the government has raised its game in supporting science and research and his tax credit reforms are intended to incentivise companies to do the same. “Businesses simply aren’t investing enough,” he said in the Mais lecture.

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