Introduction

The Northern Ireland Tax Committee of Chartered Accountants Ireland is pleased to have the opportunity to comment on the above consultation launched on 21 July 2020. Information about Chartered Accountants Ireland and the Northern Ireland Tax Committee is provided on the previous page.

We would be happy to discuss any aspect of this submission and participate in any further consultations/initiatives in this area as this consultation develops in the coming months. It should be noted that the comments in this submission are made in the context of claims for R&D tax relief under both the SME and “large” company regimes.

General comments

Overall, we commend the Government for seeking to modernise the types of expenditures which qualify for R&D tax relief. Ten years have passed since the scope of qualifying expenditure was previously reviewed and it is therefore right that this consultation considers expanding the categories of costs qualifying for relief in the context of a world dominated by technological change.

The UK’s R&D tax relief regimes should continue to drive innovation in the UK, but these should also keep pace with changes and developments in the types of costs incurred by companies carrying on genuine innovation activity in the modern world.

In formulating any changes to the R&D tax relief regimes, it will also be important for the Government to directly engage with companies carrying out innovation activity. This should assist in not only identifying areas where companies are incurring costs directly and actively related to innovation activity but should also enable trends in R&D costs to be identified earlier and allow the Government to react and amend the R&D tax relief regimes in real time in future.

COVID-19

According to The Global Innovation Index 2020 report1, the UK is in the top three of innovation economies in Europe and fourth overall in the global innovation index. However, this report was written at a time when the world was just beginning to deal with a global pandemic which continues to negatively impact on economies around the world.

With a possible disintegration of global value chains, generally reduced trade, an economic slowdown, and increased debt, there is a real possibility that innovation activity may slow down as Governments globally continue to be faced with decisions about continuing restrictions and further lockdowns and businesses affected are implementing cost saving and cash flow protection strategies and deferring investment decisions and projects.

There is therefore a concern that the current pandemic will affect innovation activity worldwide – this lends even further credence to the importance of the UK’s R&D tax relief regimes as effective innovation incentives.

Although not relevant to the current consultation we also take this opportunity to recommend that the UK’s R&D tax relief regimes be tailored to facilitate the economic recovery of the SME sector. This can be achieved by enacting legislation to enhance and accelerate qualifying corporation tax refunds/the payable tax credit to SMEs and by reducing the level of paperwork required of SMEs to qualify for and retain access to SME R&D tax relief.

Recent anecdotal evidence of our members has been that SMEs are now experiencing significant delays of up to 20 weeks in receiving the payable SME R&D tax credit. Our members also see first-hand the difficulties experienced by SMEs and start-up companies in trying to access the payable tax credit, as these businesses do not have the resources in terms of support staff or funds to engage the professional advice needed to prepare the necessary documentation under the Advance Assurance process.

A lighter-touch documentation requirement for the SME sector would go a long way in addressing this barrier and should be achievable in a way that also protects the integrity of compliance checks necessary to police the tax credit. Documentation requirements for the R&D tax credit could be aligned with Invest NI documentation requirements for grant aid.

The Advance Assurance option for SMEs could also be extended from three years to five years for the foreseeable future – this would give companies a guarantee that R&D tax relief claims would be accepted for the first five accounting periods without enquiry by HMRC if the claim is in line with pre-agreed criteria. This gives a company certainty that its project will qualify for R&D tax relief and the company will also be able to devote its resources to conducting R&D rather than dealing with tax enquiries in respect of its claim for relief.

Vaccine research relief

In the context of COVID-19, it also seems timely that the UK Government revisits vaccine research relief which ended in 2017. This was originally introduced as an additional R&D tax relief for companies undertaking research in the fields of vaccines and treatments for certain diseases. The UK Government should consider if this relief should be reintroduced for research into vaccines and treatments for COVID-19 and other SARS viruses.

EU transition

The UK’s R&D tax relief regimes also take on added significance in the context of the end of the EU transition period. Combined with the patent box regime, these regimes should be designed in such a way as to act as incentives to companies to remain in the UK post the end of the EU transition period. New direct innovation funding via the EU will be curtailed from 1 January 2021 and it not currently clear if the UK Government will itself be in a position to close that funding gap and enable direct provision for innovation to continue.

It is critical therefore that companies engaged in R&D activities continue to be able to access relief for costs directly related to qualifying R&D activity but also that those costs are expanded to reflect the cost of innovation activity in the modern world. Therefore, we do not support the proposal in the consultation that if additional qualifying cost categories are added to the UK regimes there should be a reverse “quid pro quo” effect by restricting or limit relief in other areas.

This would be extremely damaging not least in the context of the end of the EU transition period and the current pandemic but also in the context of innovation investment decisions already made by companies. To exclude costs which previously qualified for relief would mean companies who were able to claim for these amounts in the past and who continue to incur these costs in the context of their ongoing R&D projects will now find the cost of their innovation activity is higher (due to less tax relief) thus resulting in further pressure on their cash flow. This could mean lower investment in such activity in future given the uncertainty over whether costs will continue to qualify.

Cost to the Exchequer

The consultation argues that the rational for restricting/limiting relief in other areas is threefold: the cost to the Exchequer, additional complexity, and the scope for potential abuse where new qualifying costs are identified. However, each of these particular arguments can be defended.

Although there is a direct cost to the Exchequer in the form of the additional corporation tax saved if new qualifying cost categories are added to the R&D tax relief regimes (24.7 pence per pound at the current rate of corporation tax under the SME regime and 10.53 pence per pound under the “large” regime), it must be pointed out that innovation activity has indirect benefits elsewhere in the tax system through foreign direct investment, job creation and increased corporation tax, PAYE and National Insurance for the Exchequer as a result.

Complexity

The additional complexity argument also falls down as many companies engaging in innovation activity will already have systems developed to track and trace expenditure on innovation activity from an investment and cost management/control perspective. From 1 July 2016, tracking and tracing R&D expenditure is also a requirement under the modified nexus approach in the revised Patent Box regime legislation. Companies are therefore required to identify the level of qualifying development on a project which then determines the quantum of qualifying IP profits which qualify for the 10 percent rate of corporation tax under this regime. In addition, from 1 July 2021, all companies must use data from tracking and tracing relevant R&D expenditure and acquisitions in their Patent Box regime calculations.

Anti-avoidance legislation

In the context of concern for potential abuse, the existing anti-avoidance legislation in Section 1084 of the Corporation Taxes Act 2009 could be more effectively utilised to deter this type of behaviour. However, such anti-avoidance legislation should only be used to defend against artificial attempts to exploit the R&D tax relief legislation and should not colour the approach to the vast majority of genuine claims.

Data analytics and cloud computing

Anecdotal evidence from our member firms tells us that for many of their clients the use of data in R&D activities is growing exponentially. Modern business also increasingly relies on accessing cloud based services leased from external parties the costs of which do not currently qualify even where they have a direct link to an R&D project and where, if the software had been developed internally, those costs would have qualified for R&D tax relief.

This effectively penalises companies investing in innovation activity who take the (often) more cost effective decision to lease from external parties whilst at the same time harnessing the benefit of digitisation and cloud technology for their business. This is at odds with the UK Government’s own digital strategy published in 20172 which details the importance of digital transformation for businesses in every sector.

We are therefore supportive of the Government including data analytics and cloud computing costs as qualifying costs for R&D tax relief purposes where a direct and active link can be established between the costs and the relevant R&D project.

Digitisation

We are living at a time of technological change that is unprecedented in its pace, scope, and depth of impact. COVID-19 has more recently forced businesses to embrace technology and innovation in a timeframe that is unprecedented. This momentum provides a huge opportunity to create deep digital competencies within the workforce and economy, including the mainstreaming of data analytics, artificial intelligence, cloud computing and cybersecurity.

During the pandemic, businesses that have digital capability and presence have fared significantly better than those that do not. The COVID-19 lockdown has also highlighted the power of online retail and remote working, which has created a demand from customers and staff that will not abate post pandemic. Embracing digitalisation will strengthen the resilience of businesses into the future and will be a ‘must-have’ for customers and employees.

Many SMEs, however, are unsure about how to engage in digitalisation. Direct Government supports can assist with the education and adoption of digitisation within businesses. However, tax incentives could also be used to further harness the power of digitisation particularly where this is also accompanied by innovation activity.

The current consultation examines the potential to expand the categories of qualifying expenditure for R&D tax purposes to include data analytics and cloud computing. As set out earlier we are supportive of such an extension but believe this could go further to support businesses who also incur expenditure in other digital competencies, such as artificial intelligence, emerging technologies, and cyber-security where that expenditure is directly and actively related to a qualifying R&D project.

Climate change & sustainability

Advances in biological science can transform economies and societies, helping to tackle global challenges from climate change to sustainability. However, tackling climate change requires large scale changes in the behaviours of households, businesses, and governments. It is well known that taxes, including incentives, in combination with other measures are key policy instruments which can be utilised to provide clear and sustained incentives to tackle climate change and drive changes in behaviour. However, businesses also need a reasonable degree of certainty that innovation and investment in this area will be worthwhile and sustained.

According to the OECD, “environmentally related taxes are increasingly being used in OECD economies and can provide significant incentives for innovation, as firms and consumers seek new, cleaner solutions in response to the price put on pollution. These incentives also make it commercially attractive to invest in R&D activities to develop technologies and consumer products with a lighter environmental footprint. Expanding the use of environmentally related taxes can play an important part in growth-oriented tax reform, shifting the burden from corporate and personal income taxes and social contributions towards taxes that have less of a negative effect on investment and labour supply.”

Therefore, in scenarios where a company is undertaking an R&D project with a direct and active link to climate change and/or sustainability, the Government should consider offering an enhanced form of R&D tax relief to encourage companies to invest in innovation activities/projects specifically in these competencies.

Alternatively, the categories of qualifying R&D expenditure could also be expanded to include costs related to these areas, but again only where these have a direct and active link to the relevant R&D project.

A form of innovation tax incentive predicated on both innovation and climate change/sustainability would directly link into the UK Government’s strategies in both these areas as set out in the July 2018 National Adaptation Programme and Agenda 2030 The UK Government’s approach to delivering the Global Goals for Sustainable Development – at home and around the world respectively.

Rent

R&D tax relief is only available in respect of certain utilities which is currently limited to water, fuel and power consumed in the R&D activity. Despite the purchase/development of a building specifically for R&D purposes qualifying for 100% research and development capital allowances, rent of a property used wholly and exclusively in carrying on qualifying R&D activity is not a qualifying cost for R&D tax relief purposes.

If the Government is considering expanding the categories of qualifying R&D expenditure to software leased from external parties, it should also consider extending relief to the cost of rent paid to an external party where a property is used for R&D purposes. This would mean some form of tax relief is available to a company irrespective of whether it rents a property or purchases/develops a property for R&D purposes.

Even if qualifying expenditure for R&D purposes is not extended to software leased from external parties there is still a very strong convincing argument that rent should be a qualifying cost for R&D tax relief. Rent is considered to be expenditure incurred for the use of a building and one which can be directly incurred for the purposes of carrying on R&D activity. As such it is no different to other consumables used directly in the R&D process.

It can also be distinguished from expenditure on a building as rental expenditure is not reflected in the nature or state of the asset post the incurring of the expenditure. Expenditure that is truly on a building would be reflected in state of the asset post the expenditure. For example repairs or capital improvements would be regarded as expenditure on a building and a comparison of the building pre and post the expenditure would demonstrate that it is reflected in the state of the asset unlike rent, which is a cost for the right to the use of a property over a specific time period.

Rental expenditure also potentially forms a significant element of R&D claims. In the current economic environment, continuing to exclude rent from being a qualifying cost for R&D tax relief purposes may serve to undermine the financial position of many R&D activities in the UK and consequently job security as a result.

The Patent Box regime

The UK’s Patent Box regime was introduced in 2013 and is now seven years old. The regime is intended to operate in harmony with the UK’s R&D tax relief regimes and is another vital innovation tool designed to further incentivise companies to continue to carry out innovation activity in the UK.

HMRC’s September 2020 publication of statistics on uptake of the patent box set out that growth slowed in 2017-18 which was the first year where the relief was fully phased in. This is in direct contract to the granting of 5,982 patents3 by the Intellectual Property Office in the same year.

We therefore recommend that a review be undertaken of the Patent Box regime to identify potential reasons for this low uptake in addition to any barriers to entry to the regime and how these may be overcome. Such barriers may include the complexity of the Patent Box calculation, lack of awareness of the regime, the cost involved in and timescales for granting a patent, who owns the patent and the knock-on impact on the ability of the company to claim and the lack of relief for loss-making companies, amongst other factors.

Conclusion

We look forward to engaging in further consultation in future on this matter. In the meantime, in the context of the foregoing, as a minimum we believe that the following four key points merit serious consideration:-

1. There should not be a reverse “quid pro quo” effect whereby if additional qualifying cost categories are added to the UK R&D tax relief regimes, relief is restricted or limited in other areas as a result;
2. Data analytics, cloud computing and related costs such as those incurred on artificial intelligence, emerging technologies, and cyber-security where the expenditure is directly and actively incurred on the qualifying R&D project should also be included as qualifying costs;
3. Rent should be included in the expanded categories of qualifying R&D expenditure as this is would ensure companies obtain some form of tax relief for building costs irrespective of whether they rent or own the relevant property; and
4. The UK Government should undertake a review of the Patent Box regime to identify potential barriers to its uptake and consider mechanisms to reduce these barriers.

Freedom of Information

We note the scope of the Freedom of Information Act with regards to this submission. We have no difficulty with this response being published or disclosed in accordance with the access to information regimes. This response will be published on our own website in due course and will be available to all of our members and the general public.