The UK's £8 billion research and development tax credit scheme, designed to encourage innovation and growth, has inadvertently had the opposite effect. Data from a leading advisory firm shows that more than six in ten businesses carrying out R&D have cut their investment as a direct result of reforms aimed at reducing abuse of the scheme.
The reforms, implemented in April 2023, included reduced relief rates and increased scrutiny on claims. While these measures have reduced the cost of fraud and error, they have also led to a significant drop in business investment. A survey of over 250 chief financial officers at R&D-active SMEs found that a third have hired fewer technical staff than planned, and one in five has cancelled innovation projects altogether.
The consequences of these reforms are particularly harsh for smaller firms. Thirty per cent of respondents were forced to take out loans to cover delays in relief payouts, and nearly as many fell back on directors' personal funds. Lord Hammond, the former chancellor and chairman of the advisory firm, has described the findings as 'disconcerting' and urged policymakers to re-examine the scheme.
'The rates for small and medium companies were reduced at the same time as the regime was toughened up,' he said. 'The risks and the complexity increased while the rewards decreased.' This combination of tighter enforcement and thinner relief has resulted in a compliance burden that is discouraging businesses from investing in R&D.
HMRC has reported a significant decrease in the cost of fraud and error, from £1.34 billion in 2021-22 to £497 million in 2023-24. However, this success comes at a cost, as the number of R&D claims made by small businesses has also decreased. The government has defended the reforms, stating that they are aimed at ensuring that taxpayers' money goes towards genuine innovation.
However, many experts believe that the scheme has become too complex and burdensome, discouraging businesses from investing in R&D. 'The inquiry process is inconsistent, and some inspectors ask targeted questions that are easier to answer, while others can go on for two years,' said Peter Roscoe, co-founder of the advisory firm. 'This is making it difficult for businesses to navigate the scheme.'
The advisory market itself is also contributing to the problem. Online advertising has created a market for unqualified firms promising to deliver R&D claims, but often resulting in dubious and unchecked claims. This has scared off genuine innovation companies from trying to access the scheme at all.
According to the survey, nearly a quarter of respondents said they had decided not to submit a claim at all, a figure rising to nearly half among firms with 250 to 499 staff. HMRC defines an SME as a business with up to 500 employees, which means the largest firms in that bracket, typically those with the most sophisticated R&D programmes, are the most likely to walk away.
The government is unmoved, stating that the report is based on a 'tiny fraction of UK SMEs'. However, the consequences of the reforms are clear: a scheme that nobody wants to claim from can no longer be called an incentive. The question for the Treasury is whether the scheme can be tweaked to restore certainty and encourage businesses to invest in R&D once again.
