This Insight contains extracts from an article first published on Bloomberg.
Financial Services (FS) is one of the UK’s largest business sectors, contributing over £160bn to the economy per year. To survive and thrive, FS businesses have to stay relevant in a fast-changing digital landscape. This means engaging in significant continuing Research and Development (R&D) which is highly likely to benefit from R&D tax relief.
However, with the changes to the tax relief scheme from April 2023, how competitive will the UK regime be in the future?
R&D reform announcement
In his Spring Statement, the UK Chancellor Rishi Sunak promised to increase public investment in R&D to £20bn a year by 2024–25. Research has also shown that the impact of R&D tax reliefs has not been proportionate to the costs to the Government. The Chancellor reaffirmed his commitment to reforming the R&D tax relief system in the UK, with major changes due in April 2023. The goal is to keep R&D tax reliefs internationally competitive while delivering better value for the taxpayer.
This is a significant challenge and the reforms will make U.K. R&D relief in 2023–24 significantly less beneficial than it is now.
R&D Relief value
In April 2023, the current 13% Research and Development Credit (RDEC) will fall to 9.75% for large firms, due to the corporation tax rate in the UK being increased to 25%. Interestingly, for small and medium-sized enterprises (SMEs), the schemes value will increase despite also having to pay the increased corporation tax from April 2023.
Overseas expenses excluded
A key reform introduced by the Chancellor will ensure that only R&D work carried out in the UK will qualify for relief in the future. He highlighted that, as recently as 2019, only 54.5% of the £47.5bn of R&D costs on which relief was claimed arose from work carried out in the UK. The new reforms mean that from April 2023, most costs of overseas workers and R&D activities will not qualify under the RDEC and SME schemes.
This is clearly intended to bring benefits to the wider economy by having both R&D activity and workers located in the UK. However, for some businesses this could have a huge impact on profitability and costs, to the extent of making R&D tax relief not worthwhile claiming. For larger UK companies with global R&D facilities, the fall in value of RDEC reduces the benefit even further.
For large firms in financial services such as wealth managers, insurance companies and banks that traditionally have an international presence, much of their current qualifying R&D activity involves overseas activity and workers. In the future, they will need to consider the net benefits of either outsourcing development to low-cost locations or bringing activity to the UK and claiming the UK R&D relief – they can no longer do both.
New qualifying costs
New advantages from the reformed UK relief rates are the inclusion of cloud computing costs and ‘Pure Maths’ costs from April 2023. These new qualifying costs are expected to benefit many businesses within the financial services sector, fintech and insurance for example. The last two years have seen a significant rise in these costs for financial services R&D activities.
The case for a higher rate of RDEC
Between the falling rate in relief for RDEC and the restrictions in overseas costs and activity, keeping the UK R&D schemes competitive in the eyes of international businesses will be a tall order. We believe that an increase in the headline rate for RDEC is essential to help maintain the benefits of UK-based R&D for large FS companies – but how much of an increase would be enough?
We have determined that the RDEC rate would need to be increased to 55%! Using our data of past RDEC claims across the financial services sector, we think that is the level required in order for large companies to match the current level of tax relief they can claim.
Realistically, we will not see an increase of this magnitude, but it does illustrate the huge benefit the current rules have on costs for UK firms.
Other considerations to ensure competitiveness
Since a high increase in the headline rate relief for RDEC after April 2023 is unlikely, wider measures will need to be considered to increase private sector contributions to R&D. These could include:
- Expanding the types of cost to qualify for R&D – such as legal costs to protect innovations in financial services including in crypto and fintech
- Increasing capital allowances relief for qualifying expenditure of R&D; this will be particularly important as the current super-deduction also expires in April 2023
- Maintain current effective tax rate under the patent box scheme so that its overall value increases with the rise in corporation tax from April 2023.
Better value for taxpayers
With government finances the way they are, it is easy to see why the Chancellor wants a better return on the tax relief that the R&D schemes provide.
Currently, we expect smaller firms, like those typically involved in Fintech, to benefit from the SME scheme’s rise in value the new year. For larger firms, the decision to continue to invest will be much harder with the lower RDEC value eroding the tax subsidy available in the UK. The Chancellor’s reforms could actually undermine his goal of bringing more R&D work to the UK.
The decision to include ‘Pure Maths’ and cloud computing costs is positive, but a full package of measures will be needed to support future innovation in the UK. We hope a significant increase in the RDEC incentive will be part of that.
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