In the Budget on 3 March 2021, the chancellor of the exchequer announced an extensive review of the research and development (R&D) tax relief system to ensure that "the UK remains a competitive location for cutting edge research, that the reliefs continue to be fit for purpose and that taxpayer money is effectively targeted".
The government has set itself the target of raising the total investment in R&D to 2.4% of UK gross domestic product by 2027. R&D tax reliefs are viewed as being a significant incentive to encourage such investment. Boosting innovation and technology also forms part of the government's 'build back better' post-COVID-19 recovery strategy, again reinforcing the notion that the intention is to improve rather than restrict access to the reliefs.
The wide-ranging review is detailed in a consultation document published by Her Majesty's Treasury and Her Majesty's Revenue and Customs. Broadly, the scope of the review is to consider whether to:
- expand the definition of R&D;
- continue to maintain two separate relief systems for larger and smaller businesses;
- introduce changes to how the system is administered; and
- introduce territoriality requirements to make the reliefs more targeted.
The life sciences sector invests more in R&D than any other UK sector, so any improvement to the tax reliefs will be positively received. However, as outlined below, some of the possible routes for reform could prove problematic for life sciences businesses, giving rise to unintended consequences that should be highlighted by stakeholders when responding to the consultation.
Before discussing the review, it is useful to first outline the two reliefs currently available on certain qualifying R&D-related expenditure. Both reliefs adopt the same definition of R&D and qualifying activities. 'R&D' for tax purposes is defined by reference to activities that are treated as R&D under UK generally accepted accounting practice and fall within the Department for Business, Energy and Industry Strategy (BEIS) guidance. Broadly, the guidance specifies that the R&D activity must take place within a project that seeks to achieve an advancement in science or technology.
SME relief
Where certain conditions are met, relief is available for small or medium-sized companies (SMEs) in the form of an effective deduction of 230% on qualifying R&D costs. Loss-making SMEs may have the option of receiving a cash repayment of the tax credit in return for surrendering R&D-related losses. Any repayment is capped at 14.5% of the losses available for surrender. For accounting periods beginning on or after 1 April 2021, any repayment is also subject to an annual cap of £20,000 plus three times the company's total pay-as-you-earn and national insurance contributions' liability.
RDEC scheme
The Research and Development Expenditure Credit (RDEC) is also available. Although primarily targeted at larger companies, it may be used and can prove valuable to SMEs in certain circumstances. The RDEC uses a different method of calculating corporation tax relief on R&D expenditure. The 'above the line' RDEC is brought into account as a trade receipt, increasing taxable profits (or conversely reducing losses). A credit of 13% of the qualifying R&D expenditure is then credited to the company. In certain limited circumstances, a repayment may also be available.
The consultation document makes no clear proposals for reform. Rather, the document vaguely alludes to the direction of travel that reforms might follow by outlining aspects of the system that are subject to review and seeking input as to whether changes should be made. Many of these aspects will be of interest to life sciences businesses, which are strongly encouraged to respond to the consultation and ensure that the government is made aware of any changes that may have unintended consequences for R&D within the sector.
The remainder of this article highlights some of the key review proposals.
Structure and administration of reliefs
The first part of the review considers whether the two relief systems should be consolidated. Consolidation may simplify the regime, which may be attractive. However, this may be difficult to achieve in practice.
There are significant differences between the two systems and most notably there are circumstances where one relief may be available where the other is not. For example, SME relief rather than the RDEC may be available where an SME has subcontracted the R&D to another entity. The ability to subcontract R&D activities can be vital to biotech start-ups that may not have the resources and sufficient finance to conduct the R&D themselves. A cash repayment is also more likely to be available under SME relief. Simplification should be welcomed but should not lead to the dilution of the effectiveness or availability of SME relief that is vital to biotech and life sciences start-ups.
R&D definition
The consultation also considers the definition of R&D and the nature of activities that should qualify for relief. It is unsurprising that reviewing the current R&D definition would fall within the scope of the consultation, since it is based on BEIS guidelines first published over 15 years ago.
However, the government should consider that the definition is well understood by many businesses whose success may be reliant on R&D reliefs. Within the life sciences sector, R&D tax credits often form a key part of an SME's financial planning. Many biotech start-ups will be loss-making for several years and therefore the availability of SME relief may be crucial to their viability, constituting an essential component of their initial capital-raising structure.
For biotech and other life sciences SMEs, when considering whether to amend the R&D definition, it is likely to be a case of 'if it's not broke don't fix it'. Any change to the definition should be carefully considered to ensure that it remains broad enough to allow for continued developments in science and technology while also remaining straightforward and easy to apply.
Territoriality
The consultation also questions whether to introduce a territoriality requirement to the eligibility criteria for R&D tax relief. Currently, there is no requirement that the R&D activity must be undertaken in the United Kingdom. UK companies that incur R&D overseas may still be eligible for full tax relief. However, the government wants to ensure that the reliefs incentivise UK innovation and are appropriately targeted in a way that best benefits UK industry. Given Brexit, it is unsurprising that the government is now questioning whether to introduce restrictions on the availability of R&D reliefs for activity undertaken overseas.
However, territoriality restrictions are likely to be concerning to life sciences businesses, particularly those in the biotech space that focus on medicine or vaccine development. Overseas research may be vital to the eventual development and approval of a new drug or vaccine. For example, for a new vaccine or drug to obtain approval by the US Food and Drug Administration (FDA) it is likely to be essential that a clinical trial is undertaken in the United States. Given the extent of the US market, FDA approval may be essential to the viability of the new drug or vaccine. However, if tax relief is unavailable in relation to overseas clinical trials, the development or innovation may simply prove too costly for a UK biotech company. Therefore, a territoriality requirement could become an insurmountable stumbling block for some life sciences innovation.
If the government insists on introducing a territoriality requirement, it should be strongly encouraged to consider introducing a carve-out for overseas R&D that is integral to the development of the innovation.
It remains unclear how the R&D tax relief system may be reformed. Therefore, it is difficult to draw any conclusions as to the impact of the review on the life sciences sector. However, if the consultation yields evidence that changes could lead to increased investment in innovation, particularly if increased investment supports the UK's post-COVID-19 recovery, it is likely that the government will be keen to introduce reforms quickly. Across the life sciences sector, affected businesses and interested stakeholders are strongly encouraged to respond to the consultation before it closes on 2 June 2021 to ensure that any unintended and possibly undesirable consequences of the review are thwarted before concrete proposals for reform are developed.
