Jonathan Guthrie: The problem with R&D tax credits

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As the festive season approaches, we should remember the sad, lonely and neglected. I am not talking of the elderly, but of George, the Treasury official who oversees tax credits for companies undertaking cutting-edge research and development. Every day George sits at his desk in Whitehall, answering his heavy, Bakelite telephone. He yearns for calls requesting help in funding a new rocket ship or ray gun. But it is generally only mum, checking he is wearing a vest.

Readers can bring a smile to George’s peaky little face this Christmas by asking him for a cheque in his best copperplate. While the chancellor regularly trumpets the generosity of R&D tax credits – and is likely to extend it again in the impending pre-Budget report – the scheme is judged by many to have fallen short of its full potential.

The credits are an important part of Gordon Brown’s strategy for lifting shamingly low levels of UK productivity. If British business spends more on R&D, the resulting breakthroughs should raise the efficiency with which it uses assets. The chancellor accordingly wants to chivvy up UK R&D spending from 1.9 per cent of gross domestic product to 2.5 per cent by 2014. He introduced tax credits that small companies could offset against R&D costs in 2000, extending it to the big boys in 2002.

However, the CBI and the EEF, the employers’ bodies, estimate that the scheme, which has cost the Exchequer about £1.3bn, has so far only cut the R&D costs of business by 4 per cent, compared with a target level of 10 per cent. RDCL, a specialist consultancy, reckons small businesses leave about £300m unclaimed a year. The shortfalls reflect administrative snarl-ups at HM Revenue and Customs and ignorance and inertia among some eligible companies.

The value of the scheme to a small, innovative business became clear to me last Thursday, when I visited Watford, the unlikely UK convergence point of high technology and golf. There I whanged 30 golf balls implanted with silicon chips into the night sky, at a floodlit driving range incorporating elements of a bowling alley and darts tournament. Those balls that did not brain passing bats or splatter into hazards landed on giant circular targets. Through baffling feats of technology, a computer then calculated my score, as it did for 200 or so other players.

About £1m of the £5m World Golf Systems has spent on researching the technology behind its TopGolf driving ranges has come from tax credits. As a loss-making smaller business, WGS, which started up in 1999, can claim cash against eligible costs. Steve Joliffe, a founder, says this has been a “very important” funding source, alongside risk capital from MMC, a private equity partnership. Licensees already operate five TopGolf ranges around the world and WGS should break even this year on turnover of some £3m.

Importantly, WGS’s technology is of the applied variety. There is nothing new about shunting identity data onto a chip. The challenge was doing it with a chip in a golf ball that would suffer extreme stresses. Many business people do not realise their own appliance of science could be eligible for tax relief too. I blame the misconception in those sci-fi films in which technologists are depicted as cackling boffins, growing three-headed monsters in bubbling tanks of gunk. Vijay Thakrar of Ernst & Young adds that many companies “are suspicious of the idea that the Revenue wants to hand out money, instead of taking it”.

The amount you can claim depends on your business’s notional tax rate and the scale of your PAYE bill. Mr Joliffe says the credit has been worth between 16 to 24 per cent of eligible research costs for WGS, typical for a loss-making small or medium-sized enterprise. Michael Cradock, chief executive of RDCL, says the reclaim for profitable companies, which offset it against tax bills, would be closer to 15 per cent for an SME and about 7.5 per cent for a big company.

In business life, every pot of ointment contains a bluebottle practising backstroke. The main gripe concerning R&D tax credits is that for the user, administration can appear haphazard. Some claimants have waited up to two years for their cash. Mr Joliffe, who once had to twiddle his thumbs for nine months, says: “There is huge uncertainty over when you will get your money, and whether you will get it at all.” This means credits must generally be excluded from cashflow forecasts.

Emily Earl, senior economist at the EEF, accuses HM Revenue and Customs of fuzzy thinking when ruling on claims. She says: “Applications that would be passed by some tax inspectors are turned down by others.” Software development and engineering design projects are especially dogged by such inconsistencies, she says.

The EEF wants the government to set up a brains trust of scientists to pass or fail applications. But it is hard to feel warmly towards a fix based on employing more bureaucrats. Better training and greater specialisation of inspectors should come first. Moreover, there is a market solution to cashflow uncertainty. If your claim is a good one, it is possible to insure against the cost of it being whittled down or rejected.

The government has meanwhile floated the idea of focusing the credits scheme on “emerging winners”. This implies George at the Treasury is capable of identifying such paragons, which I greatly doubt. Safer to offer everyone the credit, and let the market sort the wheat from the chaff. If more companies applied, it would keep George happy, distracting him from fantasies of becoming a technological talent spotter. A helpful scheme would then be in less danger of unhelpful tinkering.

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