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 thrive, companies must seek new and improved services and fulfilment methods to match the digital landscape and FS businesses are no different. This means engaging in significant continuing R&D which is highly likely to benefit from UK R&D tax relief, However, the upcoming changes from April 2023, the question which is yet to be answered is how competitive will the UK regime be after the in the future?
R&D reform announcement
In his Spring Statement, the U.K. Chancellor Rishi Sunak promised to increase public investment in research and development (R&D) to £20 bn a year by 2024–25 and to continue the ongoing process of reforming the R&D tax relief system in the UK, with major changes in April 2023. His aim is to keep them internationally competitive yet provide the best value for the taxpayer.
Maintaining the current competitive incentive that R&D relief provides is going to be challenging as the Chancellor has already announced tax changes that will make U.K. R&D relief in 2023–24 significantly less beneficial than it is now.
R&D Relief value
The current 13% research and development credit (RDEC) from April 2023 will fall to the value of 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) their scheme’s value will increase despite having to pay the increased corporation tax from April 2023. Currently, research has indicated that the government return on investment for this scheme has not been great, so potentially a change to this scheme could be on the cards.
Overseas expenses excluded
A key point reform introduced by the Chancellor will ensure that only R&D work carried out in the UK will be qualify for relief in future. He highlighted that, as recently in 2019, only 54.5% of the £47.5 bn of R&D costs which relief was claimed arose from work carried out in the UK. The reforms means that from April 2023 most costs of overseas workers and R&D activities will not qualify under either the RDEC and SME schemes.
This is clearly intended to increase the wider benefits to the economy of 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, even to the extent of making R&D relief not worthwhile claiming in some cases. For larger UK companies with global R&D facilities, the fall in value of RDEC reduces the benefit even further.
For large firms in the financial services sector such as wealth managers, insurance companies and banks that traditionally have an international presence, much of their current qualifying activity could currently arise from overseas activity and workers – particularly on software. In future they will need to consider the net costs of either outsourcing development to low-cost locations versus onshoring activity and claiming UK R&D relief – they can no longer do both.
New qualifying costs
New advantages from the reformed UK relief are the inclusion of cloud computing costs ‘pure maths’ costs from April 2023. These new qualifying costs are expected to benefit many businesses within the sector (fintech and insurance for example) - the last two years have seen a significant rise in such costs for financial services R&D activities.
The case for a higher rate of RDEC
Between the falling rate for the relief for RDEC and the restrictions in overseas costs and activity, keeping the UK R&D schemes competitive tin 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 companies – but how much of an increase would be enough?
Using our proprietary R&D data of past claims across the financial services sector we have assessed the potential impact on the average amount of overseas costs claimed. We have used the data to try to determine the level the RDEC rate would need to be increased to in order for large companies to match the tax relief they can claim under the current rules once the changes are made in April 2023. For the financial services sector, this would require a rise to 55%! Realistically, we most likely will not see an increase of this magnitude, but it does illustrate the benefit the current rules on costs have been to U.K. firms.
Other considerations to ensure competitiveness
As a high increase in 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 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 effect tax rate under the patent box scheme so that its value increases with the rise in corporation tax from April 2023.
More ‘bang for the Chancellor’s buck’
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 such as those typically involved in Fintech to benefit from the SME scheme’s rise in value the new year, unless yet more restrictions are announced in the Budget. For larger firms the decision to continue to invest will be much harder with cuts to overseas costs and a lower RDEC value eroding the tax subsidy available in the UK - their bottom-line issues mean that the Chancellor’s aim of bringing more R&D work to the U.K. could be undermined by his own ’reforms’.
The decision to include ‘Full Maths’ and cloud computing cost is positive but a full package of measures will be needed to support future innovation in the U.K. We hope a significant increase in the RDEC cash incentive for doing R&D work in the U.K. will be part of that.
If you have any questions please contact Claire McGuigan or Tim Scott.