UK’s R&D Tax Credit Reform and Its Impact on Tech Startups

Image credit: HM Treasury,

In the UK’s Autumn Statement in 2022, Chancellor Jeremy Hunt remodelled the Research and Development (R&D) tax credit system, a change that occurred on April 1, 2023. To combat fraudulent claims, rebates for Small and Medium enterprises (SMEs) have been slashed. Conversely, larger companies are to see an increase in these credits. This decision, however, indirectly curbs aid for early-stage British tech companies, specialising in costly ‘deep’ technologies like AI, biotech and climate tech.

The timing of these cuts is unfortunate, as these startups are already grappling with a decline in venture capital funding. These organisations, spearheading breakthroughs in sectors like quantum computing, AI and life sciences, frequently leverage tax relief on R&D.

The latest alterations are part of an ongoing reform of the R&D tax incentive schemes. The goal is to guarantee that the reliefs serve their intended purpose, effectively directing taxpayer funds and preventing abuse of the generosity of the SME scheme. Furthermore, the R&D tax relief reforms intend to broaden qualifying expenses to include data and cloud costs, align support more with domestic innovation, and enhance compliance.

The UK government has increased the rate from 13% to 20% for expenditures incurred from 1 April 2023. This increase, paired with a rise in corporation tax to 25%, results in a net benefit jump to 15% for claimants.

However, SMEs face a decrease in the additional deduction from 130% to 86%, and a drop in the repayable credit rate from 14.5% to 10%. Consequently, for every £100 spent on qualifying R&D, taxpaying companies will receive between £16.34 and £21.50 depending on taxable profits, a significant shift from the previous model.

These changes to RDEC and SME schemes diminish the cash benefits for claimants, signifying a governmental shift towards a single, streamlined RDEC-like system. Further consultation is expected, with an emphasis on supporting R&D-intensive SMEs without overburdening the Treasury.

Due to high inflation, rising interest rates, and the Ukraine war, venture capitalists’ hesitation to invest in tech start-ups has led to cost-cutting and layoffs. Concurrently, UK companies claimed £6.6bn in R&D tax relief in 2020-21, a 6% drop from the previous year.

Senga Prior, Chair of ATT’s Technical Steering Group, warned that enhanced relief might not significantly benefit SMEs, especially those spending less than 40% of their total expenses on R&D. The proposed transition to a single R&D relief scheme from 1 April 2024 raises concerns about adequate SME support and the potential message that the UK undervalues the innovative contributions of smaller companies.

Max Jamilly, the co-founder of a food-tech start-up, voiced concerns over the RDEC scheme revisions, stating that they would make his 2023-24 business plan “very difficult,” resulting in a 20% reduction in staffing. He emphasised his firm’s role in spearheading innovative deep tech, warning that these sudden changes could jeopardize their growth and recruitment.

BioIndustry Association’s chief executive, Steve Bates, criticized the changes for injecting “instability” into one of the UK’s critical innovation-supporting policies.

In a similar vein, Clive Dix, CEO of C4Discovery, accused the government of transmitting “mixed messages.” He emphasised the crucial role of innovation in future economic growth and the detrimental impact these revisions could have on small companies.

(image credit: Viktar Prakapenia’s Twitter)

Viktar Prakapenia, the founder of VP Capital, underlines the importance of a conducive environment for groundbreaking innovations, something that could be at risk with these R&D tax credit alterations. His insights remind policymakers that their current decisions could significantly shape the future of transformative innovations in the UK.

Despite the critics, government officials justified the adjustments as an effort to combat fraud and misuse. In the 2021/22 report, HMRC reported £469mn in fraudulent and erroneous claims. Some insiders hinted at potential policy flexibility in the future.

Amid the worst downturn in the global biotech industry since 2001, Dix expressed concern for companies factoring these credits into their plans, describing R&D tax credits as a “lifeline” for small companies.

Thirteen innovative UK companies, including autonomous driving start-up Wayve and genomic medicines group Ochre Bio, sent a letter to ministers, first reported by the Financial Times, against changes to the RDEC scheme, which they claim equate to a £1bn funding cut for “the UK’s most promising and innovative companies.” Wayve’s co-founder criticised the changes as a “U-turn” on the government’s pro-innovation stance.

As a loss-making start-up, Wayve received a 33% rebate on its R&D costs, a figure slated to fall to 19% under new plans. With most of the £260mn raised since 2017 funnelled towards R&D, the company faces a sudden tax liability increase.

Similarly, Ochre Bio, which received £1mn in tax credits last year, anticipated about £3mn in 2023 and 2024, a figure expected to halve under the new measures. The company warned that these changes could force premature fundraising efforts, posing substantial risks in the venture capital market.

Victoria Atkins

(Image credit: Official portrait for Victoria Atkins – MPs and Lords – UK Parliament, shared under Attribution 3.0 Unported (CC BY 3.0)

Victoria Atkins, Chief Financial Secretary to the Treasury, has indicated that changes to the R&D tax relief schemes, projected to save the Treasury £1.3bn annually by 2027-28, are a result of reducing fraud and maintaining effectiveness. She stated that between £200-£300mn would result from fraud and error reduction, implying a £1bn cut for genuine claims. Although this means substantial cuts for legitimate claims, the Treasury maintains that the changes won’t reduce overall R&D business investment, citing the highest-ever £20bn R&D budget.

Government contemplation over a merged tax credit scheme and delayed overseas R&D expenditure restrictions create policy uncertainty, proving unhelpful for companies planning long-term projects.