Jenny Tragner 29 Mar 2017 05:03pm

Will government unlock innovation budgets for SMEs?

The chancellor announced in his Spring Budget that the government will work to increase certainty and simplicity around research and development (R&D) tax credits claims. He also promised to raise awareness of the incentive among SMEs. But will these measures address the imbalance that currently sees large businesses benefiting the most?

Caption: Improved accessibility and awareness of R&D incentives for SMEs could be a major driver of economic growth.

I strongly agree with the need for greater accessibility for R&D tax credits, grants and other government incentives to boost innovation, but I can’t escape the feeling that we’ve been here before. Previous measures haven’t been fit for purpose, and there remains a concern that the growth of innovative smaller businesses is being hampered by difficulties in accessing government support.

ForrestBrown’s report, Igniting Innovation, has shed some light on the scale of the problem. One thousand UK business leaders across companies of all sizes expressed the extent to which they felt incentivised by current and proposed government support (including an additional £4.7bn investment to boost R&D output - £2bn a year by 2020). They also gave their views on where government support would be best targeted, as the consultation period for the government’s new industrial strategy draws to a close.

Only 5% of small businesses - those employing fewer than 50 employees - have used R&D tax credits at any point, compared to half of all businesses employing more than 500 staff. A similarly unbalanced picture also emerged when it came to grant funding, with just more than 10% of small businesses having accessed some form of grant, compared to 45% in the larger business group.

More than twice as many large businesses said they would innovate further as a result of the government’s increased investment in R&D than small companies. Perhaps most interestingly, despite smaller businesses missing out on available support, over half of all survey respondents said that assisting start-ups, as opposed to established SMEs or large companies, should be the government’s priority.

So are current and future incentives geared towards supporting larger businesses, or is there simply a problem with awareness levels – and subsequently, access for small businesses? The answer is, unequivocally, the latter.

Let’s firstly look at the benefit that R&D tax relief delivers to small and large companies. For the purposes of the R&D tax credit incentive, SMEs are defined as having fewer than 500 staff and either turnover or gross assets not exceeding €100m (£87m) and €86m (£74m) respectively. The tax credit for companies that fall into this category is by far the most generous, allowing them to claim back up to 33.35p for every pound spent on R&D. Large companies, who must apply for any relief through the R&D expenditure credit (RDEC) scheme, can claim up to 8.8p for every pound.

So the incentive is weighted towards incentivising smaller companies, in recognition of the fact that innovation is costly and cash flow is essential for younger businesses, whereas large companies can more easily swallow the short-term expense.

But it also acknowledges that grass roots R&D is the bedrock of innovative industry, with ideas and technologies being transferred to or incorporated into larger commercial projects and smaller businesses providing the essential supply chain for larger organisations.

However, the more generous relief rate for smaller businesses means little if they don’t know about it or can’t access it. R&D tax credits are generally not understood by the smaller businesses we work with, and a large part of our role is to educate companies on eligibility. Many companies are surprised how much of their activity qualifies, and what costs they can recoup, often because it takes highly specialised knowledge or expertise to quantify this – expertise that smaller companies don’t have in-house, but large companies often do.

For those that use R&D tax credits, the system works effectively, and the cash boost almost always funds further innovation, which aligns perfectly with the policy intent. But there needs to be a clear unifying message from the government on who is eligible for relief and why. The Spring Budget appeared to prioritise the needs of big business over those of SMEs and start-ups, yet the government’s proposed industrial strategy aims for the UK to be "the best place to start and grow a business".

Both the government and the wider tax industry have a significant role to play to educate businesses further; we know from experience that R&D tax credits are a vital part of the funding ecosystem for growing, ambitious companies. Improved accessibility and awareness of R&D incentives could be a major driver of economic growth, preparing the UK for the challenges that Brexit may bring.

Jenny Tragner is a director at R&D tax credit consultancy ForrestBrown and a member of HMRC’s R&D consultative committee.