Following concerns that the SME R&D Tax relief scheme is not delivering the anticipated benefits, the chancellor today announced an over 33% reduction to the benefit rate.

For expenditure incurred on or after 1 April 2023, SMEs or Small & Medium sized Entities will be able to claim an enhanced deduction of 86% (instead of the current 130%) on qualifying R&D expenditure.

The cash-back rate for loss-making companies has been reduced to 10% from the current 14.5%.

What will this look like?

For SMEs paying tax at 19%, the additional benefit will reduce from 24.7% to 16.34%. At a tax rate of 25% the additional benefit will be 21.5%.

For loss-making SMEs claiming cash back, the rate will reduce from the current 33.35% on qualifying R&D expenditure to 18.6%.

Benefit changes for Large Companies

In contrast, for non-SMEs or large companies, the R&D Expenditure Credit (RDEC) rate will be increased to 20% from the current 13%.  As the credit is taxable, the net benefit (after tax of 25% from 1 April 2023) will be 15% compared to the current 10.53% (after the current tax rate of 19%).

What has triggered such a drastic rate change for SMEs?

Despite spending huge sums on the R&D tax incentive schemes, the related return on investment is believed to be relatively low. Recent FT articles have reported that the OBR has estimated the cost of the reliefs to increase from £7.7bn in 2021-22 to £11.9bn in 2026/27.

Despite this investment, the spending by British businesses on R&D was 4 times the value of the tax relief, compared with the OECD average of 15 times.

It was further reported that the RDEC scheme which is aimed at larger companies, generated £2.40 to £2.70 of additional R&D expenditure for each £1 of tax relief claimed, while the SME scheme generated £0.60 to £1.28.

Other than this, HMRC has recently intercepted the payment of high-value fraudulent claims to SMEs. This has resulted in increased scrutiny of these claims, as well as the planned introduction of other measures including the requirement for new claimants to make an advance notification to claim to HMRC, and a requirement for company directors to sign off on the R&D claim, amongst others. In the meantime, the government has recently consulted on other points, including how to make the scheme and related guidance easier to understand, to prevent the submission of incorrect claims.

Will these changes achieve Government’s objectives of increasing their return on investment in the SME scheme? 

Today’s changes show that the government’s focus is on the large company RDEC scheme, where the return on investment is much higher than the SME scheme.

The SME rate reduction will be disappointing for genuine claimants and in particular, micro-businesses who rely on this funding for their R&D investment.

It will be interesting to see whether, with the rate decrease, will the smaller businesses give up on making claims altogether, potentially impacting UK innovation, of which they are a key part?

Only time will tell.