David Kent: It’s time Scottish firms realised the financial rewards for their innovation
David Kent, head of Scotland for innovation funding consultancy Leyton UK, looks at why Scottish firms are missing out on R&D tax relief and what can be done about it.
Innovation is a hallmark of many Scottish companies. From oil and gas decommissioning in the North Sea, to biotech companies in Aberdeen and Edinburgh’s growing fintech hub. Innovative Scottish companies are expanding their technical knowledge and creating new solutions to intractable problems. The trouble is that these companies are not financially benefiting to the same extent as the rest of the UK. In R&D tax relief, Scotland is in fact falling behind other parts of the UK.
The UK as a whole still has relatively low levels of R&D compared with other European countries. It has an average of 1.69% investment in GDP versus 2.07% in Europe, according to the OECD. In Scotland it is even lower at 1.63%. It is something the new Westminster Government has pledged to tackle with a stated commitment to ‘double down’ on investment in R&D to compete post-Brexit.
Two schemes already in existence are the Research and Development (R&D) Tax Credits initiative and the Patent box scheme. R&D tax credits are designed to encourage greater spending in research and development, leading in turn to greater investment in innovation. Research and development, as defined by government, covers a broad set of activities across a variety of industries. This can cover products, processes and computing, ranging from improvements to existing methods or the development of new methods.
The way the scheme operates is by reducing a company’s tax bill by an amount equal to a percentage of the company’s qualifying R&D expenditure. Alternatively it can be made by the payment of a credit, again linked to the company’s qualifying R&D expenditure. A company can only claim R&D tax credits if it is liable for Corporate Tax in the UK, but otherwise there are very few limitations. Additionally, the current patent box scheme works in a similar way encouraging firms to develop intellectual property (IP) assets.
Analysis of HMRC’s recent statistics on the number of companies in the sector claiming R&D tax credits suggests that many Scottish businesses are missing out. In terms of individual claims in the UK’s nations and regions, Scotland comes ninth with 2,450 claims in total for the last full year of reporting. Despite overall claims increasing, Scotland has had slower growth than other parts of the UK. Meanwhile in expenditure gained from the scheme, Scotland comes joint seventh at £195m. It falls behind English regions such as the South West and North West.
The shortfall stems from a knowledge gap in terms of what can be claimed and more limited awareness of the scheme among SMEs in Scotland compared to England. The knowledge of what can be claimed for needs to be profound and specific depending on the sector. An accountant-led process has been shown to realise less benefits. However, Scotland has less of the specialist firms that have been set up specifically to focus on this regime.
Additionally, two of the sectors Scotland is very strong in, agriculture and architecture, also perform badly in relation to other industries in overall claims. The challenge lies in many architects not considering their work to be R&D, when actually it is about overcoming complex engineering challenges. This can range from the use of complex materials to acoustics to energy efficiency. It involves balancing instructions from clients with the needs of planning permissions and the physical limitations of what a building can do.
Similarly, many agricultural firms are unaware that what they are doing counts as innovation and can be claimed for. The reality of working in this field is that even what is deemed as a regular activity is likely to be innovative, due to the complexities of the challenges. This includes reducing downtime and optimising the soil quality to mean there won’t be any disruption to harvest and process throughout the year. Many are at the forefront of ensuring we can continue to farm in the face of climate change. This is unprecedented in human history.
For many of the newer digital businesses springing up in Edinburgh and other hubs, there is a host of backend technological support that can and should also be claimed for. Examples of technological developments that SMEs might be able to claim for include:
- Developing or integrating different technical systems for improved performance or
additional features, for example, CRM systems, ERP systems and SAS systems.
- Building web frameworks and software packages for improved security and scalability
- Cloud computing and large-scale data management, for example migrating to Amazon AWS, Google Cloud, Microsoft Azure
It is only through a root and branch assessment of their businesses that Scottish firms can realise the benefit. With challenging economic headwinds in 2020, this regime can stimulate cash flow for businesses supporting their bottom line. Scotland has hugely innovative businesses and the time has come for them to benefit financially.