Is the UK a good destination for innovation?
In 2022, more than two-thirds of UK companies moved their research and development (R&D) activity abroad. R&D is an important driver of innovation for businesses and failing to create an environment where R&D can thrive can have significant consequences for the economy.
So, why are so many carrying out their research and development elsewhere, and what can the UK do to become a more attractive destination for innovation? In this article from the latest edition of Business Leader Magazine, we take a closer look.
Brexit, R&D tax credits or something else?
According to research published in Ayming UK’s inaugural UK Innovation Barometer, 69% of businesses have moved R&D activity abroad in 2022 and 70% are planning to move activity abroad this year. We spoke to Mark Smith, who is a Partner at the business performance consultancy Ayming UK, and he unpacked the report to tell us why he believes so many are moving abroad.
He says: “Our report pointed to a number of concerning factors as to why UK businesses are moving their R&D activity abroad, with access to talent and funding being key. For example, more favourable R&D tax credit systems abroad are tempting people to offshore markets like Germany, where 25% of in-house research staff’s salaries are credited against the annual tax liability.
“Our exclusion from the EU’s Horizon programme has also had a big impact. UK businesses have lost access to a €95.5bn funding pool and will not be involved in some of the most cutting-edge R&D collaborations in the world, which encourages businesses to set up in Europe.
“To put it simply, the UK just isn’t competing at the very highest level and other markets are creating more favourable and supportive ecosystems for R&D activity.”
With the Horizon programme being limited to countries in the EU, it appears Brexit is partly to blame for the lack of UK-based R&D. Another factor, according to Jenny Tragner, Director and Head of Policy at tax adviser ForrestBrown, is that UK is competing in global markets where technical skills are becoming scarce. However, Tragner is also critical of the changes that have been made to the UK’s R&D tax relief scheme.
She comments: “According to our research, more than a third of UK businesses think the attractiveness and availability of tax incentives is the most important factor when considering where to locate R&D activity. The UK has long been considered a prime location for R&D, given our world-leading academic research institutions. Generous tax incentives for companies to base R&D projects here and commercialise this research have helped to attract and retain innovative businesses, as well as encourage global businesses to invest more of their innovation budget into UK R&D.
“Making R&D tax relief less attractive means companies will inevitably have their heads turned by other, more generous, jurisdictions.”
In Autumn 2021, then Chancellor Rishi Sunak announced several reforms to the UK’s R&D tax relief scheme. Set to come into force on the 1st of April 2023, they include:
- Reducing the additional amount of tax relief profit-making businesses can claim on qualifying research and development activities from 130% to 86%. The amount businesses can claim will also be impacted by the rise in corporation tax from 19% to 25%, which is set to come in at the same time.
- The amount loss-making companies can claim will also drop from 14.5% of the ‘surrenderable loss’ to 10%.
- However, companies who qualify for the R&D Expenditure Credit scheme (generally those who have more than 500 employees and turnover of more than €100m annually) will be able to claim 20% of their qualifying expenditure, up from 13% currently.
Tragner says it’s changes such as these which contribute to why the UK is currently such an unattractive destination for R&D.
She says: “It’s not solely about the rate of relief. Stability and simplicity are important too. Piecemeal changes which make R&D tax relief more complex to access, and continued uncertainty over the future direction of the incentive are viewed unfavourably when compared to long-standing, more stable regimes in countries such as France. Despite positive signals from Government, the current direction of travel for R&D tax relief policy is not viewed by business very optimistically.”
What effect is this having on the economy?
With so much R&D being taken away from the UK, it’s important to consider the economic ramifications this could have.
According to a report by the National Institute of Economic and Social Research, titled From Ideas to Growth, R&D stimulates innovation, which directly impacts on productivity, and has potentially other indirect benefits, as it enhances the diffusion and absorption of technology. The report also says innovation occurs more frequently in firms that are larger, more productive, export intensive, and foreign-owned, but it is also important for SMEs, particularly in terms of process innovation. Furthermore, SMEs often lack the resources needed to invest in risky R&D activities, which makes them more reliant on external sources of knowledge and R&D capabilities.
Various academic studies suggest there is a link between innovation and economic growth, so as R&D appears so closely tied to innovation, it seems safe to conclude that R&D has a direct impact on the economy.
But that’s not the only issue caused by the UK’s current lack of R&D. According to Smith, “With 70% of respondents planning to move R&D activity abroad in 2023, the UK’s international reputation as a research hub for innovation is at risk.”
He continues: “Innovation is synonymous with economic progress and competitiveness, so if we are doing less of it in the UK, it could have a significant long-term impact on the economy. If UK businesses continue to offshore R&D, we will not only be unable to make Britain the innovation-led economy the Chancellor referenced, but also run the risk of losing both talent and high-value jobs.”
Tragner says there will be a loss of spillover benefits too.
She comments: “Increasingly, R&D has become a global endeavour, particularly in developing software, where teams can collaborate without needing to be physically together. Most of the activity which will in future fall out of the incentive is there to support UK-led R&D projects and teams, allowing UK businesses access to the skills and expertise needed to accelerate R&D programmes and compete globally in cutting-edge sectors.
“When it comes to money spent overseas, the recognised spillover benefits of R&D activity are still very relevant, as it is the UK business which grows and prospers from the R&D. But if businesses instead choose to move management of R&D to overseas locations in future, these benefits will be lost, with knock-on impacts to the UK’s ambition to be a science and technology superpower.”
Encouraging more R&D in the UK
It’s clear that a lack of UK-based R&D could have significant economic consequences. This raises important questions as to how the UK can make itself a more attractive destination for R&D to be carried out.
Smith says there are some immediate changes we can make to do this.
He comments: “One thing that could really stimulate the right kind of innovation could be expanding the scope of R&D tax incentives, specifically to target sustainable R&D activity. By introducing financial incentives in the form of a supercharged green R&D tax credit, not only can the UK stimulate greater levels of R&D, but it will also enable the country to push forward its green ambitions.
“For domestic innovation, the formal launch of ARIA would go a long way and help to counteract the collaborations and funding lost from the Horizon problem. However, the Government should also introduce more local grant funding similar to the EU’s Recovery Fund and the US’s Inflation Reduction Act.
“The UK’s department reshuffle could also be an important move. However, while a Department for Science, Innovation and Technology is a good idea in principle, the proposed changes are significant so the Government must be careful not to get bogged down by the restructuring.”
According to Stanford Graduate School of Business, in addition to offering tax incentives for businesses, there are four additional policies that can improve innovation:
- Promote free trade
- Support skilled migration
- Train workers in STEM fields
- Provide direct grants for R&D
Considering the second point, the Centre for European Reform says the introduction of the points-based immigration system post-Brexit has led to a net gain of workers in healthcare, education and ICT, which they consider more-skilled sectors. This suggests Brexit could have contributed to innovation where skilled migration is concerned. However, the study also said Brexit has contributed to an overall worker shortfall of 333,000, meaning total economic output has been reduced.
For Tragner, going beyond the rate of R&D tax relief is key.
She concludes: “It is important that innovation incentives in the UK compare favourably with those available across the world. This goes beyond the rate of R&D tax relief to encompass factors such as the clarity, accessibility and stability of the incentive, as well as the wider innovation funding ecosystem of grants and incentives available to companies commercialising their intellectual property.
“The newly formed Department for Science Innovation and Technology presents an opportunity for a clear statement of intent for innovation policy and a modernised definition of R&D, which together would provide a vital foundation on which to build.”
R&D in the UK appears to be at a bit of a crossroads. With the Organisation for Economic Cooperation and Development predicting the country will be the worst-hit of all G7 nations in 2023, any measures to bolster innovation would be well-received. However, the incoming changes to R&D tax relief look set to only hinder it further. Interestingly, the notorious exacerbator of so many of the UK’s issues, Brexit, is not the worst impediment to UK innovation either.