The UK’s R&D tax budget stagnates over a decade

Over the same time period, Japan increased its R&D tax budget by 134%, South Korea by 119%, and Germany by 71%. To put this in context, Germany increased budgets by over five times that of the UK. 

The report critically examines the UK's recent R&D tax reforms, focusing on the 2024 merger of the Research and Development Expenditure Credit (RDEC) and the Small and Medium-sized Enterprises (SME) schemes. With comparisons with nations like Germany, South Korea, and France, it underscores the urgency of implementing a more competitive R&D tax framework to keep pace with global leaders.  

The UK's R&D tax credit system has seen substantial changes in the last two years. The merged scheme launched in April 2024 now offers a flat 20% taxable credit on qualifying R&D expenditures for all companies. While this simplifies the process, many SMEs that once enjoyed more favourable conditions face diminished benefits unless they meet the "R&D intensive" threshold. These reforms could alter the innovation landscape, particularly for smaller businesses that drive a large share of R&D claims. 

Lord Philip Hammond, Ex-Chancellor of the Exchequer and Senior Adviser at RCK Partners comments, “The challenge has always been to reduce fraud and error in the R&D tax credit schemes and eliminate organised criminal activity targeting them, without undermining the positive incentive effect of the schemes for businesses undertaking eligible R&D investment. HMRC has made good progress on reduction of fraud and error, and I expect that agent identification will be an important further step, but reductions in the rates of credit payable risk disincentivising R&D investment in the UK, to the detriment of our competitive position.”

The UK's R&D challenges are compounded by low private-sector investment in innovation. While countries like South Korea and the US invest 3.8% and 2.6% of their GDP in business R&D, the UK trails at 1.99%. Even with a total R&D expenditure (GERD – Gross Domestic Expenditure on R&D) of 2.9% of GDP, the UK lags behind nations like Germany (3.13%), Sweden (3.41%), and South Korea (5.21%). This underinvestment puts the UK at a disadvantage, particularly as other nations ramp up their R&D efforts amidst tightening fiscal conditions.

While the UK has relied heavily on tax incentives—providing 4.1 times more tax relief than direct government R&D investment in 2021—the effectiveness of this system is lagging. According to the Implied Marginal R&D Tax Subsidy Rate, countries like Iceland, France, and Portugal offer more generous tax benefits to both profitable and loss-making SMEs. This highlights the structural inefficiencies within the UK’s system, particularly for smaller businesses that drive a significant portion of the country’s innovation.

Martin Veselinov, Student at London Business School, explains, “According to the UK Innovation Report 2024, the UK is a global leader in research output, ranking just behind China and the US in total academic publications. To maintain the UK’s position as a global leader in innovation, the government must revisit its R&D tax relief system, focusing on bolstering support for R&D-intensive SMEs. By introducing targeted incentives for these firms, the UK can help bridge the gap in private-sector investment and foster the commercialisation of groundbreaking research. Additionally, aligning R&D tax incentives with a long-term industrial strategy in high-growth sectors such as AI, biotech, and cleantech, will stimulate private investment and strengthen the UK’s global competitiveness in emerging industries.”

Main image: Lord Philip Hammond, Ex-Chancellor of the Exchequer and Senior Adviser at RCK Partners