House of Commons - Risk and Reward: sustaining a higher value-added economy

Risk and Reward: sustaining a higher value-added economy - Business and Enterprise Committee Contents

6 The policy framework

R&D tax credits

101. R&D tax credits are the key Government policy for raising levels of business investment in R&D. The scheme was established first for SME research spending after 1 April 2000 and was extended to large company spending after 1 April 2002. In order to claim, companies must undertake qualifying R&D, a government definition of which is given as "working to resolve scientific or technological uncertainty aimed at achieving an advance in science or technology".[116] Innovation in products, processes and services is not currently defined as R&D.

102. The credit can be used to reduce a company's tax bill or, for some SMEs not in profit, to provide a cash sum. Companies must be spending at least £10,000 a year on qualifying R&D and can claim for revenue, but not capital, expenditure. SMEs (fewer than 500 employees and an annual turnover less than €100m or annual balance under €86m) can make a deduction of up to 175% of qualifying expenditure incurred on R&D activities when calculating their taxable profit (they can also claim a credit for R&D performed if they are not in profit). Large companies can claim up to 130% of expenditure incurred. From 1 August 2008, companies can also claim 140% (down from 150%) of their qualifying vaccine research expenditure. In 2006/07, over 6,500 R&D tax credits claims were made, meaning that government support totalled £650 million, split between SMEs (around £180million) and large firms (around £460million).[117]

103. A CBI survey published February in 2009 found that the value of the credit to companies now exceeds the "noise-level for investment decisions"; it was large enough to influence companies' decisions. Key findings included:

savings on R&D costs delivered by the tax credit now average 8% (with SMEs on average saving 10.5%, medium-large companies 8.5% and large companies 6.0%);
37% of companies surveyed increased R&D as a result of the credit; and
three quarters of companies surveyed said the credit had helped directly or indirectly to maintain their R&D investment in the UK.

104. The CBI survey also found that the role of HMRC in handling claims and providing advice had improved significantly. Also, the credit was an important factor for companies when deciding where to base R&D activity, improving the attractiveness of the United Kingdom as a destination for high value investment and jobs.[118] Our witnesses also acknowledged the success of the R&D tax credit scheme. For example, the Institute of Physics[119] and NESTA said that "Studies have consistently shown that R&D tax credits are effective at raising investment in R&D".[120]Universities UK said that they "strongly support R&D tax credits extension to companies with less than 250 employees, which, in a SME-dominated economy, is vital to achieving the government's targets for research and innovation".[121] Rolls-Royce, giving the perspective of a large, multinational company, told us that the tax credit "incentivises those who spend on R&D to continue to do so in the UK".[122]

105. Most witnesses considered that it was too early to evaluate the scheme, given that larger firms in the United Kingdom have only been able to benefit from the tax credit since 2002.[123] Even so, the CBI noted that "the R&D tax credit may not be an incentive for the short term, but with more certainty and continuity of the legislation, business will be able to work the relief into its long term strategy and it will increasingly stimulate innovation in parts of the UK economy where R&D is an important factor".[124] The CBI told us the Government would evaluate the scheme in 2014.

106. However, the evidence also highlighted a number of concerns about the more detailed workings of the scheme. Some evidence suggested that tax credits were complex and not widely known about or taken up. The Institute of Chartered Accountants in England and Wales (ICAEW) said that "the majority of SMEs do not consider tax credits before they choose to invest in R&D […] there is significant evidence that the R&D tax credit is not as effective in encouraging smaller business to invest in R&D as compared to larger business".[125] Coventry University noted that SMEs could not always get good advice from accountants and suggested that the system needed to be simplified.[126]

107. Rolls-Royce also warned while that the tax credits were useful, they were only worth a small amount of money to them, particularly compared to the incentives provided by the US and other countries.[127] Sir John Rose warned that if the United Kingdom:

wants to be in high value added manufacturing, it has to understand the competitive environment in exactly the same way as a company has to understand the competitive environment… the rational company will go to those places where the environment is more conducive to what they are trying to do.[128]

It is worth noting the importance of research and technology incentives to many companies operating in the United Kingdom's most successful manufacturing sectors. In a climate of increasing international competition for mobile R&D investment, this factor must be borne in mind when deciding policy on the future of the R&D tax credit scheme.

108. On balance, the evidence available suggests that R&D tax credits have been successful and that they are becoming more so as awareness of them grows. Businesses take time to adjust to new policy instruments, so this increased awareness is not surprising. We recognise, then, that the policy needs time to produce its full effects, and welcome the Government's commitment to a full evaluation in due course. However, although we support the principle that business needs some basic certainty about the incentives available, this should not prevent improvements to the tax credit scheme before then. We particularly urge the Government to look at ways in which the scheme could be made more accessible to SMEs by reducing both the eligibility thresholds and the complexity of the scheme.

109. Questions were also raised about the principles on which the scheme has been built. NESTA highlighted the fact that R&D is becoming increasingly global, which raises questions about what expenditure should qualify. NESTA noted that "R&D performed by foreign multinationals in the United Kingdom generates benefits for the UK economy, while R&D expenditures by UK firms abroad improve the United Kingdom's ability to apply new knowledge".[129] We encourage the Government to consider this point in the future development of tax credit policy.

110. NESTA argued that Government "policy should concentrate on building capacity for innovation rather than the creation of specific innovations" and therefore that the tax credit should be widened beyond traditional R&D to encourage innovation more generally and particularly to take account of innovation in the service sector. It suggested that an innovation tax credit should replace the current R&D tax credit.[130] The CBI also called for the extension of the scheme (and other government supported measures) to the service sector,[131] saying that "R&D is only one factor in innovation and, with our service-dominated economy, not always the most important. Care is thus needed in making international comparisons on the potential for value-added activity in the economy on the basis of national R&D performance alone".[132]

111. The Committee strongly agrees that innovation is much broader than R&D and that wider innovation should also be encouraged. Nonetheless, we would be cautious in making radical changes to the R&D tax credits scheme, which is currently seen as a success, particularly before it has been properly evaluated. However, we strongly encourage the Government to think about how it might better encourage innovation beyond the current support for traditional R&D and particularly, how it will encourage innovation in the service sector.

Intellectual property

112. The importance of intellectual property (IP) to innovation and entrepreneurialism and the challenge of properly protecting ideas have been discussed in a number of reports over recent years.[133] The Committee does not wish to replicate that discussion, but appropriate protection for intellectual property is a critical factor in encouraging the growth of the higher value-added economy in the United Kingdom. The CBI told us that IP had become more important in recent years due to the "high-value challenge. If you are going to move up the ladder of high value and you have the Chinese and the Indians chasing you up that ladder, it matters hugely whether you can protect the thing that differentiates you from your East Asian competitor".[134]

113. The Committee is also aware, however, that attitudes to IP are changing in the increasingly fast-paced technological market, where the emphasis is on getting a product onto the market before competitors, and securing IP protection may not always be the highest priority. It also recognises the implication of product user innovation on goods. There are circumstances in which copyright or patent protection is not appropriate. A company may gain greater market advantage from trademark protection, branding, or even foregoing protection altogether.

114. The Committee welcomes the fact that responsibility for IP within government will lie with the new Department for Business, Innovation and Skills. All too often, intellectual property is seen as synonymous with patenting; one of the tasks of the department should be to raise awareness of the variety of ways in which such property can be protected.

115. Although these days many larger companies have IP expertise, it is more difficult for SMEs to protect their ideas.[135] The Committee recognises the importance of intellectual property to the development of a higher value-added economy and wishes to see greater support for businesses in understanding and researching their IP options. This challenge was identified by the British Library and inspired it to re-launch its Business and IP Centre in 2003 to provide support for businesses within the M25 (see Case Study 3 for further explanation). The Committee was very impressed with the centre when it visited it as part of this inquiry. Similarly, the Intellectual Assets Centre in Scotland aims to raise business awareness of the importance of managing intellectual assets. We believe that the British Library Business and IP Centre is providing an exemplary service to the SMEs and entrepreneurs of the capital and we would like to see this model replicated throughout the United Kingdom. The Committee recommends that the Government secure the Centre's long term funding to enable it to provide a service to business people across the United Kingdom and provide funding for similar centres in key business hubs within the United Kingdom.

Case Study 3: British Library Business and IP Centre

The centre was designed to support entrepreneurs and SMEs in the start up and development of a business. It provides free access to information and advice on IP, market research, and databases. It also runs events to encourage entrepreneurs; and it acts as a hub for the Knowledge Transfer community in the capital and many other businesses. The centre has exceeded all its targets to give business advice and skills development by a wide margin since it was re-launched in March 2006. It has links with more than 50 service providers in the enterprise sector and provides information to businesses in person, over email or on the telephone. The objectives of the centre, agreed with the LDA who fund the centre, include: promoting economic growth through information and knowledge transfer; providing guidance and information to SMEs and entrepreneurs on IP and the protection of innovative ideas and promoting innovation; encouraging the creation of new businesses and helping create new jobs within the M25; and regeneration of the King's Cross area.

Public procurement

116. Estimates of expenditure on public procurement vary but the Glover Committee review into strategic procurement[136] estimated its worth at over £175 billion per annum, representing 13% of GDP.[137] QinetiQ told us that the Government spends "between £125 billion and £150 billion annually on procuring goods and services, such procurement is widely recognised as potentially being a major driver of innovation, through the Government creating a market for innovative products".[138] If used properly, public procurement could not only increase the market for innovative products or services, but foster the collaborative approach which allows higher value-added products and services to be developed.

117. There are significant barriers to this. QinetiQ said:

Previous procurement problems have made Government even more risk-averse. This leads UK Government to procuring existing technological solutions which it perceives are low risk and provide value for money, thereby acting as a late adopter of technology. As a result procurement contracts are placed increasingly frequently with overseas companies (or with UK companies buying overseas equipment) because they have been able to develop track record with overseas governments who have been more agile in their procurement. This leaves UK industry at a distinct disadvantage.[139]

Another criticism was that parts of the Treasury and the Office of Government Commerce often interpreted the EU procurement rules very conservatively.[140]

118. There are signs this conservatism is changing. The report of the Glover Committee recommended that "Departments should use their Innovation Procurement Plans to set out how procurement aligns with their overall commercial strategy, encourages innovation and gives advanced notice of long-term procurement plans" [emphasis added] and "Government should encourage wider use of outcome-based specifications across the public sector, as a means of driving innovation".[141]

119. The Glover Report also contained proposals to make the public procurement system more transparent and simpler, so that it was easier for SMEs to access. These proposals were accepted in the Pre-Budget Report (PBR) 2008, when the Government said

The Government will advertise government contracts worth more than £20,000 in a single free online portal, it will introduce measures to reduce bureaucracy and will make opportunities more transparent for small businesses. In addition, it will standardise qualification criteria and encourage innovation by increasingly specifying outcomes rather than prescribing solutions. It will also help SMEs get a fair deal when they are sub-contractors.[142]

The Committee welcomes this move by the Government and we hope that it produces tangible results for SMEs. The Committee will continue to monitor the situation.

120. The Committee highlights the vitally important role for public procurement in stimulating innovation in the United Kingdom. The Government has an obligation to use the large amount of money that it spends each year on public procurement to stimulate innovation. We welcome the Government's promise to accept the Glover Committee recommendations and look forward to monitoring the results this produces for SMEs.

121. In its Report on public procurement, our predecessors on the Trade and Industry Committee commented that "Given competition from lower-cost countries, the Government is anxious to encourage manufacturing industry to develop higher value products, and to this end it aims to promote innovation. The Government could use its purchasing power to support innovation".[143] The Office of Government Commerce (OGC) has recently published a guide to driving innovation through public procurement, which "seeks to encourage public sector organisations to be intelligent, demanding customers and open to new ideas".[144] We welcome the OGC's guidance on innovation and procurement; the difficulty will be to ensure that departments and individual officials really understand the ways in which procurement can support innovation, and are supported in using procurement policy in this way. It will require the public sector, and those who monitor its effectiveness, to take a balanced approach to risk, rather than simply reaching for the tried and tested way of doing things, because it is safer.

SMALL BUSINESS RESEARCH INITIATIVE

122. One way to reduce the risk that adopting an innovative approach will expose an organisation or individual to criticism is to have programmes explicitly designed to foster innovation. Since the PBR 2008, the Government has set up a Small Business Research Initiative (SBRI) in the United Kingdom. This Initiative is championed by the Technology Strategy Board and significantly reworks the previous scheme that was launched in the United Kingdom in 2001. It is similar to the SBIR scheme in the United States, which has been running successfully since 1982, and which the Committee was briefed on in detail during its visit to the USA last year. The programme aims to find innovative solutions to specific public sector needs, by engaging a broad range of companies in competitions for ideas that result in short-term development contracts. These fully funded development contracts between the successful company and the government department (usually with an initial feasibility study and then more detailed product development) should result in a commercial product or service. It is a fast track, simplified process that allows government departments to engage with businesses they would not normally work with. The government department (or public sector body) acts as the lead customer and is instrumental in helping the business develop its product or technology.

123. The Committee welcomes the establishment of the SBRI in the United Kingdom and hopes that it will play its part in fostering a true spirit of innovation. The Committee also recommend that the Government use a larger part of the public procurement budget to invest in riskier, high payoff projects that will help to stimulate a change of culture within government departments and in the UK economy. Such a policy may be considered courageous in the prevailing climate, but the example of DARPA in the USA shows the value of such courage.

Access to finance

124. The availability of finance to support both new start-ups and established companies has been widely discussed. Indeed, this is something that we are monitoring actively in our current work.[145] We do not attempt to deal with the subject in detail here, simply to draw attention to a few key points. As we noted at the beginning of this Report, the US benefits from a well-developed venture capital industry. There are individual business angels in the United Kingdom, and a range of venture capital funds. Nonetheless, while venture capital accounts for 33% of investment in the US, it accounts for only 4% in the United Kingdom.[146] In particular, there is a funding gap for businesses that need sums under £2 million.

125. There are measures to support very early stage businesses. NESTA invests about £10m per year into early stage companies, but recognises that this will not transform the market. However, it may draw others into the market by demonstrating the returns which can be made.[147] Similarly, Scottish Enterprise's Proof of Concept scheme helps researchers to export their ideas and inventions from the lab to the global marketplace, usually after a background patent has been filed, but before full scale development of the technology or commercial backing.

126. The state was readier to support industry in the past. In 1945, the Bank of England established the Industrial and Commercial Finance Corporation (ICFC) to provide capital to small- and medium-sized companies; this was privatised and became 3i, which was reported to have moved out of technology start ups. Earlier this year, the Government established the Capital for Enterprise Fund, a £75 million fund, with a contribution of £50 million from government and £25 million from the banks. When she gave evidence to us on 12 May, Baroness Vadera hinted that more might be done.[148]

On 29 June 2009, the Government launched the UK Innovation Investment Fund in which the Government will invest £150 million, to be matched by private industry. It is hoped that this will leverage enough private investment to build a fund of up to £1 billion over the next 10 years.[149] We welcome the launch of the UK Innovation Investment Fund, although only time will tell whether the investment from the Government will leverage all the money required.

116 HM Revenue & Customs website on R&D tax credits, available at: http://www.hmrc.gov.uk/randd/ Back

117 Statistics available at: http://www.hmrc.gov.uk/stats/corporate_tax/randdtcmenu.htm Back

118 Summary of CDI survey taken from Department for Business, Innovation and Skills website on R&D tax credits. Rounding figures to the nearest £10 million has caused the sum of some figures not to equate. Back

119 Ev 211 [Institute of Physics] Back

120 Ev 217 [NESTA], see also Q 124 Back

121 Ev 290 [Universities UK] Back

122 Q 124 Back

123 Ev 152 [CBI] Back

124 Ev 153 [CBI] Back

125 Ev 210 [ICAEW] Back

126 Qq 249, 250 Back

127 Q125 Back