Taxes

R&D Tax Credits and the Current State of Brexit Negotiations

British businesses of all sizes are at the epicenter of the fallout from Brexit. Since Britain voted to leave the European Union in 2016, there’s been an immediate impact on inflation, house prices, and the strength of the pound. However, the impact has been deepest for business owners and decisions makers across the country. At the recent Confederation of British Industry’s Annual Conference, Prime Minister Theresa May criticized business leaders for not spending enough on research and development. Although the government has committed to spending more on the R&D Tax Credits program, British businesses still spend far less on R&D than their American and German counterparts. However, business leaders blame Brexit for their lack of investment opportunities. Uncertainty and a complicated system of negotiations has discouraged a number of businesses from making long-term investment and expansion decisions. With no clear indication about what the country’s trade and legal relationship with the EU will look like after March 2019, many businesses have adopted a wait-and-see approach. Here’s how the negotiations are shaping up and how government programs for research and development could be affected:

Brexit So Far

When the UK voted to leave the European Union in June 2016, there was no doubt the continent would be embroiled in intense negotiations and politically charged rhetoric for years. No country has ever left the bloc and the framework for such an exit is, at best, experimental. There remain a number of unanswered questions about the future of immigration, trade, research funding, infrastructure spending, and common regulations after the UK completes the process of leaving the EU. 2017 has been an eventful year for negotiators on both sides of the Channel. After the prime minister triggered Article 50, negotiators worked throughout the year and struck a deal in December that will preserve the rights of EU citizens currently living in the UK, eliminate the need for a hard border in Northern Ireland, and create the basis for calculating the UK’s final bill for leaving the union. Although the new divorce deal from early-December isn’t legally binding, it is a major breakthrough in negotiations. The formal agreement signals that Theresa May is making progress and the deadlock has been broken. It allows both parties to move forward and shape the trade relationship between the UK and the EU. While the prime minister is at an important EU Summit this week, her government’s E.U. Withdrawal Bill is making its way through parliament. This bill would instantly convert 12,000 EU laws into UK laws when the country leaves the bloc in 2019. These recent developments have launched the UK and EU into the second phase of negotiations. European Council president Donald Tusk described the divorce deal as “moderate progress” and said the current phase was a “furious race against time” to iron out trade and diplomatic relationships within the next 15 months. That could mean more uncertainty and volatility for UK industry over the coming year.

Business Implications of Brexit

There is growing evidence that Brexit negotiations are having a negative impact on the economy. The depreciation of sterling has caused CPI to spike. Weekly earnings and household consumption are trending downwards. GDP growth has slowed, house prices are down, and the FTSE 100 has underperformed its counterparts in Germany and the US. A report from RaboBank tried to analyze the impact of a Hard and Soft Brexit. The report also tried to figure out how the economy would perform if the UK struck a free trade agreement with the EU based on the format of the EU’s current trade agreement with Switzerland. Their results showed that a hard Brexit would cost 18% of total GDP till 2030. A soft Brexit or FTA would cost 10% or 12.5% of GDP growth over the same period. In other words, each UK resident can expect to lose thousands of pounds in cumulative value from the breakdown of this relationship. The damage is magnified further when considering the knock-on effects on domestic trade and business sentiment across the country. These reports are estimates for how much the country will lose when the process of leaving the bloc is complete. However, there is a tangible and immediate impact on long-term business investment and scientific research as the negotiations unfold.

Brexit’s Impact on Investment

This divorce has had the most noticeable impact on business investments and sentiment. Business investment has dipped year-on-year since the vote to leave. Business leaders seem to be worried about the way negotiations have shaped up. In a recent paper by the Centre for European Reform (CER), a UK-based think tank, analysts expect the divorce to have a negative impact on British innovation. The report states that the UK could lose its heft in key sectors of international manufacturing, face a shortage of skilled workers, and shortfalls in research funding. The UK benefits immensely from science and research funding from the EU. Although it contributes 11% to the EU budget, the country benefits from 20% of the science fund offered by the union. Cutting off ties could result in a number of researchers and scientists losing their funds for research. Although the government is determined to support science in the country by offering £3 billion a year through seven science councils across the country, this amount is unlikely to cover the gap left by Brexit. This has rattled the tech industry and small business sector in Britain. The situation is fluid and volatile enough to discourage current investments in R&D. Also, the R&D tax credits program is further complicated by current EU laws. Under State Aid legislation, the EU regulates the SME scheme of the R&D tax credits program. Under this legislation, individual countries in the EU cannot offer financial incentives for businesses without prior approval from the European Commission. This framework was designed to ensure fairness in international competition for all businesses in the EU. Meanwhile, the RDEC (Research and Development Credit), designed for larger businesses, is less lucrative but detached from EU oversight. This means the most crucial part of the R&D tax credits program, the SME scheme, is likely to undergo transformation as Brexit moves forward. It is currently impossible to say how the tax incentive program will change over time. However, the current government has recognised the importance of these tax credits and their long-terms impact on the British economy. Lawmakers are determined to pour more money into R&D funding over the next decade. By leaving the EU, the government can further improve these incentives by boosting the program and getting rid of the cap on payable tax limits. Increasing the amount of money spent on R&D is a top priority for the government. It is also a necessity to offset the expected cuts to UK corporation taxes once Brexit is completed. If the UK corporation tax is slashed to 17% by 2020, the R&D tax credit scheme could seem less attractive for businesses. However, by increasing the headline amount of funding for the program, the government can achieve its goal of making Britain an attractive destination for innovators and business leaders from across the world. Lower taxes and better incentives should help stem the brain drain from Brexit and attract international talent and companies to the country. Regardless of the outcome of Brexit negotiations, businesses can continue to expect the government’s help in research and development spending. Private platforms like Tax Cloud should make it easier for small and medium-sized businesses to file claims. The R&D Tax credits scheme may be modified, but it will continue to be an integral driver of UK innovation and invention.

Final Thoughts

When Brexit was set in motion last year, policymakers, business leaders, and citizens expected protracted and complicated negotiations for years. After recent events it seems the government is making slow and steady progress in leaving the bloc while preserving elements of the current trade and regulatory framework. However, the discussions are unpredictable and there is little clarity on how they will end. No one knows how the negotiations will end. These unanswered questions and the lack of clarity has spooked business leaders and innovators in the UK. Business investment spending has slowed down and the government is struggling to encourage R&D investments from the private sector. Leaving the EU will undoubtedly change the structure of the R&D tax credits scheme currently offered by the government. However, the government is determined to lower corporate taxes and boost funding in research and development directly over the next few years. For the foreseeable future, businesses of all sizes can expect the government to support their long term investments in cutting-edge research and crucial development projects. Regardless of the outcome of these negotiations, Britain will remain open for business and an attractive destination for innovative entrepreneurs, long-term investors, and talented researchers from across the world.

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