The Budget: Tax credits for R&D tempt big companies to concentrate on innovation

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The Chancellor pledged to extend tax credits for research and development to bigger companies, in an attempt to provide an incentive for them to increase spending.

The Chancellor pledged to extend tax credits for research and development to bigger companies, in an attempt to provide an incentive for them to increase spending.

The move was welcomed by some, who said that large companies accounted for about85 per cent of R&D, and that there appeared to be a culture of under-investing in R&D and innovation in larger businesses. The present tax breaks only apply to small and medium-sized enterprises (SMEs).

The Government launched its paper yesterday on "increasing innovation" to seek views on the design of a new tax incentive aimed at encouraging innovation by larger companies.

Two main options are described - an incremental credit scheme and a volume-based scheme - and the Government is inviting views from businesses and other interested parties on the full range of issues that need to be resolved.

A volume-based scheme would take each year in isolation and reward all R&D expenditure undertaken in that year. An incremental scheme measures R&D spending against a pre-determined baseline and rewards increased R&D expenditure only. The latter would offer a higher rate of relief and, therefore, offer a greater incentive for an increase in R&D expenditure.

Consequently, the Government said it was minded towards an incremental scheme "given the policy objective of providing both a real incentive and a clear signal to companies to improve their innovation and R&D performance".

But the consultative document said that administering an incremental scheme would be the more complicated option. "A baseline would need to be established against which future expenditure would be measured. It would also need to take account of group structures so that groups of companies were rewarded only for increases in their total R&D spending," it said. Such a scheme would need to address the issue ofannual fluctuations in R&D to discourage, among other things, the manipulation of the timing of payments between years purely to get the taxrelief.

It said no decisions had been made on design issues such as the rate of relief but noted that similar schemes in other countries tended to have rates of between 15 and 50 per cent.

It said an incremental credit at a rate of, say, 50 per cent, would stimulate R&D by allowing a company that increased its qualified spending on R&D by £1m to deduct £1.5m from its taxable profits instead of the £1m under normal rules.

In the pre-Budget report, the Chancellor said the Government would look at measures to boost investment in R&D throughout businesses.

Last year, the Government introduced R&D tax credits to encourage research and development by SMEs. That provided an additional deduction for qualifying R&D spending over and above the amount deducted in accounts, by raising the rate of relief from 100 per cent to 150 per cent.

All G7 countries allow companies to write off current expenditure on R&D against their taxable profits in the year the expenditure is made. In Britain, companies are allowed to write off immediately all R&D capital expenditure, including plant and machinery and commercial buildings but not land and dwelling houses.

SMEs have a more favourable regime for their current expenditure with a 50 per cent credit on most of their current spending. Many industry experts had criticised last year's initiative, saying the definition of R&D was too narrow.

Broadly speaking, the definition of R&D was that activities "must be creative or innovative work in the fields of science of technology and undertaken with a view to the extension of knowledge". The Government's intention is to introduce the tax incentive as soon as the design issues are satisfactorily resolved, and to legislate subsequently, in the finance Bill for 2002.

In the Budget, the Chancellor also pledged a number of reforms to promote competition and innovation. In addition to the proposals on R&D, he also proposed tax relief to companies for the cost of intellectual property and goodwill and other intangible assets. He set out proposals for a relief on gains arising from the disposal of substantial shareholdings.