RCK Partners, a financial consultancy specializing in research and development (R&D) tax relief, and London Business School have published a comparative review of the UK’s R&D tax relief system compared to other OECD countries. The report found that compared to other OECD countries, the UK’s R&D tax budget increased by only 14% between 2007 and 2021 (latest data available), while Japan, South Korea and Germany reveals that it continues to increase its budget for innovation.
Over the same period, Japan increased its R&D tax budget by 134%, South Korea by 119%, and Germany by 71%. To put this into context, Germany has increased its budget more than five times as much as the UK.
This report critically examines the UK’s recent R&D tax reforms, focusing on the integration of the Research and Development Expenditure Allowance (RDEC) and Small and Medium Enterprises (SME) schemes in 2024. Comparisons with countries such as Germany, South Korea and France highlight the urgent need for a more competitive R&D tax system to keep pace with world leaders.
UK R&D tax system: Opportunity cost?
The UK R&D tax credit system has undergone significant changes over the past two years. Launched in April 2024, the combined regime will provide all businesses with a flat 20% tax deduction on eligible R&D expenditure. While this simplifies processes, many small and medium-sized enterprises that once enjoyed more favorable conditions will now face reduced profits unless they meet the ‘R&D-intensive’ criteria. Masu. These reforms could change the innovation landscape, especially for small and medium-sized enterprises, which account for the lion’s share of R&D claims.
Sir Philip Hammond, former Chancellor of the Exchequer and senior advisor at RCK Partners, commented:
“The UK’s move to a harmonized R&D tax credit system could have a serious impact on the competitiveness and innovation of SMEs. 88% of R&D claims have historically come from SMEs; A move to a flat 20% credit risks stripping small businesses of important tax benefits. This cut in support could stifle innovation, and the UK will continue to have strong R&D support for small businesses. Without targeted relief, the very companies that drive much of the research and development activity will be the ones driving future economic growth. We may face an uphill battle in doing so.”
OECD Innovation Outlook
The UK’s R&D challenges are further exacerbated by low private sector investment in innovation. Countries such as South Korea and the US invest 3.8% and 2.6% of their GDP in business research and development, followed by the UK at 1.99%. Despite having a gross research and development expenditure (GERD) of 2.9% of GDP, the UK lags behind countries such as Germany (3.13%), Sweden (3.41%) and South Korea (5.21%). This lack of investment puts the UK at a disadvantage, particularly as other countries ramp up research and development efforts amid tight fiscal conditions.
The UK relies heavily on tax incentives, with the government offering a 4.1x tax cut on direct R&D investment in 2021, but the effectiveness of this system has been slow. According to the implicit marginal R&D tax subsidy rate, countries such as Iceland, France, and Portugal offer more generous tax incentives to both profitable and loss-making SMEs. This highlights structural inefficiencies within the UK system, particularly for small and medium-sized enterprises, which drive a significant part of the country’s innovation.
Martin Veselinov, a student at London Business School, said:
“The UK Innovation Report 2024 report shows that the UK is a world leader in research output and ranks second only to China and the US in total number of academic publications. To maintain the UK’s position as a global leader in innovation, , the government needs to reconsider its R&D tax relief system, with a focus on increasing support for R&D-intensive small and medium-sized enterprises. By introducing targeted incentives for these companies, the UK can improve the private sector. It can help close the investment gap and accelerate the commercialization of breakthrough research. Additionally, R&D tax incentives can be integrated into long-term industrial strategies in high-growth sectors such as AI, biotech, and cleantech. Alignment will stimulate private investment and strengthen the UK’s global competitiveness in emerging industries.”
