The unique backdrop to this year’s Budget means that the announcement on 3 March is one of the most eagerly awaited Budget speeches in recent memory. Some tax rises are inevitable as the UK needs to balance the books after the impact of COVID-19. However, we also need to continue encouraging entrepreneurial activity. Brexit may give us additional opportunities for incentivising UK business, but the commitments made by the UK in order to reach a post-Brexit deal with the EU could limit the Chancellor’s scope for creativity. In this article, Frazier & Deeter’s tax experts highlight areas where there could be scope for the Chancellor to make changes for the better.
R&D Tax Relief
Over recent years, the popularity and awareness of the R&D tax relief system has grown with the most recent statistics showing a year-of-year increase in claim volumes of 17% with it remaining one of the most generous tax reliefs available to SME businesses. Historically, the UK’s R&D tax relief system and the support available has been governed by the EU’s wider regulation of Government State Aid and Competition Laws. Following Brexit, it is hoped that the Government will be in a position to further develop this scheme to drive innovation within the UK marketplace for years to come. With rumours circulating suggesting an increase in the Corporation Tax Rate, the R&D tax relief system will become more beneficial to SME claimants. Recent improvements to the scheme have focused on the large company RDEC scheme; improvements across both would be most welcome.
April 2021 sees a key change in the R&D legislation being introduced, capping the R&D Tax Credit available to loss-making companies. While the thinking behind this legislative change is sound, the real-world effects will heavily impact many of the UK’s most innovative and up-and-coming tech businesses, where managing costs through outsourced or freelance development is essential. Postponing the implementation of this legislative change would allow these businesses to restructure their activities to allow them to continue their work with appropriate support.
In last year’s Budget, the Chancellor announced that £750m would be made available to the UK’s most innovative businesses in a range of grant funding opportunities, mostly through InnovateUK. Later in the year, a further £750m was made available through similar grant funding avenues. The aim of this was to cement the UK as a key innovation hub, driving forward technology across a range of industrial sectors. Looking forward to the 2021 budget, a similar initiative would again be welcomed by the wider UK tech community.
One key failure of innovation grant funding is the rigorous and onerous application process SME’s and larger corporates have to go through. A simplified application process and reporting methodology would be welcomed and could open the scheme up to far larger cross-section of SME Small and Medium Enterprise businesses, fuelling innovation across the UK marketplace.
Capital Gains Tax (CGT)
There has been much speculation that the rate of CGT will rise – in November last year the Office of Tax Simplification recommended equalising CGT rates with income tax rates. The impact of this could more than double the amount of CGT payable when a business owner is looking to sell his or her business. Most commentators do not expect full alignment with income tax rates, but raising the rate higher, or lowering the Annual Exemption (for which a certain amount of gains arising in a tax year are tax-free), could win public support given CGT impacts relatively few taxpayers overall.
If the Chancellor were to announce a rise in CGT rates from April 2022, many taxpayers could be tempted to dispose of assets and realise gains before the rise. This could create a short-term boost to CGT tax revenues and give a boost to the wider economy (particularly where UK properties are sold) and might be an attractive option to the Chancellor. Alternatively, we could see rises come in with immediate effect (i.e. April 2021) along with anti-forestalling measures.
Frazier & Deeter would like to see the Chancellor protect entrepreneurs, SME business owners and their investors from significant CGT changes. SMEs play a crucial role in the UK economy and keeping the UK and its workforce at the forefront of global tech, research and development. Reducing the relief available under existing Business Asset Disposal Relief (formerly Entrepreneurs Relief) and EIS/SEIS schemes could diminish the desire for future investment in this sector of our economy in the years to come. Our firm would like to see the Chancellor distinguish any CGT rules changes between passive and non-passive realised gains.
The UK Corporation tax rate of 19% remains largely competitive when compared to UK’s top trading partners, namely the United States, Germany, France, China and Japan. Added with the incentive of being a top location for access to seed funding from high-net-worth investors, the UK remains an attractive headquarter destination for technology-based start-ups. With media speculation that the Chancellor might look for an increase in the corporation tax rate to fund the COVID – 19 subsidies and schemes, a cautious approach would be to keep the start-ups and the small and medium enterprises out of the ambit of any tax rate increase. While many of the start-ups and SMEs will have their initial losses to recover, and would not have contributed to the corporation tax pool in their initial years, there is still merit in keeping the current tax rate intact for these companies. While there are multiple methodologies that can be adopted for any tax rate changes e.g., a specific COVID related surcharge or a slab-based corporation tax rate with higher rates for higher revenue slabs, we would hope that start-ups and SMEs could be given a longer period to recover from the pandemic related impact.
Digital Services Tax
With the introduction of Digital Services Tax (DST) from April 2020, the UK Government adopted a unilateral measure of taxation of large companies having ‘’worldwide digital services revenue” of more than £500 million and “UK digital services revenue” of more than £25 million. A DST of 2% is applied on revenues from the provision of social media services, search engine or online marketplaces to UK users. The DST has mostly affected the large US technology companies which have significant online-based revenue from UK customers. While introducing DST, the UK government had clarified that it is committed to dis-applying the DST once an appropriate international solution is in place through the G7, G20 and OCED discussions. However, the subject of tax challenges arising from digitisation is very complex, and it may take a few years for an international consensus on a common programme regarding the taxation of the digital economy.
It will be interesting to see how the Chancellor will deal with the DST provisions, as there is always an incentive to mop up some of the COVID-19 related costs from high-performing large digital inbound companies. The possible interventions in the DST provisions could happen through increasing the DST rate, lowering the DST threshold, and increasing the scope of categories of digital revenue.
A DST rate increase may indirectly increase the cost of operations of downstream smaller technology start-ups which utilise the services of these large technology multinationals, as the DST-related costs are generally passed on to their customers. The United States Trade Representative (USTR) Report of January 2021 has concluded that the UK DST discriminates against US companies and is unreasonable, as it is in contravention of international tax principles. Any of the above DST-related measures may not have an immediate “big bang” impact on the UK inbound investments of these large MNCs; however, the Chancellor will need to tread carefully when it comes to its impact on the proposed US – UK trade deal.
The 2021 Budget will be a balancing act beyond what we have ever seen before as the Chancellor seeks to cover the costs of COVID-19 whilst adjusting for Brexit. We are hopeful that there will be attention given to supporting innovation and fostering entrepreneurial activity to bolster economic recovery.
About the Authors
The tax leaders at Frazier & Deeter UK include Malcolm Joy, Jonathan Clark, Jay Menon and Thomas Wells. You can read more about our team at https://www.frazierdeeter.co.uk/about/.