Joe Benton (Bootle, Labour)

With this it will be convenient to discuss new clause 5—Cost of claims for R & D—

‘The Chancellor of the Exchequer will publish a review in relation to the cost of making claims for relief for research and development before 1st March 2007 and will consult with organisations which have a special interest in claims for relief for research and development.'.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I should like to pick up on some of the Financial Secretary’s comments and those of some of my hon. Friends. Schedule 3 refers to the harmonisation of the timing of claims rules for R and D tax credits. In other contexts, harmonisation might not be welcomed, but it is in this one.

I shall talk about the claiming of tax credits. New clause 5 calls upon the Chancellor to

“publish a review in relation to the cost of making claims...before 1st March 2007”

and to

“consult with organisations which have a special interest”

in that particular area.

The Government and the Financial Secretary are proud of the introduction of tax relief for R and D expenditure, but the fact that it is available does not necessarily mean that it is accessible to all businesses. The Treasury needs to think about the cost of claiming those credits and how it might be made easier, and about who is currently excluded by the complexity of the system.

The Institute of Chartered Accountants commissioned independent research into the R and D tax credit, and the claiming of it. In the context of the debate on the  schedule and the new clause, it is worth reflecting on that research. The report highlighted some of the challenges faced by businesses without the resources to make claims, and the impact on those businesses.

A large business with a well-funded R and D programme will find it relatively straightforward to make a claim, because it will have the systems and procedures in place, and the technical expertise to claim efficiently and effectively. The institute’s research indicated, however, that that did not necessarily lead to an increase in R and D expenditure, because the business had already maximised its programme. That is, the business would already have made the decision on how much to spend, and the decision would not be particularly affected by the nature of the offered incentives.

Medium-sized businesses, on the other hand, did actually benefit from the tax credits. They tend to be have better resources and to be better able to go through the process of making claims. The view was that the tax credit has been very helpful for them and has enabled businesses to grow without having to seek further venture capital funding. Businesses that have taken advantage of the tax credit have commented to me that it has aided their cash flow, and that they have not had to raise funding from outside sources.

The area of greater concern is that of smaller companies, and the Government need to think about that. The report quoted the example of a small business run by two scientists, which did not have adequate human resources to complete the returns, and so did not submit a claim. It therefore missed out on the incentives brought by the R and D tax credit.

As to the cost of preparing the returns, the indications were that it could cost approximately £12,000 to employ a chartered accountant to fill out the returns fully and to provide all the necessary support and administrative back-up. That is quite a significant sum. The taxpayer would need to consider the cash-flow benefit that it would receive from submitting the return and obtaining the tax relief, and whether it would be worth spending £12,000 of the small resources available to most small companies in order to make the claim.

Alternatively, the company could decide that it needed only to be briefed by a chartered accountant, in which case it could submit a claim itself. It was estimated that such a briefing would cost approximately £3,000, but the HMRC would come back and question the claim. I am not disputing the need for HMRC to ensure that claims are valid, but there is a cost in time and resources, including financial resources.

In preparing for the debate I looked at the guidance that is available to small businesses on the HMRC website, because one might ask why one should spend £3,000 on a chartered accountant if one can go to the HMRC website to find the information. In saying that I am probably doing a great disservice to fellow accountants who are still practising, but on looking at the website I was struck by why it would be difficult to complete a return without professional assistance. There is a series of user steps that companies need to take to determine whether they qualify, and there is a web page entitled “Is it worth reading any further?” which has a flow chart with more than a dozen boxes.  If I were hard pressed for time I think I might question whether it was worth reading further.

Nevertheless, I continued, and I came across theR and D tax credit claim template for SMEs, which has a number of different lines for completion relating to, for instance, consumable items, consumable stores, computer software, staffing costs, externally provided workers, payments to staff providers, issues about connected persons, underlying relevant expenditure, subcontracted activities and payments to subcontractors. That is a lot for a small business to consider and I can understand their having difficulty with it. However, there are pages of helpful guidance to underpin it. I have one here headed “CIRD82400—R&D tax relief: categories of qualified expenditure: consumable items: meaning of consumed or transformed.” That sounds fairly hopeful. The first sentence begins:

“It is not possible to offer a simple definition”—

that supports my case that we need more chartered accountants to help by providing us with advice. However, it continues—

“because of the variety of possible circumstances.”

It goes on to say that it is specified in statute that

“the term ‘consumable or transformable materials’ includes water, fuel and power...Apart from these specific items, we then have to deal with the generality of the wording.”

I am reminded of the comments of the Financial Secretary during the last debate in which we discussed the importance of using general wording so that we do not need specific items. However, specific items might be helpful for somebody completing an R and D tax relief claim. The form says that

“A good example of a consumable item would be a laboratory chemical used in the R&D process which is used up...or converted to an unusable product.”

I am sure that scientists will be able to work their way through that. I quote this not for cheap laughs but to demonstrate the complexity that businesses face in trying to deal with some of the issues. Another page of guidance, “CIRD82500—R&D tax relief: categories of qualifying expenditure: software”, sounds as though it could be fairly straightforward. It rightly mentions that software, directly employed, can be used. However, it goes on to talk about the apportionment of software that a business might already have:

“Where software is only partly employed in direct R&D an appropriate apportionment of the expenditure should be made.”

So I suppose that if a business bought a licence to use Microsoft Office, and used Excel spreadsheets for the purpose of tracking the expenditure for R and D tax credits but also for some of the calculations that are required for research, it could apportion the cost of that software to the R and D tax credit. It rightly says that a pragmatic approach should be adopted. I make these comments to illustrate the scale of the challenge that is faced by businesses trying to claim these reliefs.

The other aspect is not the complexity and the record keeping that is required, but the degree of uncertainty about the likelihood of success of a claim. Companies with a stable and recurring path of expenditure find it relatively easy to claim tax credits. However, evidence collected for the ICA report suggests that that is not a universal experience; there can be issues about what  constitutes R and D expenditure according to HMRC. Often, people’s decisions to invest in R and D are irreversible. Once the die is cast, that is it: they are going forward. Particularly in the case of a smaller business, the extent to which the likelihood of success of a claim is under question might have an impact on its willingness to make that irreversible decision.

In that context, the Financial Secretary was right to highlight the importance of setting up dedicated teams to tackle R and D tax credits. A concern that was highlighted by a number of respondents to the survey was that although some tax offices are very experienced—I should imagine that the one that serves Silicon Fen in Cambridgeshire would be very adept at dealing with such claims—there could be problems for somebody whose tax office did not have that experience. The dedicated teams that the Minister mentioned will help to tackle that.

I hope that in ironing out the wrinkles, to use the metaphor introduced earlier by my hon. Friend the Member for Braintree, the Financial Secretary will reconsider the cost of making claims, and think about what further steps can be taken to simplify claims, to provide better guidance to taxpayers who might want to take advantage of the relief, and to ensure that tax relief is not just available but accessible to smaller businesses.

Julia Goldsworthy (Shadow Chief Secretary To the Treasury, Treasury; Falmouth & Camborne, Liberal Democrat)

In their own terms, the new clause and schedule are rational and attempt to simplify the process by aligning the claims processes and time limits for R and D tax reliefs with those of enhanced deductions. However, I should like to follow the points made by the hon. Member for Fareham by considering the impact of the changes in tax credits on small businesses and the knock-on impact that they may have on them again. If all claims need to be made in company tax returns within 12 months of the filing date, what will be the impact of these changes on small businesses? Given that that is already a difficult administrative burden for them, reducing the time scale will be an additional difficulty.

There is still an issue with small businesses having to pay up front and claiming back tax credits. I should like to quote one conclusion from the report by the Manchester and Nottingham business schools, commissioned by the Institute of Chartered Accountants in England and Wales, which says:

“R&D tax credits on offer in the UK are similar to some of the best schemes offered around the world. The incentives are relatively more generous to smaller firms. The application process, however, diminishes the effectiveness of the policy and this is especially so for smaller firms and firms with small R & D programmes. In some cases the costs of preparing and administering claims prevents firms from taking advantage of the incentives.”

Given those conclusions, I wonder whether the Government really consider this to be an efficient mechanism for supporting small businesses in particular.

Rob Marris (Wolverhampton South West, Labour)

It is a pleasure to follow an entertaining speech by the hon. Member for Fareham. I say to my hon. Friend the Financial Secretary that I have some sympathy with new clause 5. [Interruption.] Before the hon. Gentleman gets too excited, I should say that the  new clause is perhaps a little premature for the reasons to which he and my hon. Friend adverted in a previous debate.

The Red Book says, on page 62, paragraph 3.80:

“In ‘Supporting growth in innovation: next steps for the R&D tax credit’, published in...2005, government announced that HMRC would set up dedicated R&D units to handle all SME claims for tax credits. It is envisaged that these units will be fully operational across the country before the end of the year. At the same time, a statement of practice will be published presenting the standard of service and support that SMEs can expect from the new units.”

I understand that, at the end of the calendar year 2006, the dedicated SME claims units for R and D tax credits and statements of practice will be in place.

New clause 5 suggests a date of 1 March 2007 for the research to be done on the costs of claiming R and D tax credits. Understandably, we have a particular concern for SMEs. I am delighted that the Budget extended the number of employees from 250 to 500 in respect of the beneficial arrangements. However,1 March 2007 is a little bit early for a procedure or new way of doing things—including new support and so on—in respect of provisions that will be in place by the end of 2006. However, if the Government have not already included such provision in the Finance Bill next year, the hon. Gentleman might consider tabling a new clause similar to new clause 5.

I have sympathy with the hon. Gentleman’s approach. To echo the comments that have already been made, I say to my hon. Friend the Financial Secretary that we have to be careful that we do not have a wonderful tax regime that is too difficult for people to claim under and therefore does not boost R and D in the United Kingdom in the way that all hon. Members wish.

Stewart Hosie (Spokesperson (Chancellor of the Exchequer; Home Secretary); Dundee East, Scottish National Party)

I am intrigued by new clause 5, and I hope that the hon. Member for Fareham can offer some enlightenment. It suggests publishing a review, having first consulted organisations with a special interest in claiming the tax relief forR and D. Would he envisage that the organisations consulted may not offer feedback in the published review that would make the R and D tax credit system more effective and efficient, but might suggest alternatives to it, at least in some small way?

I have said previously to the Financial Secretarythat in 2004-05, the last year for which I have figures for R and D tax credits and other R and D funding for Scotland and England, £670 million was budgeted to be made available for the tax credits, but only £290 million was actually taken up. In the same year—the figures are useful and interesting in this regard—in addition to the tax credit, a total of £710 million of Government funds were available, of which some £37 million came through collaborative research and development, knowledge transfer networks, knowledge transfer partnerships, grants for research and development, and the grant for investigating an innovative idea. The latter two apply only to England. In the same year in Scotland, some £16 millionwere available through Smart Scotland, SPUR, SPURplus, Score, SEEKIT, R & D Plus, and the small company innovation support scheme, which also includes a certain element from the Highlands and Islands Enterprise area.

Given that £670 million of tax credits were budgeted for, of which only £290 million were taken up, these small, more targeted schemes seemed to be quite successful, and the take-up seemed quite high. Does the Financial Secretary envisage that in the published review of the consultation, he will look for feedback from companies to have the Government’s research and development funding provided through such other mechanisms, not merely through the R and D tax credit system, of which, in certain years, only 50 per cent. of the budget has been taken up?

John Healey (Financial Secretary, HM Treasury; Wentworth, Labour)

There appears to be something of myth around that, somehow, the R and D tax credit is costly to operate from a company’s point of view, and too difficult to operate in order for companies to claim. Frankly, if that were the case, I do not think that£1.8 billion-worth would have been claimed so far by companies, including £1 billion by small firms. Alongside that, I do not think that I could have been clearer. Since the system’s introduction—first for small firms; then for large companies—we have been ready, and have proved that we shall continue to look at its costs for business. We have been willing to improve, and have improved, the process for applications and administration where we can. We have also been ready and willing, and continue to be so, to improve the guidance that is available to firms if suggestions that seem sensible to us are made.

Julia Goldsworthy (Shadow Chief Secretary To the Treasury, Treasury; Falmouth & Camborne, Liberal Democrat)

Does that mean that the Financial Secretary rejects the conclusions of thework commissioned by the Institute of Chartered Accountants for England and Wales that found that there were significant difficulties for smaller businesses in accessing these credits?

John Healey (Financial Secretary, HM Treasury; Wentworth, Labour)

Is the hon. Lady aware of how many companies constituted the study to which she refers? The answer is 10. I shall come to that shortly.

The schedule before us is not a big move; it is a modest move, and should help companies in the process of claiming tax credit. Harmonising the rules for claiming across the two elements of the R and D tax credit system ought to make it easier for companies to understand the claims process, and improve the incentive effect of the schemes.

New clause 5 urges us to publish a review and a report by 2007. However, we have gone further than that. We have already commissioned an independent survey of almost 1,000 R and D performing companies, looking at their experiences in claiming tax credits, the results of which we published last year, In contrast, the Manchester business school study was based on interviews with just 10 R and D performing companies. Members of the Committee could reasonably conclude that that was not the strongest piece of evidence. Interestingly, the results from that very small study contrast strongly with the results of the much wider first-stage evaluation that the Government undertook. The results of the latter, in contrast to the points made earlier, were very positive. It found that three quarters of the companies that had claimed R and D tax credit found the claims process  fairly or very easy. That does not suggest that the costs of claiming are prohibitive, and experts generally agree with that view.

Finally, a recent article in Tax Journal surveying the R and D fiscal incentives in the UK compared with the US, Canada, Japan, Austria and the Netherlands, stated:

“For SMEs, the UK system is widely regarded as the most generous and the simplest to administer”.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I am grateful for the Minister’s response. He is right to highlight the nature of the survey by the Institute of Chartered Accountants, which acted almost as a focus group in the way it carried out its work. Hon. Members on both sides of the Committee are aware of focus groups and the role that they play in modern politics. Perhaps the ICA should not be criticised for adopting the techniques with which so many of us are familiar.

So that the Committee is clear about the structure of the survey, 10 businesses were involved in R and D and five people who were interviewed were involved in manufacturing. Any manufacturing business today that does not invest in R and D is likely to suffer from the competitive challenge posed by India, China and eastern Europe. It is entirely reasonable to discuss with businesses their experience of R and D. I do not necessarily concur with the Financial Secretary that it is a myth that it is costly to claim, as there are issues that affect the cost of claims that the Government should think about and it is helpful to keep the system under regular review.

I say to the hon. Member for Wolverhampton, South-West that I wish the Standing Orders had allowed us to discuss new clause 5 to capture his mood of co-operation and harmony. I am pleased that he expressed support for a simpler tax system and I am sure he will warmly welcome the outcome of the Tax Reform Commission’s report on simplification later this year, which will contain much for him to comment on positively.

The hon. Gentleman is perhaps right to say that the date of the review should be moved backwards. I hope that the system of dedicated units will be evaluated as they are rolled out, rather than waiting until the full roll-out is completed across the country. I will not be  setting the terms of the review as I do not expect to become Chancellor of the Exchequer shortly, but I am sure that the Chancellor will take note of the hon. Gentleman’s comments.

The hon. Member for Dundee, East (Stewart Hosie) made a valid point about the complexity of the support on offer to businesses investing in R and D and taking up new developments. A theme taken up by businesses in my constituency and expressed to me is that there are several different means of support as well as R and D tax credit and that it can be difficult to navigate their way around them.