Clause 52 - Tax relief for expenditure on research and development

Finance Bill – in a Public Bill Committee at 5:30 pm on 21st May 2002.

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Question proposed, That the clause stand part of the Bill.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I think that everyone, particularly large companies, is pleased with the inclusion of the clause in the Bill and with the fact that a volume-based scheme is being introduced for large companies. However, the difference between the schemes for SMEs and large companies will lead to difficulties when small companies grow into large companies and vice versa. We believe in principle that there should be some integration between the two and our amendments to schedule 12 address that in part.

The complexity of the legislation and the continuing difficulty in determining whether expenditure falls within the definition of research and development will make it difficult for companies to decide in advance whether proposed expenditure will qualify for the new relief, and we have tabled amendments to schedule 12 to sharpen the definition. Those points of principle underlie the amendments that have been tabled to schedule 12.

Photo of Edward Davey Edward Davey Shadow Chief Secretary to the Treasury, Shadow Minister (Olympics and London), Liberal Democrat Spokesperson (Olympics and London), Liberal Democrat Spokesperson (Chief Secretary to the Treasury)

I welcome you to the Chair, Mr. Gale. It is important to tease out some of the policy issues that lie behind the approach in the clause. It has been long heralded and there has been significant consultation on the new research and development tax credit. The Government listened to that consultation and changed their original proposals. However, it is worth having a short debate on whether that approach alone is sufficient to achieve the policy objectives.

There has been debate over a long period about the need for a research and development tax credit. Small allowances and support for research and development have been provided, but nothing as substantial as what is proposed now. Governments have said in the past that a tax credit would not do the job and have argued that most of the extra research and development that would gain the credit would have happened anyway, so there would be a high deadweight cost. The Government's proposal seeks to deal with that by trying to achieve extra research and development for

taxpayers' expenditure, but there has always been a question in many people's minds about whether the provision would make a marked improvement.

The reason for that scepticism is that until recently the results of several studies on how other countries use such tax credits were equivocal. Evidence from some countries showed that their effect was limited and that large amounts of taxpayers' money was spent, with no major behaviour change in the private sector.

The Government have been fortunate in many ways because further studies have been carried out in recent years to discover the objective of tax credits. Today's Government policy has been instructed by lessons from other countries. The policy is undoubtedly needed because Britain's performance on research and development has been lamentable for a long period, particularly when military R and D is excluded from the overall figures. I am convinced that we need to pursue the route that we are on, because international evidence is overwhelming—I speak as someone who is generally reluctant to go down the route of extra tax credits and reliefs.

I hope that the general policy direction receives support from all hon. Members. Can the Paymaster General reassure us that the debate does not rest here and that the Government will deal with other aspects of R and D policy? It would be out of order for me to mention competition policy, regulation policy and so on, but a more imaginative use of the grant system is needed. For example, ideas are being developed for an old-fashioned way of promoting R and D, namely offering prizes. The Government, a research institute or a royal society could offer a prize for the first person or body to achieve a particular breakthrough. Emerging evidence from the past few years suggests that that is a cost-effective way to promote R and D. Only one sum of money would be offered, but if one ensured that it was the right amount and that it created the right incentive, an awful lot of extra research would be carried out in the private sector for a small amount of public money.

The international evidence suggests that the provisions in the clause are the right approach, but I hope that the Government have an open mind to alternative approaches so that we can turn Britain's performance on R and D to better effect for our economy's productivity performance over the longer term.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I support the comments of hon. Members. I shall add one specific and separate point on improving R and D performance. We could reconsider patent law and have a two-stage patent arrangement. The first stage would take products up to the point of licensing, and the second would deal with specific needs thereafter. That would be particularly valid to the pharmaceutical industry. In the round, we want measures that will increase R and D activity here rather than overseas. As well as tax incentives, the relative attractions of patent law are important.

The Paymaster General (Dawn Primarolo): I shall make a few brief remarks, but the debate on these amendments should tease out in more detail many of the points raised by hon. Members.

I welcome the positive comments from the hon. Member for Kingston and Surbiton (Mr. Davey). They echo comments by the Society of British Aerospace Companies, the Confederation of British Industry and the Federation of the Electronics Industry, to mention but a few.

Photo of Jim Cunningham Jim Cunningham Labour, Coventry South

A number of us who have lobbied for several years appreciate the move on tax credits, but may I ask my hon. Friend a question? If we consider a company such as Rolls-Royce which has put considerable expenditure into research and development, is it the Government's intention to retain what they call lift-off loans, along with the tax credit?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I am afraid that I am not in a position to answer specifically the question posed by my hon. Friend, which is similar to the point that the hon. Member for Kingston and Surbiton made, concerning Government policy across the board in the encouragement of research and development. In the statement that my right hon. Friend the Secretary of State for Trade and Industry made last week on manufacturing, she specifically focused on aerospace as well as the pharmaceutical, chemical and car industries. The appointment of Sir Richard Evans to chair the innovation and contracts team that will advise the Department of Trade and Industry is crucial. Rolls-Royce itself may be the subject of debate in relation to some amendments.

Yesterday, I was with David Marshall at a conference in the south-west, where there are a great many aerospace companies. We should be in no doubt that the tax credit will enormously help investment into research and development in this country. As we go through the amendments, we will see how the small and medium-sized tax credit on research and development and the larger company research and development tax credit fit together.

Underpinning all companies is a 100 per cent. deduction for research and development on current and capital expenditure. That underpins everything. On top of that, the two tax credits are boosting—they are super-plus credits. For the small and medium-sized companies, there is a 50 per cent. boost; for large companies, it is 25 per cent. Without drifting into the amendments, it will come out later in the debate why they are different, and what the Government are trying to achieve.

The historic position for the United Kingdom is that investment in research and development—with the exception of pharmaceuticals, perhaps—lags behind that of other major economies. To stick with the example of aerospace, we have the second largest aerospace industry in the world. We are second only to the United States, with a complete capacity to design, develop, manufacture and deliver. That is obviously enormously important, and great strides have been made in the past, but more must be made in the future.

We have considered the position on international comparisons and what other countries are doing to give assistance to their companies for research and development. Putting in place the large company element, the value of the credit for research and development as a percentage of gross domestic product will be second only to that of Canada. That is the only G7 country that will—marginally—be ahead of us. We will be spending more, using the tax credit, than the United States or France, which have traditionally invested more than us.

Photo of Michael Jack Michael Jack Conservative, Fylde 5:45 pm, 21st May 2002

On a point of clarification, and I apologise if I have missed something, but will the Paymaster-General explain why she is talking in general terms about the operation of the research and development tax credit? For example, the Marconi part of BAE Systems in the United States consolidates its company accounts in the United Kingdom but incurs research and development expenditure of a qualifying nature in the United States. How does that operate in relation to the credit?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

That is the subject of one of the amendments, but I shall make my general comments now. I have taken the challenge to compare and contrast that the right hon. Gentleman often poses to Ministers. Perhaps if I give my response in the general debate on the clause, it will set the matter in context. I shall compare and contrast how and why the small and medium-sized enterprises tax credit is different from the larger company tax credit.

The obvious headlines are the rate of relief and whether it is payable; the subcontractor issue, which relates to the point that the right hon. Gentleman is making; intellectual property rights—there is a variation there—and the definition of research and development. Every one of those subjects relates to amendments, but I shall just discuss them briefly now.

The rate of relief for research and development costs for small and medium-sized companies is 150 per cent.; it is 125 per cent. for large companies. We have to draw a line somewhere. I should also just say as a caveat that in all the consultations the industry and professional associations were clear that we had to have simplicity, transparency and certainty. There was much discussion about the different ways to operate the credit, whether based on volume or incrementally. Hon. Members will have seen the outcome of that debate.

A reason for the difference between 150 and 125 per cent. is that small and medium-sized companies face particular difficulties attracting finance, especially for research and development. For example, banks often find it difficult to assess the worth of a project. That is a real problem for small and medium-sized companies. In addition, the difference in the effective rate of the subsidy is smaller for larger companies. Typically, it is 9.5 per cent. for small companies and 7.5 per cent. for large companies, because smaller companies pay tax at a lower rate. We are considering the introduction of a system, and more detailed explanations will come up when we deal with the amendments.

Another issue is whether relief is payable. For small and medium-sized companies, the credit is payable for a loss-making company, whereas it is not for larger companies. Loss-making companies carry credits forward until they make a profit, but smaller companies cannot always do that. Obviously, we are trying to create an environment in which research and development are undertaken in this country. That is the purpose of the measure. The reasons that apply are the same as those that I gave for the size of the credit. For instance, the difficulty that small and medium-sized companies have in finding financing reflects the fact that the finance market sometimes fails specifically to assist them.

A payable credit also has public expenditure and state aid implications, and we had to be very careful and consider the laws. On subcontractors, we might discuss Rolls-Royce again when we deal with the amendments later. For small and medium-sized companies, the company funding the contract gets the credit, but for large companies, the company undertaking the research and development gets the credit. It is a natural preference to give the credit to the funding company, as it makes the decisions and takes the risks. However, for the large company, the credit essentially rewards all UK-based research and development, whether or not it is funded from abroad. That would not occur, on the whole, for small and medium-sized companies. By their very nature, they operate in one country.

To answer the right hon. Member for Fylde, we do not want to give credit, if we can possibly avoid it, for R and D undertaken elsewhere, by non-resident subsidiaries of UK multinationals. When we discuss the amendments, we shall see how our measures interact with tax treaties and other issues to ensure that that does not happen. By focusing on UK R and D, we have been able to deliver an enhanced rate of credit for the same Exchequer cost. What we have tried to do has been to produce a usable credit that maximises the rate at which we can pay it, by ensuring that it benefits UK investment. We have been greatly assisted in our detailed discussions in relation to tax by both the companies and the professional accounting bodies.

Photo of Claire Curtis-Thomas Claire Curtis-Thomas Labour, Crosby

My hon. Friend should be aware that I have recently been in discussion with some of my engineering colleagues, with particular reference to the R and D tax credit. First, I pass on their congratulations concerning the consultation that took place to ensure that the R and D tax credit was gifted to large companies. I also applaud the moves that the Government have made to ensure that the tax credit is passed on to third-party suppliers. As my hon. Friend will be well aware, large companies have, in the recent past, evolved their research capacity out of third parties. There was great concern that they would miss the bonanza. Can she comment on the future viability of such organisations, particularly with reference to the substantial enhancement for R and D?

Photo of Roger Gale Roger Gale Vice-Chair, Conservative Party

Order. I have allowed the hon. Lady to intervene, so I shall allow the Minister to answer the specific point if she wishes to do so. Clause 52 is a narrow clause; it is really a trailing clause for schedule 12 and, although I appreciate that these are complex issues, and interlinked, we are effectively entering into a stand part debate on schedule 12. As swiftly as possible, we should put clause 52 to bed then move to the amendments to schedule 12 and have a proper debate in the proper place.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

It would make it far easier for me, as the Minister, to respond if we could deal with the points in context. If my hon. Friend the Member for Crosby (Mrs. Curtis-Thomas) will allow me, I shall return to her point on how the large company tax credit will operate vis-a-vis not-for-profit organisations—universities, for example—when we debate the amendments.

My final two points of concern set the scene for the clause. The first is the issue of intellectual property rights. Small and medium-sized companies must retain some, however small, intellectual property rights within their R and D. There are obvious reasons for that, given their size. There is no requirement on large companies, and we must ensure that the United Kingdom research and development of foreign multinationals qualify in order to encourage inward investment, because that is part of the issue.

My second point concerns the definition of research and development. First, for small and medium-sized credit, we are using the DTI guidelines. After a great deal of discussion, we are using the same guidelines for large companies. They are based on the research and development definition of the Organisation for Economic Co-operation and Development and underpin the UK accounting standards and the R and D credits of other countries. That becomes crucial when making international comparisons and considering the possibility of what might be called double dipping, or getting credit from two different countries for doing the same research. That issue is part of the subject of the amendments. Although I welcome hon. Members' contributions to date, perhaps we are just setting the scene for how the provisions vary so that now we can tease out in the amendments why they do so. I should perhaps conclude my remarks on the clause and save further detailed discussion for the debate on the amendments.

Photo of Roger Gale Roger Gale Vice-Chair, Conservative Party

I call Mr. Jack, but very specifically on clause 52.

Photo of Michael Jack Michael Jack Conservative, Fylde

Indeed, Mr. Gale, I would not have risen had I not wished to make a specific point while we are considering things in the round. In the Red Book, the amount of money that the Government are going to expend on research and development tax credits in the financial years 2003-04 and 2004-05 is shown as a flat figure of £400 million. Will the Paymaster General put my mind at rest on that? For example, if the R and D tax credit is more successful than she has outlined, can I assume that that £400 million is not an upper limit, that this is not a cash-limited figure?

I was intrigued as to why the sum was deemed as flat instead of, for example, a rising trend of numbers. There may well be a very good explanation, for which I would be grateful.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

The figure is not cash-limited and the figures assume the ability of the companies, on the information we have to date, to draw down on new investment to do that new R and D work. The right hon. Gentleman is quite right. If the measure is astronomically successful, the figure could rise. That would be good for the British economy as a whole, good for all the figures in the Red Book and not something of which the Government would take a dim view.

Question put and agreed to.

Clause 52 ordered to stand part of the Bill.