As the UK charts its course post-EU and looks to recover from the economic damage caused by the COVID-19 pandemic, it is more important than ever to attract innovation and investment into the country. The development at unprecedented pace of vaccines categorically shows the direct impact that innovative science and technology has upon the whole UK economy. However, when compared to other nations, the UK underinvests in research & development (R&D) relative to most competitor nations and is losing foreign direct investment (FDI) at an alarming rate. We are calling for an expansion of R&D incentives to encourage the flow of FDI and innovation into the UK and in this response, we will detail actions the UK can take to attract investment and produce innovation.
The UK benefits from the investment, innovation and demand that inward investment brings, but the value of net FDI flows into the UK is dropping, falling for the third year in a row in 2019, with a further fall expected in the 2020 figures. To illustrate the importance of FDI to the UK economy, FDI into the UK results in approximately 4 million jobs, contributing 27% of UK approximate gross value added and contributing to 27.2% of capital investment. The UK has the highest FDI stock as a proportion of GDP in the G7 (at 68.8%). This is higher than the OECD average (43.8%).
Combining these figures with spend on R&D that is below the OECD average (1.7% of GDP) and much lower than competitor countries offer (R&D expenditure in Germany is 3.1% of GDP, the US is 2.8%, France is 2.2%) as well as the OECD’s low ranking of the UK’s R&D tax scheme for large companies (23 out of 44), the vulnerabilities abound. Although the UK is ranked in the top 10 on most measures of business competitiveness, other countries are constantly improving their business environments. The UK needs continuous reform to increase competitiveness and to retain and attract FDI as any increase in international competitiveness will see the UK susceptible to disinvestment.
There are two ways that this problem can be approached. The first is by incentivising existing investors to spend more on their R&D in the UK and the second is to attract more R&D spend. Increasing R&D intensive FDI will contribute to the UK becoming a world-leading science superpower and see total R&D spend as a proportion of GDP reach 2.4% by 2027. It will also enhance UK competitiveness, boost productivity and create highly skilled jobs across the nation, unlocking wider economic and societal benefits.
Recent studies have shown that that tax incentives are effective drivers for FDI given that with globalisation, locations are becoming more and more similar. When combined with other positive business environment elements, nations that offer tax incentives become more attractive places to invest. These tax incentives influence the decision-making process for internationally mobile investments that have competition between locations.
As examples from highly attractive countries for inward investment, Singapore, behind their low corporate tax rate of 17%, provides grants for science, technology R&D/innovation covering up to 30% of project costs. Grants covering manpower (up to 50%) are also widely available. Germany provides grants of up to 50% of cost in R&D projects.
With this context in mind, we propose the following actions to fix the problem and capitalise on the opportunity:
– Introducing an incremental sliding-scale for R&D tax credits which rewards increased R&D investment over time to incentivise multinationals to undertake incrementally greater R&D investment in the UK over other locations.
– Introduce a sliding scale of R&D tax credits depending on the nature of the work e.g. higher rates for work leading to a patent, or focusses on key sectors or projects such as hydrogen power and battery storage – such a policy has the advantage of being potentially self-funding by reducing credit rates on less innovative work.
– Increase R&D tax credit relief for R&D activities in the most disadvantaged regions which could introduce bands reaching up to a 50% reduction on eligible expenditure in the highest priority region(s), giving the UK a headline grabbing highest discount compared to key competitors, e.g. G7 or EMEA. For example, an increase in R&D Expenditure Credit (RDEC) rate from 13% to 20% on R&D carried out in a freeport, subject to clearance being granted by HMRC via the existing provisions of the Advance Assurance scheme would come at a modest cost but create a significant increase in attractiveness for innovative overseas companies.
– Tighten existing rules to reduce ‘leakage’ that allows global R&D activity undertaken outside the UK to benefit from UK R&D tax credits in order to incentivise increased UK-based R&D activity.
– Double-count PhD salaries as qualifying expenditure for R&D tax credits to encourage high-value R&D activity, increase academia-industry crossover and retain top talent in the UK, as well as attracting the best scientists and engineers from around the world.
– Update Patent Box and R&D tax credit eligibility to strengthen the UK’s offer to innovative software, AI, quantum and other ‘big data’ companies by measures such as allowing data purchase to qualify for R&D tax credits
– Expand the scope of Patent Box to cover intellectual property (IP) such as software, licences and copyright companies, so that non-patented code-based R&D is eligible, keeping pace with competitor nations.
– Permanently extend the capital expenditure ‘super-deduction’ announced at Budget 2021 for buildings and assets to be used in R&D, matching competitor nations and encouraging FDI into tangible assets, creating ‘sticky’ jobs and associated spillovers into clusters and local communities.
A focus on better incentives to enhance the UK’s attractiveness for FDI does not neglect domestic business. Increased flows of FDI benefits all businesses and ultimately the wider economy through higher productivity, lower prices and higher wages. The actions presented here provide tangible ways to both address the problem of underspend on R&D and the decline in FDI as well as seizing on the opportunity that the UK has to become a more innovative economy.