Alan Mak: Reform capital allowances and R&D tax credits to fire up investment and create jobs

1 Jul

Alan Mak is MP for Havant and Founder of the APPG on the Fourth Industrial Revolution.

Improving Britain’s productivity is key to both our economic recovery after Coronavirus and enhancing our global competitiveness post-Brexit. The best lever for firing up Britain’s productivity is incentivising more investment in the latest IT and software, new plant and advanced machinery – all proven catalysts of growth and efficiency. Failure to direct billions of pounds into these fundamental building blocks of our economy will hold back our recovery.

The State cannot be expected to do all the heavy lifting, especially given the Government’s substantial spending commitments to help the country through the lockdown and beyond. Instead, it must be businesses that take the lead, especially SMEs who have traditionally made up the “long tail” of unproductive companies.

Rather than a safety-first approach of hoarding cash, postponing investment and hunkering down, businesses must be incentivised to invest more in the coming months. This must be an economic recovery powered by bold investment decisions that create jobs, upgrade technology and boost productivity.

The dampening effect on capital expenditure (capex) and investment caused by Coronavirus is already large and destructive. One investment bank estimates that £23 billion has been slashed from this year’s capex budgets already, whilst the Bank of England predicts a 26 per cent drop in business investment for 2020. In 2009, as the financial crisis erupted, the fall was 16 per cent by comparison. Some of the country’s biggest employers such as BP and HSBC have already started cutting investment.

In practice this means IT systems and software – now at the heart of every business – being used for longer. Machines normally replaced every decade will have their life extended. Trucks and vans will be allowed to age. Outdated buildings that offer no room for new employees will be kept on. Research and development (R&D) could stall.

Reductions in investment not only have negative consequences for our country’s GDP, jobs and productivity, it also damages our capacity for R&D and our reputation as a nation that innovates for the future – key to our leadership of the Fourth Industrial Revolution.

Reforming and adapting two existing incentive schemes – the Annual Investment Allowance and the R&D Tax Credit – would have a major impact in reversing this decline in business investment and productivity.

Introduce a new Annual Investment Allowance ceiling for green or digital investments

Capital allowances enable a business to deduct the cost of qualifying items from their profits, lowering their corporation tax bill. This incentivises investment in key productive goods from machines to laptops.

The Annual Investment Allowance (AIA) is the annual cap on such deductions and its level has varied dramatically in recent years from £25,000 in 2012 to £500,000 in 2015. Until December 2018, the AIA was £200,000 but it was raised to its current £1M level from January 2019. The £1 million level is due to expire this December.

To encourage a green recovery and investments that focus on digitisation, the AIA could be allowed to fall back to the previous £200,000 ceiling, except for certain types of capital expenditure that achieve environmental or digital goals which would still benefit from the £1 million special ceiling. Replacing a diesel-powered machine on the factory floor with one powered by electricity, or digitising a production line by adding new software powered by artificial intelligence (AI), could be examples of investment that would be rewarded by the new special AIA ceiling.

Alongside the introduction of a special £1 million ceiling, the scope of what can be claimed through capital allowances should also be expanded to take account of the growing digital dimensions of every business. For example, digital tools purchased on a subscription basis (such as monthly website hosting costs) should benefit from relief not just one-off investments in physical goods (such as buying a new machine).

Increase R&D tax relief rates for SMEs and widen the scope of the reliefs

R&D tax reliefs support companies that work on innovative projects in science and technology, and enables the cost of qualifying projects to be reclaimed from HMRC. They’re especially effective for digital start-ups, who get a tax break and much needed cashflow back for critical work.

From April this year the relief rate is 13 per cent, but the lion’s share of R&D tax relief is claimed by large, research-intensive businesses. SMEs can currently claim up to 14.5 per cent in certain circumstances, but incremental increases such as this do not have a dramatic effect on investment appetite.

Often the most cutting-edge innovation, especially in the digital sphere, is carried out by small teams and growing start-ups – not just multinationals. To encourage more micro businesses and SMEs to pursue more R&D, new and much higher rates of relief should be introduced. For example, a rate of 25 per cent for SMEs with fewer than 150 employees, and 35 per cent for SMEs with fewer than 50 employees.

What qualifies for relief must also be broadened to include more of the digital tools that software developers use, including software testing tools and data analytics software. In addition, cloud storage fees, user experience development work and the cost of buying data sets needed to train algorithms for AI-driven start-ups should also be tax deductible.

Britain is currently 19th out of the 37 industrialised nations in the OECD when it comes to R&D investment, spending 1.7 per cent of GDP against the OECD average of 2.4 per cent. To match world leaders including Germany and Japan, who invest over three per cent, we must urgently update and expand our R&D tax relief regime.

This is the second in a three-part series on how to boost our economy after Coronavirus.

Stephen Booth: While UK-EU talks gather momentum, Britain should continue to diversify its trading relationships.

25 Jun

Stephen Booth is Head of the Britain in the World Project at Policy Exchange.

There are signs that the UK-EU negotiations on the future relationship may be gathering some momentum.

Last week’s stock take meeting between the Prime Minister and Ursula von der Leyen and Charles Michel, the European Commission and European Council Presidents, respectively, confirmed there will be no UK request to extend the transition period beyond December 31 this year.

Both sides agreed to inject fresh impetus into the negotiating process, with talks set to intensify in July, August and September. This marks the make-or-break period to reach a trade agreement and new arrangements in other areas such as cooperation on policing and security.

In my previous column, I argued that the nature of the impasse – essentially whether the EU is prepared to cut a deal under which the UK would be free to leave Brussels’ regulatory orbit – means that it is incumbent upon the EU to move on the key sticking points.

These are fishing and the demand for ongoing UK alignment with EU law on the “level playing field”, particularly with regard to state aid. Important UK-EU differences remain but there are encouraging signs that this is now happening.

Following her meeting with Boris Johnson, von der Leyen signalled in a speech to the European Parliament that the EU was prepared to compromise without, of course, putting into question “our principles and the integrity of our Union”.

In her speech, von der Leyen made no mention of the EU’s initial demand to maintain EU boats’ access to UK waters on the basis of the status quo. “No one questions the UK’s sovereignty on its own waters,” she said. “We ask for predictability and guarantees for our fishermen and women, who have been sailing in those waters for decades.”

Neither did von der Leyen mention the demand for ongoing alignment with EU law on state aid or a role for the Court of Justice (ECJ) in overseeing the level playing field. “It should be a shared interest for the EU and the UK to never slide backwards, and always advance together towards higher standards,” she said.

Notably, she limited her remarks on the role of the ECJ to the part it should play “where it matters” in the area of police and judicial cooperation, rather than in the wider trade deal. If the UK wishes to retain access to EU crime and policing databases, these are underpinned by EU law and there is no escaping that the Court has the role of interpreting how law applies on the EU side.

Though, as the UK has pointed out, the EU has consistently agreed treaties with non-EU countries on policing and judicial matters without requiring the ECJ to settle disputes between the two parties. Equally, the Government has said it will not agree to the extraordinary EU demand for treaty provisions that would oblige the UK to maintain its existing implementation of the European Convention of Human Rights in domestic law.

Meanwhile, there is speculation that a compromise on the level playing field is being explored, under which Britain would assert the right to deviate from the EU rules that it will inherit after the transition period expires. And, in return, the EU would have the ability to apply tariffs on British exports if regulatory divergence amounts to unfair competition.

Neither side has formally adopted the idea yet, but there are reasons to suggest it might have legs. The UK would regain regulatory independence (and the consequences), while the EU would retain the ability to control access to its market in instances where it perceived the UK was lowering standards.

Brussels would need to give up on its desire to export its regulatory model to the UK indefinitely by treaty and the UK would need to compromise on its current position that any commitments on subsides, labour and environmental rights should be exempt from dispute resolution.

It is also an idea hiding in plain sight. The EU’s draft UK trade agreement text already proposes so-called “temporary remedies” and “interim measures” in the event of non-compliance with treaty commitments.

Such a model would not be without difficulties. The UK and EU would still need to agree on the relevant benchmark for identifying a breach of level playing field commitments. The UK could insist that evidence should be required to show that the effects of divergence are harmful to open and fair competition. The EU could continue to insist that the letter of EU law is the benchmark.

Equally, the prospect of the EU using tariffs or market restrictions as a political tool to secure leverage over the UK in other areas of the agreement cannot be discounted. This has been a feature of the EU-Swiss relationship in recent years. However, this needs to be weighed against the prospect of UK-EU trade facing the full panoply of tariffs on day one, if talks break down completely and trade reverts to World Trade Organisation terms.

Critics have noted that rather than providing for managed divergence, such a mechanism would create perpetual conflict. But, ultimately, while it would be nice to avoid it, the likely reality is that the UK and the EU will face disputes in the future, just as they have in the past. This is a feature, rather than a bug, of an independent UK. Some disputes may be easily resolvable through treaty dispute mechanisms, others will require political resolution.

One way for the UK to insure itself in the event of such disputes is to diversify its trading relationships outside of the EU. And negotiations with the UK’s priority non-EU markets, the US, Australia, New Zealand and Japan, are also intensifying over the coming months.

This week, Hiroshi Matsuura, Japan’s chief trade negotiator, called for a UK-Japan deal to be secured in just six weeks to be ready for ratification in the Japanese parliament. The challenge is to replace the existing EU-Japan agreement, which is due to expire at the end of the Brexit transition period, and Japan is insisting on a bespoke UK deal rather than a simple rollover of the existing EU agreement.

This may mean that the deal is less ambitious than the UK would like on agricultural tariffs but Japan and the UK could go further than the EU was prepared to in areas of mutual interest such as services and digital.

Unlike the Japanese deal, the talks with the US, Australia and New Zealand are about fresh deals and the talks are expected to run into next year. UK accession to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership is next on the agenda. India would be another potential candidate for the future.

With this week marking the fourth anniversary of the EU referendum, the contours of the UK’s international trade policy are beginning to take shape.