Submission in June 2012
RESPONSE FROM TRUE RESEARCH LIMITED TO ATL CONSULTATION QUESTIONS RAISED BY HM TREASURY IN MARCH 2012.
Author within True Research Limited: Barbara Arzymanow
True Research Limited is an independent consultancy firm with expertise in financial matters relevant to R&D.
Further information about Barbara Arzymanow and her published work is available at www.researchideas.co.uk .
Do you agree with the above criteria for assessing proposals for the ATL credit?
For the basic model of the credit, as it applies to profit making companies, what is your assessment of its effectiveness in meeting the criteria set out in Chapter 2?
The criteria are successfully met for companies
with sufficient CT liability to achieve maximum benefit.
Do you agree with the basic design proposals for the ATL credit? In particular, do you agree that the credit should be taxable and administered and settled through the tax system?
YES to both questions.
For the different models for the payable part of the credit, what is your assessment of their effectiveness in meeting the criteria set out in Chapter 2?
A fully and immediately payable credit is strongly preferred.
The companies in most need of encouragement if
they are to establish, maintain or increase R&D in the UK are those that
will be necessarily loss making for many years. Such companies have the
greatest difficulty raising finance and therefore need the most immediate cash
in the bank. If they receive less financial support than profitable companies
then they are simply not on a level playing field. Furthermore, well-financed companies
that are about to launch major products resulting from R&D success are not
the ones in most need of support.
An example of a type of company that will inevitably be unprofitable for many years is an emerging pharmaceutical business that plans to discover and develop drugs at its own risk. A new drug often takes 6 to 10 years to develop before launch at a cost that can well be over £100m. The risk of failure by any one company is high but taking such risks is at the heart of why the USA has become pre-eminent in the biotechnology industry and has the brightest future in pharmaceutical R&D.
2. A major global pharmaceutical company that carried out most of its R&D in the UK but spread its production around the world would necessarily make a loss in the UK. R&D is typically around 15% of global sales in the industry whilst the UK is only 3% of the world market. We want to encourage carrying out a major proportion of R&D in the UK, not punish it. Similar principles apply in other high-technology industries where the locations of R&D, production and customers can be separated.
3. A system that treats all companies in the same way is obviously the easiest to administer and has less scope for artificial tax planning, for example by manipulating where and when profits are earned.
There is no harm in paying the credit net of standard-rate corporation tax. What matters is that all companies receive the same cash support at the same time.
Taken together, do the above models for the payable credit change your assessment of the basic model of the credit in response to Question 2? What are your overall comments on the basic proposals for the ATL credit?
As set out in reply to Question 4 a fully payable immediate credit is vital if major companies in certain industries (e.g. pharmaceuticals) are to consider carrying out a high proportion of R&D in the UK. Biotechnology companies aiming to develop drugs would also be seriously disadvantaged by any option other than immediate, full payment.
Are there alternative models for the payable part of the credit that the Government should consider? Please describe and explain how this would better meet the criteria in Chapter 2.
No, unless a full and immediate payment system for some unexpected reason cannot be implemented.
What challenges do you envisage businesses encountering on taking up the ATL credit? If necessary please provide details of any specific procedural changes and/or associated costs.
Providing the R&D specialist units
respond rapidly with accurate, comprehensive advice there should be no major
challenges that a sizeable international company should be unable to handle
with its advisers.
What specific steps could the Government take to help businesses who currently claim the existing R&D tax credit transition to claiming ATL?
Ensure that the R&D specialist units have the resources required to give prompt, authoritative, comprehensive advice in response to questions.
Do you think the ATL credit should fully replace the existing R&D tax credit? If not, please explain why and what changes to the ATL design might change your view.
Providing that care is taken to ensure that
no class of business is significantly disadvantaged, one system is better than
If both systems were to be retained, would some businesses be likely to claim under both schemes? If so what would be the administrative costs and issues associated with this?
If the ATL is well designed to avoid unintended consequences, there is no reason why a company should wish to claim under both schemes beyond the transitional period or indeed be permitted to do so. Running two schemes increases the risk of tax avoidance techniques being found that involve switching between schemes.
In what situations do businesses provide R&D services to Government where the contractual arrangement or price could be affected if the business claimed under an ATL credit as opposed to the existing R&D tax credit? What would be the effect of this?
The essential problem arises when any contract or agreement is arranged so as to control financial returns (profit, margins, return on capital or reimbursement of costs plus an added profit). An above-the-line credit will increase the return if nothing else changes. If however the return is fixed contractually, there may be the perverse effect of the Government paying less to keep the return as it was before and so effectively removing the benefit of the ATL.
The solution for Government contracts and procurement is for all return calculations to be done with the ATL and R&D tax credits stripped out except where on a case-by-case basis Government decides otherwise. Companies will readily agree to stripping credits out of procurement computations because this change is in their interests.
The purpose of the ATL is to encourage R&D that would not otherwise occur in the UK. Work commissioned by the Government would generally take place anyway. There may be circumstances where the Government may not wish companies to gain the full benefit of the ATL or R&D tax credits. This area requires a policy decision by Government that can be reflected in individual agreements.
In the case of pharmaceutical companies the
present PPRS appears to give drug companies the full benefit of the ATL without
the need for amendment. However, the matter needs to be double-checked with
expert legal advice and the wording of any future changes in the PPRS must be
studied carefully to make sure that the consequences are as intended.
Would you propose corresponding changes to the ATL credit or procurement guidelines? If so what would these be?
See answer to Question 11.
To what extent might groups be disadvantaged if ATL credits were not available on a group basis enabling companies to surrender unused credit to fellow group members?
If all companies receive immediate, full payment of ATL credits as we propose, then group structure has no relevance. This provides an example of why immediate, full payment is administratively the simplest (see answer to Question 4).
For relevant multinational business, what are the effects on tax liabilities in other countries (or the home country) from moving to ATL in the UK? If ATL does not fully replace the existing scheme, does this assessment change?
Expert advice is required to answer these
questions but we would expect that ATL alone would be treated as a revenue
receipt above the line and that no special tax liabilities should arise. If the
existing scheme remains partly in place, there is more scope for concern given
the complexity of double tax agreements, anti-avoidance legislation and
transfer pricing policy around the world.
Do you agree that the Government should not replace the existing SME R&D tax credit with an equivalent ATL credit?
One scheme must over the long term be easier to administer than two. There is no compelling reason for SMEs to operate under a different system from larger businesses, providing that a full, immediate payment system is in place. The ATL system must provide benefits to SMEs at least as attractive as the current system.
What would the additional impact be on SMEs of introducing ATL for large business? In particular for SMEs making the transition to the large company scheme and SMEs making claims under the large company for subcontracted work for large business. Would these impacts be any different than under the current large company R&D credit?
These problems can be avoided by introducing an ATL scheme that covers businesses of all sizes and phasing out the existing scheme.
What would be the best way(s) to ensure that the benefits of the scheme are only available to claimants on the basis of activities that promote employment and innovation in the UK?
The rules can use exactly the above wording: “ the benefits of the scheme are only available to claimants on the basis of activities that promote employment and innovation in the UK”. In many circumstances it will be obvious whether this requirement is met or not. However, specific rules could be laid down to cover special situations. An example might be when an R&D effort managed and directed from the UK involves subcontracting work to businesses abroad or when a company carries out an R&D project by cooperation between scientists in different countries. The calculation of qualifying R&D expenditure in the UK could involve certain guidelines such as that the R&D calculation can include the employment costs only of people who are based in the UK. There could also be a specific list of expenditure that cannot qualify as UK R&D e.g. work carried out in an overseas laboratory, whether or not the project is managed from the UK.
Do you think that there should be a rule to prevent a claimant from entering into arrangements intended to ensure that it does not suffer any reduction in the credit?
No. All companies should receive the full payment immediately for the reasons set out in response to Question 4.
Do you see any other particular opportunities for avoidance from the introduction of an ATL credit scheme?
A pure ATL scheme with full immediate payments has very little scope for abuse if the recommendations followed in response to Question 17 are followed and put into practice with appropriate drafting.
QUESTION 20 and A1 – A4
See Chapter 5 for detailed questions on the impact of the ATL credit. See Annex A for detailed questions on the accounting treatment of the ATL credit.
True Research Limited is an independent advisory firm that does not itself carry out R&D. It is also not an accountancy firm. We therefore only consider it appropriate for us to answer Questions 1 to 19 inclusive, as above. Neither True Research Limited nor Barbara Arzymanow has any commercial interest in the decisions reached in relation to this Treasury consultation.
Submission in September 2011
Contact: Barbara Arzymanow
RESPONSE TO HM TREASURY FURTHER CONSULTATION ON RESEARCH AND
DEVELOPMENT TAX CREDITS
This submission has been prepared by True Research Limited, a healthcare consultancy firm which mainly advises institutional investors (e.g. pension funds) and biotechnology companies. True Research Limited and its directors have considerable experience in raising finance for biotechnology companies and in analysing what makes pharmaceutical businesses of all sizes and geographical origins successful. The firm is independent of lobbies associated with large NHS suppliers (e.g. big pharmaceutical companies), the medical professions, patient charities and NHS managers. The main person who has worked on this submission within True Research Limited is Barbara Arzymanow. The main motivation of True Research Limited and Barbara Arzymanow in submitting this document has been to make use of our specialist skills in giving our thoughts on recent proposals on R & D Tax Credits.
THIS DOCUMENT GIVES OUR ANSWERS TO ALL QUESTIONS ASKED IN CONNECTION WITH THE FURTHER CONSULTATION ON RESEARCH AND DEVELOPMENT TAX CREDITS.
A separate submission is being made in respect of the further consultation on the Patent Box.
ANSWERS TO SPECIFIC RESEARCH AND DEVELOPMENT TAX
In this document consultation questions raised in HM Treasury’s further consultation on Research and Development Tax Credits appear in red. Our responses are in black.
RESEARCH AND DEVELOPMENT TAX CREDITS
Q1. What difference, if any, to levels of
R&D investment in the
Big companies should be able to handle different tax systems by adapting their decision-making processes. However, if they prefer a system with payable credits, then that must be an argument in favour of having them. However, the financial benefit should only be material for large loss-making companies, which are rare.
Q2. What tax treatment would allow loss-making companies to account for the credit above the line? Given the potential complexity of offsetting the tax credit against other taxes apart from CT, would loss-makers need the credit to be payable if there was insufficient CT cover?
If large loss-making companies are to benefit, the credit should be payable if there is insufficient CT cover. The idea of offsetting against other taxes would introduce an element of complexity that is only relevant if the credit is not fully payable.
Q3. If a payable credit was introduced for loss-making companies, should the benefit be less than that available to profitable companies, to recognise the value to the loss-makers of being able to utilise the credit immediately?
No. Payment or the offset against tax should be made at the same time to create a level playing field. If payment to all companies cannot be immediate for reasons of tax flow to the Exchequer, the sums due to loss-making companies should be certificated in a way that could be used as evidence to investors or commercial lenders.
Q4. Are there additional issues around added complexity to the schemes that should be considered?
There would be detailed drafting points that can only be addressed when more detail becomes available.
Q5. The majority of respondents in favour of the change were large companies. What separate compliance and complexity issues would arise if the SME scheme also moved to an ‘above the line’ credit system?
None with appropriate drafting.
Q6. Should the relief for Qualifying Indirect Activities be retained? Does it provide significant benefit to companies currently claiming QIA costs?
The relief is rarely of major benefit, although we favour a system that allows all revenue expenditure on R & D because that is what we wish to support. Uncertainties and complexities can be removed by widening the scope of qualifying expenditure instead of narrowing it.
Q7. Would either the certification process or joint election process (or an alternative process) be effective in delivering the intended certainty for both contractor and subcontractor to allow the subcontractor to claim the large company credit?
The certification process is simplest and should be workable. Contractors are likely to be willing to issue certificates in order to avoid having to pay more to subcontractors if the tax benefit is important to the transaction.
In our experience subcontractors are a rare source of breaches of security. Like bankers, accountants and regulators, subcontractors understand the need for confidentiality. The commonest sources of R & D leaks relate not to subcontractors but to: movement in personnel between competing contractors; careless discussion between friends; doctors and patients involved in clinical trials; loose talk at scientific and medical conferences; and revelations made during licensing discussions that do not result in a deal.
Q8. Are there any particular safeguards that companies think would be effective but not add significantly to compliance burdens to ensure the removal of the PAYE/NICs cap on the payable credit is not abused?
Removal of the PAYE/NICs cap is important because new companies cannot be expected to carry out every kind of activity in-house from the outset. The reasons may include the availability of expertise or a lack of economies of scale. Recent cutbacks in R & D by large employers also provide scope for redundant scientists to set up or expand companies whose role is to fund and manage R & D subcontracted to others.
The safeguard issue is about making sure that the company funding R & D really is spending the claimed expenditure on R & D and that no artificial arrangements are involved. With appropriate drafting and possibly a requirement for an expert report in support of claims above a certain level, adequate safeguards should be achievable. Spot checks might also be part of the system.
Q9. Would companies welcome reform of the ‘going concern’ definition so that it more closely matched that used for the EIS/VCT schemes?
Yes. Further adjustments may be appropriate. Some companies (e.g. start-ups aiming to discover and develop drugs) may anticipate losses for six years or longer. Often investors only invest enough to provide two or three years of funding in each round. When investment conditions for the whole stock market are adverse, such companies may be forced into a very difficult position despite having achieved good progress objectively.
Q10. The Government would welcome comments or evidence to support the assessment of the impacts of the changes under consultation.
Payments are fair because without them large, profitable companies still receive a prompt cashflow benefit, whether or not their R & D proves successful. Effectively the R & D costs of established, profitable businesses are reduced. On the other hand new, innovative companies that are still in the loss-making phase can only be helped in the near future by receiving money.
The performance of the