R&D: The race for the future

By Ian Harper, The CA magazine

20 March 2015

In a world threatened by rising carbon dioxide levels, diminishing supplies of crucial resources, and the growing ineffectiveness of antibiotics, there's a clear and urgent need for new thinking in technology.

Integrated into the "real economy", research and innovation drive cost efficiencies, improve performance, and make possible the sustainable and efficient use of scarce resources with positive environmental and social consequences. In short, research and innovation underpin modern society.

So why do we see yet another report stating that, while the UK is world number two for the quality of its scientific research institutions, we are the poor relation when it comes to spending on research and innovation? Not only have we been here before, we've been here many times.

Building a Stronger Future, a report by the UK's four National Academies - the Royal Society, British Academy, Royal Academy of Engineering, and The Academy of Medical Sciences - says investment is needed to stop the UK's world-leading research base being eroded.

The report sets out what the next government needs to do to build a strong research and innovation base and drive economic growth, calling for a target for investment in research and development (R&D) and innovation of 3 per cent of GDP for the UK as a whole - 1 per cent from the government and 2 per cent from industry and charities - in line with the top 10 OECD research investors.

The UK Government currently invests 0.5 per cent of GDP, with 1.23 per cent from the private sector. The figures are 0.86 per cent and 2.03 per cent for Germany; 0.56 per cent and 2.79 per cent for Japan; and 1.04 per cent and 3.32 per cent for South Korea.

Chart showing who does UK R&D 

Encouraging R&D

We asked a number of experts their views on where the UK is in terms of research and innovation, and what stimulates it. As to whether R&D and innovation is important, there's little doubt. For Dominic Preston, partner and head of innovation at Grant Thornton UK: "R&D and innovation underpin every aspect of value creation. Nothing could be more relevant."

While many people regard R&D as central to science and technology, industrial processes and design, and medicine, it's just as important in every other area of enterprise. According to John Godfrey, director, wealth and investment management at Barclays: "The banking industry is not an obvious one to be associated with R&D and innovation." It was, he says, Barclays that introduced the first UK ATM in 1967, and other initiatives from the bank include video banking, cheque imaging and the advanced mobile payment application, Pingit.

In London in April, the first Insurance Times Disruption & Innovation Conference will examine the innovations and disruptions that will shape the future of this major industry. Elsewhere, the British Museum, the UK's largest visitor attraction which had 6.7m visitors in 2013/14, secured a record £3.26m in research funding.

Our experts have no doubt that UK companies are good at research and innovation. Preston calls the UK: "A world leader and has transported some of its finest minds, technology and processes around the world."

Chart showing who invests in UK R&D 

David Ward, tax director with Johnston Carmichael, says: "Many UK and indeed Scottish companies have shown they are world leaders when it comes to innovation. This is especially the case in sectors such as life sciences, food and drink, technology and energy."

Although Ward is confident we can take this to a higher level, he is not alone when he warns: "One of the key challenges going forward is to raise awareness among UK and Scottish companies about R&D and other innovation incentives that are available as there is still a relatively low take-up rate within the business community."

What lies behind this low take-up rate of R&D incentives? What role does taxation play in boosting research and innovation? Can tax breaks alone bridge the gap between the UK and its major competitors?

Shona Quigley, financial director at Jumpstart, a consultancy focused on R&D advice, says: "The recently announced increase in R&D tax credits from 10 per cent to 11 per cent for above-the-line credit and an increase in the SME enhancement rate of 225 per cent to 230 per cent from 1 April 2015 is a positive move by the government to support R&D and innovation. Failure to take advantage of the scheme may stem from confusion as to what costs and activities are eligible, and uncertainty arising from the definition of R&D as given in guidelines from the Department of Business, Innovation and Skills."

Barbara Walton, senior tax manager at Henderson Loggie, says this is not a large increase in relative terms: "For lossmaking companies, it increases the benefit from 32.63p to 33.35p in the £1 of a cash benefit. The low take-up is partly due to the lack of clarity in the HMRC guidance as to what R&D is, added to the practical capturing of the information and financial information to allow an R&D claim to be made."

She adds: "We must also look beyond technology/sciencefocused businesses. HMRC now accepts that R&D can be claimed by businesses which do not carry out research in laboratories, so manufacturing, waste recycling and construction businesses, among others, are claiming R&D tax credits."

What's in the patent box?

Alongside R&D tax changes, the UK government introduced the "patent box", which offers an effective headline corporation tax rate of 10 per cent on qualifying profits. This is open until 30 June 2016 and for those companies joining will last five years.

Ian Durie, director, HW Corporate Finance, says: "The patent box scheme was introduced as a reaction to a decrease in innovation levels and patents filed by UK companies - estimated to be around 30 per cent in 2010 by the IFS - which had been attracted to more lucrative taxation regimes in other countries. However, the UK remains at a disadvantage as it is years behind other jurisdictions in respect of application of the legislation and also in terms of tax rates."

A key issue with the patent box is that while it reduces tax paid on qualifying profits, it doesn't really help innovative SMEs and start-ups that have still to break even. Walton says: "The take-up of patent box has been slow for loss making companies as they probably struggle to see the benefit of the relief, which requires legal costs in preparation to enter the regime. The relief is more beneficial for taxpaying, profitable companies as it reduces tax paid."

What's more, according to Shepherd and Wedderburn partner Joanna Boag-Thomson: "The patent box regime is not popular with the European Commission. It has raised questions over whether it could distort competition and there is a possibility that the government might cave in to pressure to restrict its lifespan."

The UK, along with Luxembourg, the Netherlands and Spain, has found itself at odds, particularly with Germany, over tax breaks for intellectual property (IP)-related income. An Anglo-German accord, reached last November, looks set to restrict patent box relief so that it applies only to IP specifically developed in the UK. As part of the agreement, the UK is set to close its existing regime to new entrants by 30 June 2016 and will abolish this particular regime altogether by 30 June 2021. The UK Treasury has said it will consult on changes to the current law in 2015 whilst working with the OECD's Forum on Harmful Tax Practices to ensure a practical outcome based on the principles agreed in November.

A key benefit of research and innovation, aside from creating profits from the sale of improved products, processes and services, is intellectual property: tangible and nontangible creations of the mind such as music, literature, and other artistic works; discoveries and inventions; new processes and words, phrases, symbols, and designs.

Under intellectual property laws, owners of IP have certain exclusive rights and these rights also have a monetary value, so it's important to know what key legal changes may be in the pipeline. There are two: one affects design rights, the other patents.

Durie says: "On 1 October 2014 the UK introduced changes to the law surrounding design rights, as effected by the Intellectual Property Act 2014, including simplification on the issues surrounding unregistered design rights and ownership of design rights in commissioned works. A further change was the introduction of criminal sanctions for intentional copying of registered designs - the effect of this was that registered designs now receive the same level of protection as trademarks and copyright."

On the way is the option of the new European unitary patent now being introduced under European IP law.

Says Boag-Thomson: "The unitary patent will offer a single European patent in participating EU countries with a new unified patent court offering a one-stop shop that allows a unitary patent holder to bring a single infringement action throughout participating member states. This will also enable third parties to knock out unitary patents in just one cross-state revocation action. Companies will need to think carefully about which patent route to follow and also, if the unified patent court is given jurisdiction over other European patents, whether to opt out of its jurisdiction. The new system will potentially offer a much reduced cost for patents and a streamlined court procedure, but companies will need to make informed decisions about which route to follow for applications and court actions."

Of course, there is a cost to protecting IP, but IP is an asset that can have value. Susan Snedden, a director in the IP and technology team of Maclay Murray & Spens, says: "IP rights can be used as security for loans, which can also be of assistance in securing finance. A recent, high-profile example is the loan from one of Mike Ashley's companies to Rangers Football Club, in which the company has reportedly obtained a fixed charge over Rangers' registered trademarks as security for the loan."

Durie adds: "We have been involved in a number of situations where increased sophistication in IP recognition, assessment and valuation has provided comfort for lenders in treating IP assets as security."

A novel approach is the use of IP to fill a hole in a pension scheme using securitised IP assets. In one example, Kelvin King, senior partner of Valuation Consulting, part of the IP firm Marks & Clerk, in 2011 assisted TUI Travel to use the Thomson and First Choice brands to help finance their defined contribution pension scheme. The partnership set up for this purpose by the scheme trustees will receive royalty payments totalling about £16.5m until 2026. How long can it be before securitised IP underpins retail "income" investments, just as securitised mortgage debt did a few years ago?

The investor's dilemma

Bearing in mind Warren Buffett's warning: "Never invest in something you don't understand," what should investors make of R&D and IP?

Andrew Holloway, tax manager in National Innovation Group, Grant Thornton, says: "The ability to monetise IP, the ability to benefit from the generous tax reliefs available to businesses in the UK, and the ability to constantly develop and build on key IP attributes should all form part of an investor's thought process when performing diligence on a business that is 'innovating'. One other point an investor should consider is that if a business is not innovating - does it have a competitive edge in the market that will drive profitability now and in the future?"

Durie notes: "There is growing recognition and acceptance of IP rights as an asset which investors can use as security when providing funds to a company."

Walton warns that investors need to take care that the IP of the company they're investing in actually belongs to that company: "A business will often start off with one or more individuals designing a patented invention or a copyrighted software product, perhaps also registering trademarks and domain names, and only later setting up a company to start trading. The IP in those circumstances belongs to the individuals, not the company, unless and until the individuals sign it over to the company. A careful investor makes sure that happens before he invests in the company."

The circular economy

To return to our starting point. The fact that the global population is expected to rise from 7bn now to 10bn in 2050 can only fuel the need for research and innovation in every conceivable area. One such is "remanufacturing" and "closed loop" or "circular" manufacturing. The former is becoming more commonplace and involves a company, not always the original equipment manufacturer, returning a used item to "as new" condition with a full warranty; the latter is based at the outset on design for reuse and is very much in its infancy.

For Durie, the shift towards remanufacturing: "…is likely to be one of the biggest influencers in recent times on UK regulations regarding ownership, enforcement and protection of IP."

The big question is, does the UK government, whatever its colour, have the wit and imagination to see the trends and act accordingly? As things stand, the UK will continue to fall behind. Tax breaks favour established companies, and there is much good research, notably from the US, that shows small companies are the real game-changers when it comes to the development of innovative and disruptive technologies, processes and ideas. Such companies need investment, not tax breaks.

 Private and third sectorGovernment
South Korea 3.32 1.04
Israel* 3.49 0.48
Finland 2.60 0.95
Sweden** 2.45 0.94
Japan 2.79 0.56
Denmark 2.11 0.87
Germany** 2.03 0.86
Austria 1.69 1.15
US 1.93 0.86
Slovenia 1.88 0.75
UK 1.23 0.50
R&D as % of GDP. Source: Building a Stronger Future. Data is from 2012 unless otherwise stated. * Israel's data is from 2010. ** Sweden & Germany's data is from 2011.


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