BioCentury
ARTICLE | Politics, Policy & Law

U.K. biotechs risk losing millions in R&D tax credit changes

As bear market grinds on, proposed changes could see U.K. life sciences sector lose up to £800m a year

December 1, 2022 12:02 AM UTC
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Proposed changes to the U.K.’s R&D tax credit scheme threaten to partially roll back years of progress in the government’s support of life sciences innovation as a pillar of the U.K. economy.

The U.K. government’s autumn budget proposed two changes to R&D tax schemes: an increase in the rate for the R&D expenditure credit (RDEC) and a decrease in the rates for the R&D tax relief scheme.

The RDEC program targets revenue-generating, larger companies, which under proposed changes would see the percentage of R&D expenditure credits increase from 13% to 20%. However, the vast majority of U.K. life sciences companies are SMEs that make use of the R&D tax relief scheme; if the proposals are carried out, they would effectively cut in half the value of the R&D tax credit.

Despite the U.K. government’s strategic goals of supporting life sciences as a key innovation sector, the proposed changes to R&D tax relief would see companies lose millions of pounds in real capital, which could translate into companies running fewer trials and having tighter research budgets. 

The measure, announced in the autumn statement, is part of the U.K. government’s urgent need, under new Prime Minister Rishi Sunak, to address its troubled economy. The stated goal is to clamp down on abuse and fraud in R&D tax relief for SMEs.

The U.K. biotech sector has blossomed from a combination of government incentives and growth of entrepreneurship in its strong biomedical academic sector. It represents the hottest hub for newco creation after Boston and the Bay Area, and has weathered successive hits from Brexit and the collapse of the Woodford empire.

But this proposal couldn’t be more poorly timed — the downturn in the broader financial markets, now deep into its second year, has most companies trying to stretch their cash runways. If it comes into effect in April, the measures would effectively shorten those runways even further.

“For biotech, the IPO markets are very weak, effectively closed, and the fundraising environment is not good,” said Andrew Muncey, COO of Artios Pharma Ltd. “So, we then become very focused on preserving our cash runway. If you are losing money from the R&D tax credit, that’s shortening your runway. Therefore, we’ve got to find a way to extend our runway, which is basically to spend less.”

A step back

While the U.K. government has been touting the importance of innovation sectors, and life sciences in particular, as a pillar of the country’s future economy, reducing the R&D tax relief scheme will blunt innovation and make U.K. life sciences less attractive to investors.

Under the existing SME tax relief scheme, companies can claim 130% of R&D expenses and convert that to a cash payment at 14.5%, effectively meaning companies could recoup around 33p for every £1 of R&D spend in a cash payment. The proposed changes would see those numbers reduced to 86% claims on R&D expenses with a payable credit rate of 10%, meaning companies would get back 18.6p per £1 of R&D spend — a 44% reduction.

For clinical-stage companies with high cash burn rates, this could equate to millions of pounds in lost cash that would have been spent on R&D, leading to fewer clinical trials being conducted and fewer new pipeline programs being brought forward.

The BioIndustry Association (BIA) estimated that the proposed changes would result in a reduction of £400-£800 million ($484-$968 million) in cash payments to the life sciences sector per year. Over the past five years, U.K. biotechs have raised an aggregate average of $1.7 billion in venture financings. The lost R&D tax relief payments could equal up to 57% of what biotechs raise annually in venture capital.

The reduction in capital support appears to be out of sync with U.K. government policy, including the U.K. Innovation Strategy, launched last year that aims to build the U.K. economy around innovative sectors, including life sciences. The initiative was coupled with the U.K.’s Life Sciences Vision, which aims to apply the approach of the U.K. Vaccine Taskforce to other therapeutic areas to spur the development of new treatments.

“There’s been so much talk about the U.K. becoming a tech economy and supporting things, how strong biotech is in the U.K. as a government policy,” Muncey said. “And then they suddenly cut it off at the knees by taking a load of funding away.” 

Artios CEO Niall Martin added that the R&D tax scheme in the U.K. was a distinct advantage for British companies in terms of competing globally, in particular with U.S. companies, and attracting international investors. 

“We are trying to be competitive, particularly with the U.S.,” Martin said. “Any advantage we can have financially is just really helpful for us.”

The proposals also would make it less attractive for U.K. companies to keep their R&D activities at home if there are cheaper options abroad.

Possible solutions? 

The BIA is hoping that a carve-out for knowledge-intensive companies could be a compromise that addresses the government’s concerns.

The government’s rationale for scaling back tax relief for SMEs is alleged risk of fraudulent claims. The BIA said on a webinar that these claims are often the result of contingent fee structures, where firms promise “no win, no fee” representation to process R&D tax credit claims that may claim tax relief for more spurious forms of research.

BIA argued that the fraud risk is low for companies that are spending a large portion of their capital on R&D.

The industry group is proposing maintaining the status quo for the R&D tax relief scheme for companies that meet a definition as a “knowledge-intensive” SME, a term that already exists in the U.K. tax system. This would create an exception for companies with less than 500 employees where the primary aim of the business is to create IP as the basis for the future business. To qualify, companies would also need to have had 20% of their employees conducting research for at least three years and meet a minimum spend on R&D as a percentage of overall costs.

The trade group’s hope is that this exemption would keep most life science companies within the current scheme, while excluding companies that may have been higher risk for abusing the system.

Any changes will have to be made fast. The Autumn Finance Bill 2022 already had its second reading in the House of Commons on Monday and progressed through the committee and report stage on Wednesday. It is expected to head to the House of Lords for a reading next week, before returning to the Commons for a third reading, after which it would be moved for Royal Assent.

If the bill remains unchanged, the changes would come into effect April 1, 2023.