The research and development tax credits scheme has been a terrific boost for small UK businesses, enabling them to recover up to 24% of their R&D expenditure in cash and to receive more than £200m in support from the Inland Revenue.
Unfortunately for larger companies the extension of the scheme in 2002 failed to fully meet their needs and the cash boost they receive is not quite as generous.
The reason for this is that in its purest form the scheme allows large companies to recover 7.5% of R&D costs. However, because of the narrow definition applied to eligible R&D costs, the effective rate of recovery is actually nearer 3% to 4%.
This figure is too low to make a difference to the costs of much IT investment and it is for this reason that IT trade body Intellect has been lobbying for a broader definition of costs to include expenses such as overheads and recruitment. These costs are currently excluded.
The lobbying has successfully achieved the inclusion of expenditure on fuel, power, water and software licences, which all became an eligible cost with effect from 1 April.
However, the chancellor, in his latest Budget, failed to do enough to move the effective rate above the critical "noise level" of 10%, a level which provides enough incentive to the R&D decision-makers of large multinational companies.
Crucially, Intellect argued that until the noise level is breached, the scheme will not be sufficiently attractive to persuade large multinationals to conduct their R&D activities in the UKand the economy will lose out as a result.
With the effective rate below the noise level, there is also concern that larger companies will simply not see the eligibility of R&D activity within their IT divisions.
Consider, for example, a large retail enterprise investing in space-management software or trialling radio frequency identification tags. All of this work will fall within the IT budget and some of this work will definitely qualify for the R&D tax credit scheme. Other examples in IT could include proprietary trading platforms within the financial services industry, or model offices which would be used to conduct feasibility studies for new in-house IT systems for most industry sectors.
This aspect of R&D has not registered with enough large businesses. A study by the Department of Trade & Industry has suggested that 60% of the large company tax credit goes to only 16 companies in the pharmaceutical and aerospace industries, where their R&D budgets are fundamental, and visible, engines of the business.
Many companies which believe they do not invest in R&D should review their activity within their IT departments. Millions of pounds are being spent on R&D, particularly in the services industry. However, most companies perceive this to be incidental to their IT budgets and do not consider it within the context of the R&D tax credits scheme.
The government has indicated that it is reluctant to increase the absolute rate of the R&D scheme as the benefits are concentrated on such a narrow industrial and company base.
Once large companies across all sectors understand that their IT division is a source of eligible R&D, the impact of the scheme will increase. This in turn will focus attention on the level of the effective recovery rate.
Larger companies must change their perception of the IT division and begin to recognise its value as a source of immensely valuable R&D innovation.
Peter Denison-Pender is senior principal at technology merchant bank Interregnum and a member of Intellect's R&D tax credits committee
This was first published in May 2004