The Importance of Innovation Funding in the Construction Sector

Posted by Construction Industry News Magazine on 21st June 2023 -

The UK’s construction industry is critical to the country’s economic growth and here David Byrne, Director at R&D tax specialist, ForrestBrown, underlines the importance of funding innovation/R&D for the sector’s long-term prospects, even in the face of various challenges.

In 2022 alone, the size of the UK construction sector was valued at over £365bn and it is a central piece of the government’s plan to build back better. But alongside helping to drive the economy forward, the government also wants the industry to build back greener as part of the country’s pathway towards net zero.

Doing so will require a great deal of innovation to develop more sustainable methods of building new homes, roads, railways, and other infrastructure. In its recent construction playbook, which acts as a guide to best practice in publicly funded construction projects, the government highlighted the importance of driving reforms in the industry, particularly around sustainability, digitisation, and modern methods of construction.

However, today construction firms are facing a host of challenges, from disrupted supply chains to labour and material shortages impacting profitability. To encourage these firms to continue innovating, getting incentive and relief mechanisms right, including R&D tax relief, will be paramount.

Supply chain issues and inflation create cost pressures

Brexit, the Covid-19 pandemic, and now higher inflation have all caused sustained disruption to the construction industry. From major material and labour shortages to rising material costs, these challenges create further setbacks to construction programmes and lead to higher costs from sub-contractors. Purse strings have certainly been tightened, and firms must make the most of government support mechanisms to maintain healthy cash flows.

Firms investing in construction projects and innovating new construction methods to meet the aspirations of the construction playbook must utilise the range of government incentives available, such as grants, Patent Box and R&D tax relief to maximise their returns on investment. Yet, the industry has perceived hurdles associated with these schemes, particularly concerning R&D tax relief, which has made claiming these benefits more challenging. 

Compliance clampdown has mixed impact 

In the recent Spring Budget, the Chancellor referenced an increase in the abuse of R&D tax relief claims, which has led to HMRC’s increased focus on compliance. The recent rebalancing of rates between the incentives for SMEs and larger companies (the Research and Development Expenditure Credit) was in part driven by a desire to address abuse of the SME scheme where HMRC believes error and fraud to be more prevalent. However, there is a danger that some businesses claiming legitimately could face becoming collateral damage – either through a reduction in benefits received as a result of the rate changes, or by being discouraged from claiming at all because of HMRC’s approach.

Error, fraud, and abuse are different types of behaviours which require action by HMRC, yet the level of transparency regarding how these cases are being investigated remains vague. In 2022, HMRC’s Fraud Investigation Service sent a number of letters to businesses they suspected of claiming R&D tax relief fraudulently, deleting claims where companies offered no further information to support the claim. Although there have been high profile cases of criminal activity in this area resulting in prison sentences, this action fell short of any form of real investigation.

Such an approach risks not only allowing those who are abusing the system to escape punishment, it also potentially disincentivises those businesses that have legitimately sought relief but found themselves accused of committing fraud. While awareness of HMRC compliance activity has increased, there is uncertainty regarding how it is being targeted and whether it is resulting in legitimate R&D claims being denied. This uncertainty inevitably leads to some firms becoming wary of claiming the benefits they are entitled to, and potentially discouraging further innovation.

Uncertainty over the future design of R&D tax reliefs

The government has consulted on combining its Research and Development Expenditure Credit and SME schemes into one single R&D tax relief scheme, potentially locking in the recently rebalanced rates. For SMEs investing heavily in innovation, relief can be crucial to managing cash flow. Reduced generosity and ongoing uncertainty regarding future changes to the structure create extra administrative work for companies already working to tight deadlines.

In the consultation for a merged scheme, there is particular concern in the construction sector around rules for including third party costs.  In an industry dependent on third party organisations and where firms often involve multiple contractors and subcontractors in projects, deciding which entity should claim relief and on what expenditure is often complex. Further changes to the rules, if not properly and clearly implemented, will require more onerous coordination between stakeholders, adding to the administrative burden of claiming relief on projects.

In addition, HMRC has not taken action to resolve uncertainty resulting from its position on the issue of subsidised R&D, despite being overturned in the tribunal and multiple stakeholders calling for a resolution. ForrestBrown helped our client, Quinn (London) Limited, secure victory in a first-tier tax tribunal case on this issue in 2021, where the judgement called out HMRC’s interpretation as   “wholly out of kilter” with the commercial reality of the construction sector.

These hurdles in claiming tax relief for R&D projects, coupled with rising cost pressures and supply chain challenges, have created much uncertainty within the industry. While the construction playbook is a positive starting point to reform and modernise the sector, there is a clear frustration in the industry that not enough is being done to support firms working towards the shared aims established in this guide. Many construction firms are concerned as to how their already tight overheads can accommodate these changes.

Moving forward, the government must seek to align the R&D tax relief scheme with its aspirations set out in the construction playbook. In the first instance, this could involve better regulating the marketplace for professional tax advisers to directly address errors and abuse, rather than stifling innovation by reducing generosity for SMEs and increasing the administrative burden for firms that are already stretched, or by simply denying claims on grounds that make no sense in a commercial context. A longer term strategic roadmap for R&D tax incentives would provide construction sector businesses with the confidence they are seeking to make the commitments the government is calling for into innovative approaches to solving the big challenges ahead.

If we can simplify this pathway for construction firms and remove these hurdles, that will incentivise all important innovation, which will help the sector to continue to play its important role in driving economic growth, while building a more sustainable industry for the future.

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