Tackling the UK's research lag

Research is crucial for drugs companies

The UK is falling behind the rest of the world in terms of research and development.

Pressure is now growing on Chancellor Gordon Brown to make it cheaper for companies to do their research in the UK - and he may well take action in the 7 March Budget.

Spending on research and development may be growing in the UK, argues the Confederation of British Industry, but not as fast as elsewhere.

The Institute of Fiscal Studies even argues that total R&D spending as a percentage of GDP has been falling or static since the 1980s, in sharp contrast to other countries, where more government incentives exist.

Fear exists that multi-national companies may increasingly relocate their R&D activities in countries with more favourable tax treatment.

But giving tax incentives for research and development may not be cheap.

PriceWaterhouseCoopers estimates full tax relief on R&D could cost the chancellor £1.5bn per year.

What already exists

Gordon Brown has already gone some way to giving companies help with R&D spending.

Some companies could move their research and development abroad

Last year, the government introduced a tax credit for small and medium sized companies.

And he has already hinted that this will be extended to larger companies.

On 26 February, he said he will offer a tax credit for companies which do research into drugs for diseases in developing countries.

The move has been welcomed by drugs companies.

"Tax credits for research will allow Glaxo SmithKline to allocate resources to more new projects.

"In particular, this initiative could go a long way to pushing forward further research and development into vaccines for those infectious diseases that cause millions of deaths each year," Glaxo SmithKline's Jean-Pierre Garnier said.

Political logic

The political logic for making a move now is clear.

The research industry in the UK is already feeling pressured by the activists that targeted Huntingdon Life Sciences.

For the pharmaceuticals industry, the future can depend on the fruits of labour-intensive research.

An estimated 40% of the research and development carried out in the UK is in the pharmaceutical sector.

Globalisation in the sector in recent years has meant that many of these companies have subsidiaries or sister companies in other countries - where there are better tax breaks for research and development.

Business groups, such as the CBI and the Engineering Employers' Federation, believe that unless the chancellor acts now, the risk exists that companies will relocate their research and development facilities overseas.

"They have manufacturing bases all over the world. You may find that another country might be more friendly to you in terms of doing R and D. If the skills are transferable, the infrastructure as good as in the UK, you have to look at the bottom line," the CBI's senior policy advisor Tim Bradshaw said.

EEF director general Martin Temple said:"We are concerned that a failure to act would significantly hinder our efforts to close the productivity gap."

Logistics of a tax

But extending the tax credit to include larger companies is not as straightforward as it may first appear.

Animal rights activists have targeted Huntingdon Life Sciences

Fear exists that it could breach European state aid rules.

This increases the chances that the chancellor will announce a consultation period first.

The EEF - one of the strongest advocates of the tax credit - believes it will not breach EU rules.

"Our strong view is that this does not break the rules, and the chancellor should go ahead with it," the EEF's Martin Temple said.

The EEF also believes that in the long-run the chancellor will gain, not lose money by encouraging R&D.

The EEF argues that the government could actually make £240m a year.

Most of the expense of research and development is staff costs, which should in any case generate additional tax and national insurance revenues for the government anyway.

The EEF estimates that a 50% incremental tax credit could benefit large firms by £225m in one year.

Targeting issue

Targeting the tax credit at the right companies may also be difficult.

The tax credit typically favours pure research, and the CBI argues that - as well as widening it to cover large companies - it should be widened to "include the more commercial aspects of development".

The IFS also points to the fact that "large firms incorporated in the UK appear to undertake an increasing share of their research and development spending abroad - usually in the US or Europe - so targeting these companies would involve providing tax credits for research and development undertaken overseas."

In reverse, a significant amount of R&D undertaken within the UK is carried out by foreign firms with large UK subsidiaries.

And many other factors affect company decisions to locate R&D in the UK - such as a large university research base and a favourable rate of corporation tax - which a tax credit would not change.

One way to limit the cost would be to introduce a tax credit just on the additional, extra R&D spending that they undertake.

But perversely, the introduction of such an incremental tax credit - rewarding companies for the fresh research they take on - may encourage companies to keep their base level of research low.