A Spoonful of Sugar - Shraddha Sisodia, R&D Tax Consultant at Ayming UK

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Many drinks companies will be forced to change their products in response to the Chancellor’s new sugar tax. Shraddha Sisodia, R&D Tax Consultant at Ayming UK explores why this is such a tricky undertaking, and how manufacturers will need to make full use of R&D tax reliefs in order to offset the investment costs.

One of the standout features of George Osborne’s recent budget was the somewhat controversial announcement of an incoming sugar tax on soft drinks. Having been a bee in the bonnet of youth health campaigners for some time, the new levy is squarely aimed at the high-sugar, fizzy drinks that tend to be popular with teenagers, and will come into effect in 2018.


While the precise details have yet to be determined, we know the tax will have two levels: a lower band for drinks with sugar content above 5g per 100 millilitres, and a higher one for those with more than 8g per 100 millilitres. Analysis from the Office of Budget Responsibility suggests these two levies will be 18p and 24p per litre respectively.


Although the soft drinks industry has been reducing the sugar content of its drinks for some time, this still presents manufacturers with quite the dilemma. Do manufacturers simply continue on as before, either passing the levy onto customers or taking the hit themselves – or do they try to innovate and bring their products under one or both of the thresholds? Given the highly competitive and low-margin nature of the market, the former option may not be feasible for most.


But the innovation route is no easy path either. This is not the first time the food and beverage sector has found itself at such a crossroads. Previous clampdowns on salt content forced a similar wave of innovation. The lesson from that episode, was that tweaking a product to meet external requirements while maintaining brand consistency as far as possible, is a difficult undertaking – requiring substantial time, thought and effort.


It’s a double-bind: the trick is to make the changes while keeping things as similar, and familiar, as possible. Consumers are creatures of habit, and psychologically extremely fickle and sensitive when it comes to the slightest changes to their favourite products. This especially applies to familiar food and drink products, which many customers will have consumed day in, day out, for much of their lives. The smallest discrepancy can make a big dent in sales and reputation.


The most obvious point here is the taste of the drink – the high sugar content of many fizzy drinks on the market today goes a long way to defining their taste and flavour. Any classic Coke fans who have had to switch to diet as part of their own diet will be able to attest to this. Trying to achieve the same taste with sugar substitutes – or more natural alternatives such as honey and nectar – can create plenty of issues. Sprite’s decision to use ‘Stevia’ (a synthetic sugar alternative) in its drinks is a case in point here.   Stevia tastes very similar to sugar, but not quite the same, and consumers can tell the difference: sales of Stevia-based Sprite crashed 9.4 per cent in the year following the ingredient change.


But the difficulty goes well beyond just the issue of ‘objective’ taste or the ingredients list. The branding and overall ‘look and feel’ of the drink can make a huge difference to our sensation of taste; the psychology at play is complex. The infamous Coke/Pepsi blind test trials are testament to this – many people prefer the taste of Pepsi when the brand is hidden, but find Coke ‘tastes better’ once the brand is known. Pepsi may continually use this in the advertising, but it still hurts them. This effect can extend to features that should intuitively have nothing to do with taste, such as colour and packaging. Witness the introduction (and swift withdrawal) of ‘green ketchup’ in the early 2000s, or the fact that people will regularly attest that the same drink tastes better from a glass bottle than a tin can.


So, tweaking a drinks product without hurting brand loyalty is a potential minefield. But there are broader manufacturing issues here too. Companies cannot afford to shut down existing production lines while they undergo the process of testing new recipes. This means installing a second line in the meantime. This will require investment, but it also makes for a quality control issue. Even where the equipment being used is technically identical, new equipment will often make a big difference to the taste of the end product.


All of this amounts to a prolonged and thorny ‘trial and error’ period for drinks companies looking to innovate their way around this problem. The first new recipe is unlikely to work, and what works in the kitchen may not work in the factory. So while 2018 may seem like a long way off, the timing is actually fairly tight; the required technical processes will likely take anywhere from 6 to 18 months, or perhaps even longer.   The fact that the food and beverage sector is one of the most secretive industries out there with regard to methods and recipes, will only elongate the process.


Innovation will therefore mean major investment – new lines, new teams of consultants brought in to help existing specialists, branding, testing, packaging costs, and so on. However, what many drinks manufacturers don’t fully appreciate is that this investment needn’t represent a 100% loss. Much of this innovation can be claimed for under the UK Government’s Research & Development tax schemes.


What is particularly important for businesses is being aware of exactly what constitutes R&D in the eyes of HMRC. In this instance, research into new sugar substitutes and recipes is relatively obvious. However, its scope also reaches far beyond this, to efforts we less readily associate with ‘innovation’.  For example, on the manufacturing side, the costs of activities such as trying different production methodologies, through to the design and development of equipment can be claimed for under the R&D tax credits schemes. Similarly, developments to do with packaging, and advances in logistics and delivery for instance, can also be eligible. Even something as seemingly peripheral as new software to help machines and systems ‘talk to each other’ more efficiently, can count too. And let’s not forget that time and money spent on ‘failed’ projects can be potentially eligible as well.


For many drinks companies the next two years will be a period of intense innovation. For commercial reasons, many will have no choice but to embark on a substantial and involved period of product experimentation in order to reduce the sugar content of their products, without reducing their profits. The least they can do to offset these necessary costs, is ensure they receive the tax breaks they are entitled to, in full.