More than twenty years ago, in the heady days of Cool Britannia, Chancellor Gordon Brown introduced research & development (R&D) tax credits to encourage innovative technological research and improve Britain’s global competitiveness. Over the next two decades, this expanded into two R&D schemes, one for larger businesses, one for SMEs.
An investigation by The Times in autumn 2022 sparked significant interest, highlighting long-held concerns about abuse of the schemes by criminals, unregulated advisers and those willing to test the boundaries of the schemes. In 2010, R&D relief totalled around £1billion per annum but by March 2020, this had increased to £7.4billion, with around 85,900 claims for relief being made annually. The inflation in potentially unmeritorious tax claims has become harder for HMRC to ignore.
HMRC has been unable to estimate the scale of losses from R&D claims which should not have been paid and this has resulted in a worrying level of uncertainty in HMRC’s balance sheet. The doubts over R&D losses means that the National Audit Office has been unable to sign off HMRC’s own accounts for the past three years!
The key weak spot has been HMRC’s oversight of claims, particularly from SMEs. The particular lure of the SME scheme is that, where R&D credits exceed corporation tax, HMRC can make cash payments to the company. The large volume of SME claims at an individually low value means many do not trigger red flags within HMRC. According to HMRC, around 60,000 claims each year are below £50,000.
HMRC is now making a determined effort to tackle the criminal fraudsters making multiple smaller claims. In October 2022, HMRC raids resulted in the arrests of 8 people (including a tax agent) for alleged organised criminal activity connected with over 100 claims for tax relief, collectively exceeding £16million.
Aside from organised criminals, HMRC is taking action against advisers and companies who HMRC consider to be inappropriately pushing the boundaries of R&D claims. The Times investigation gathered evidence of a raft of R&D tax credit advisers advertising their skills in assisting companies to claim R&D relief. Some advertised that HMRC checked only 0.2% of claims. The apparent strategy was to find a ‘hook’ that could be described as a ‘development’, allocate spend to developing it and submit the claim to HMRC, at a low enough level that it would rarely be checked. ‘Developments’ allegedly accepted by HMRC have included blueberry croissants, pub menu designs and cocktail recipes.
Jeremy Hunt’s November 2022 Autumn Statement confirmed there will be reforms and a significant reduction in benefits available to the SME scheme. Extra checks will be imposed. From April 2023, R&D claimants will need to provide additional information about the nature of the R&D, obtain endorsement from a named senior officer, notify HMRC on the day the R&D activity takes place, and provide details of any advising agent. The last point is clearly intended to assist HMRC in tracking agents who advise on what HMRC view as multiple unmeritorious claims. Being quizzed by the House of Lords Finance Bill Sub-Committee, the Financial Secretary to the Treasury (Victoria Atkins) stated that the Treasury was “very, very concerned” and that, in addition to the reforms announced, the Government would be considering possible regulation of agents.
HMRC revealed that from April to October 2022, more than 1,600 R&D claimants were asked to provide further information to validate their claims and 80% of those were rejected. That rejection rate indicates the potential scale of the problem. Although it may be a blunt instrument, making the SME scheme less attractive by reducing the tax relief available is viewed as a more efficient use of resources than devoting more HMRC personnel to checking individual claims.
HMRC’s harder stance is already being recognised in an M&A context. Over the past 12 months, it has become increasingly common for a target company’s tax affairs to be thoroughly examined as part of the due diligence process. Tax reliefs claimed by the target company, which will include historic R&D claims, are being ‘red flagged’ and addressed before the M&A transaction completes due to the risk of subsequent challenge by HMRC. Buyers are alive to the financial impact and reputational damage that tax challenges can bring.
Inevitably, when there is a renewed focus by HMRC on any tax scheme, or changes introduced to clamp down on what HMRC views as marginal applications, there is a risk of disputes arising between clients and their professional advisers. Where R&D claims have been submitted which could be viewed as ‘pushing the boundaries’, advisers should prepare for HMRC to challenge and possibly reject the claim. Advisers may consider it prudent to update clients about the tightening regime, and to revisit their warnings about the possibility of claims being rejected. Even where claims are entirely proper, clients may not be prepared for HMRC’s extra interest in their affairs and the additional documentation required to substantiate claims, which may cause friction. Advisers onboarding new clients should be alert to previously submitted R&D claims and the potential for challenge by a reinvigorated HMRC.
Publicity about HMRC’s clampdown and criticism of alleged ‘rogue agents’, may discourage advisers from advising companies to apply for R&D credits in genuine cases of innovation, and this could expose advisers to claims they negligently failed to advise on the tax reliefs available. Advisers should ensure they are familiar with the revised scheme and continue to identify and properly advise their SME clients who are entitled to benefit.
Comment
Tax advisers should remember that if they submit a tax claim which they know or believe is incorrect, then they are at risk of the following:
- Criminal facilitation of tax evasion (action against the firm)
- Criminal aiding and abetting tax evasion (action against the individual adviser)
- Their activities may not be covered by their professional indemnity insurance
- Investigation and sanctioning by the Chartered Institute of Taxation/ Institute of Chartered Accountants in England and Wales (ICAEW)
- Breaching the Promotors of Tax Avoidance Scheme (POTAS), resulting in sanctions imposed by HMRC.
