Here at Advocate Commercial Debt Recovery, we recently came across a client bamboozled as to why HMRC was trying to reclaim £65k of Research & Development Tax Relief. Fearing debt collectors and bailiffs would soon take up residence in the laboratory foyer; they were understandably anxious. Unfortunately, this client is not alone in staring down the barrel of insolvency purely because HMRC had a change of heart. In this article, we explore why some British businesses are being asked to hand back Tax Relief to HMRC.
What is Research & Development Tax Relief?
Research & Development Tax Relief (R&D Relief) was launched by the government in 2000 to encourage scientific and technological innovation. Claimants can recover a percentage of their R&D expenditure from HMRC. R&D Relief was originally split into separate schemes – the SME scheme catering for Small and Medium Sized Enterprises, and the Research and Development Expenditure Credit (RDEC) scheme designed for larger businesses. As of 1 April 2024, both were merged. For profitable companies, a tax credit is given and offset against corporation tax. For loss-making companies, the credit can either be offset against other liabilities or received as a cash payment. R&D Relief can be claimed on staff costs and consumables (including prototypes). Regulatory and reverse engineering costs cannot be claimed as the relief is only applicable to research and development expenditure. Not all R&D projects are successful, and that is a key distinction between innovation and product development. It is about creating something new, not replicating existing knowledge. The arts, humanities, and social sciences (including economics) fall outside of scope for R&D Relief.
Proving Grounds
To receive R&D Relief the claimant must first put a case to HMRC. They need to explain why the project is innovative, detail the challenges, prove that success is not guaranteed, target an advancement in a specific field, and show that it goes beyond standardised industry knowledge and expertise. R&D is fundamentally about learning through trial and error – just ask SpaceX, who spend billions on R&D yet still manage to become the butt of memes when a test rocket goes boom for all the wrong reasons!
R&D by Numbers
The number and value of claims have been steadily rising since 2015. For the year to April 2022, HMRC estimated £7.6bn was paid out in R&D Relief. This was an increase of 11% on the previous year with over 101,400 firms making use of SME or RDEC schemes. The manufacturing, information and communication sectors account for 46% of all claims. There are, of course, regional variations. London is home to 22% of claimants who, between them, received 32% of the money paid out. Businesses registered in Northern Ireland and Wales submitted the fewest claims. The average SME claim value was £60.1k, with RDEC businesses averaging £252k. The survival of a start-up can literally depend on receiving an R&D payment to sure up cash flow. R&D Relief can also be make or break when persuading angel investors to get on board.
Finding Fraud
No matter how securely state benefits and subsidies are handed out, there will always be individuals gaming the system to receive more than they otherwise should. The same is true for R&D Relief, which suffers from three types of fraud. The first is shell companies being set up to claim relief on non-existent R&D projects. The directors simply pocket the money and run. Secondly, a sham subsidiary is set up by an overseas business to claim R&D Relief despite the parent company having no presence or intention of trading in the UK. The third type of fraud is claiming with an intent to receive relief for a non-qualifying project. Fraudsters bank on HMRC being blind to the deception or vanishing before justice can be served.
HMRC were losing over £1bn a year to R&D Relief fraud. This prompted them to establish the Research and Development Anti Abuse Unit (RDAAU) in 2022. RDAAU operate as a specialist team inside HMRC’s prestigious Fraud Investigations Service and is behind the increase in companies being asked to hand back their R&D Relief. To deter fraudsters, HMRC now only accept claims submitted online. They have also increased the amount of information required in a bid to highlight suspicious claims. Successive government budgets have seen R&D Relief rates reduced to further discourage fraudsters and limit HMRC’s losses.
What a Mistake-a-to-make-a
Determining if the claimant intended to deceive or made an honest mistake will ultimately dictate whether they receive the softer hand of reprimand from HMRC or, on the other hand, throwing the book. Cases have come to light where the claimants have been misinformed, ill-advised, or just made a mistake.
One restaurant attempted to claim R&D Relief for cinnamon croissants – tasty, yes, but definitely not a scientific or technological innovation!
R&D claims take 40-60 days to process and longer if there are irregularities or queries. Since 2019, over 430,000 R&D Relief claims have been paid out. Even with a fully resourced RDAAU, the sheer number of claims means HMRC are trying to claw back funds years after they signed off on them. In the modern world it seems untenable that two HMRC experts can give different determinations when presented with the same facts. HMRC are in a privileged position where they can get it wrong, backtrack and collect a debt on the basis they did not follow their own rule book. Businesses in the same position have little option but to take the hit.
Feeling Blue
Ocushield is one of thousands of British firms who are having to demonstrate why HMRC was correct in awarding R&D Relief. The optometrist received £49k for the development of a portable daylight device that filters out shorter wavelength blue light. HMRC now sight that similar products already exist. It appears rivals caught and passed the innovative optometrists in the R&D phase, resulting in someone else being first to market. The case is now proceeding to the Tribunal and will set a precedent for firms in a similar position. It raises the question of whether R&D Relief can only be claimed by the project first to market. If so, that would discourage the scientific and technological race R&D Relief is supposed to sponsor.
The Business of Persuasion
Submitting an R&D claim is a time-consuming and even daunting process. Claims can be submitted through self-service, an accountancy practice offering R&D claims, or via a specialist R&D agency. When HMRC tries to claw back relief obtained via a third party, the waters inevitably muddy where one side claims the other misinformed them. Unlike accountants, R&D agencies operate in an unregulated landscape, so there is no barrier to entry for rogue operators. The RDAAU are actively trying to identify and stop agents with a history of submitting spurious claims. If in doubt, tax matters are best left to the experts, but it is equally important to ensure they are as competent as they claim to be. A valid ICAEW or CTA qualification can give reassurance the agent is at least familiar with making high-level financial judgments. At Advocate, we work with several R&D agencies who openly offer up their qualifications on a platter for inspection.
The cornerstone of obtaining and retaining R&D Relief remains to prove scientific or technological innovation. However, there is no clear definition of what constitutes R&D innovation. In short, it is open to interpretation and down to convincing the reader that cinnamon croissants are indeed an innovation!