HMRC estimates error and fraud accounts for over £1bn of R&D claims.
Earlier this year, on 17th July, the day before new draft R&D legislation was published, HMRC released updated statistics on the level of non-compliance they have identified in research and development tax claims. Based on their findings, HMRC’s analysis stated that ‘the overall level of error and fraud for both reliefs (SME and RDEC( for 2020-21 is 16.7% (£1.13bn), which is significantly higher than the previously published estimate of 3.6% for 2020-21’.
The majority of this ‘non-compliance’ was found to be in the SME scheme, where error and fraud for 2020-21 was estimated as 24.4%. While in the RDEC incentives an estimated, much-lower, figure of 3.6% of claims were deemed to consist of error and fraud. This seems alarming. Why were the levels of non-compliance for the companies claiming SME incentives so much higher than in Large Companies?
This figure of 24.4% error in the SME incentives was based on a ‘different methodology’ for assessing non-compliance and, as such, it does not mean that the rate of non-compliance has risen. The figure is based on what HMRC have called a ‘new, more accurate methodology for measuring non-compliance’.
Some context surrounding the statistics
During the Autumn Statement in 2022, it was announced that on 1st April 2023 the RDEC rate will be increased to 20% from 13%, the SME deduction rate will be reduced to 86% from 130%, and the SME credit rate decreased to 10% from 14.5%.
Around this time, Jeremy Hunt announced his vision for the UK as a ‘silicon valley’ of innovative businesses in the coming years. Since then, the government have actively moved towards a single, monolithic R&D scheme for all claimant companies – regardless of their size. And various incremental changes to R&D tax-credits have accompanied this move towards a single scheme which more closely resembles the RDEC incentive for large companies. These large companies are likely to be most resilient in times of economic downturn; and prioritising incentives and relief-rates which favour businesses who already operate at a larger scale necessarily leaves many smaller – though equally innovative – UK SMEs paying the price.
With the transition to a single scheme which is more generous to Large companies in their sights, HMRC introduced a ‘mandatory random enquiry programme (MREP)’ for SMEs claiming under the SME or RDEC. The MREP is the basis for these figures of ‘error and fraud’. This new measure involved taking a random sample of claims to more accurately estimate levels of non-compliance. Crucially however, Large Business customers claiming RDEC were not included in this sample.
The figures and HMRC’s analysis
HMRC have said, so far in 2022-23, claims are ‘determined to be inaccurate in 84% of closed 1-2-1 enquiry cases in the SME R&D scheme. Of those R&D claims challenged and closed in 2022-23, the average additional amount due as a result of the inaccurate claim is £128,000.’
Furthermore, according to HMRC:
- Analysis of the claims examined as part of the MREP shows that a quarter (25%) of claims were fully disallowed as no qualifying R&D activity took place, although HMRC had no specific indication that the claimants were attempting to commit fraud.
- In 19% of cases, qualifying R&D activity was being undertaken, but businesses had overclaimed the relief. In these cases, some of the claim was agreed. Again, HMRC had no indication that these claimants were attempting to commit fraud.
- In 2% of the cases, there was an attempt to make a genuine claim, but there was a technical misinterpretation of the R&D legislation.
- In claims where expenditure was over £1 million, around 75% of claims were fully compliant. In smaller claims the percentage of claims being fully compliant was lower, at between 35% and 64%.
- As the size of expenditure decreases, the value of non-compliance expressed as a percentage of the value of the claim increases. In the smallest claims where expenditure was less than £10,000, over 75% of the value of the claim was non-compliant.
A closer look at the figures
In many ways, HMRC’s statistics show that they have found what they wanted to find. According to HMRC’s statistics, in claims whose R&D expenditure equated to <£10,000 (relatively low-value), only 47% of the MREP sample were found to be compliant; 27% were found to be partially non-compliant; and a further 27% were found to be wholly non-compliant. This led to HMRC’s estimated percentage of non-compliant claim-value of 78%.
As our own experience shows, there are businesses with legitimate R&D claims – businesses who have acted honestly and in the spirit that the incentives were designed to support – have had their claims rejected in their entirety by HMRC caseworkers. Where the onus is on the taxpayer to alleviate the burden of proof in support of their R&D claims – including records for its quantum of eligible expenditure – many of these companies do not have the time or resources to continue the prolonged discourse with HMRC that is usually required to resolve a compliance check.
The other problem is one of under-trained caseworkers at HMRC making decisions about a company’s R&D project. And this issue was also discussed at an HMRC consultation where Victoria Atkins MP (Financial Secretary to the Treasury) stated that the specialist R&D team focused on SME compliance ‘had more than doubled in recent years in response to the growing levels of error and fraud’. And that this ‘was part of a wider team of 245 full time equivalent staff of all grades working across a range of incentives and reliefs.’
The bigger picture: HMRC and the House of Lords
When asked during a recent consultation if she was satisfied that HMRC is dedicating the right amount of compliance resource to R&D claims, Victoria Atkins said: “At the moment, yes … At the moment we have enough.” But many R&D tax specialists have raised concerns about whether HMRC’s R&D team had a sufficiently well trained and experienced specialist resource that was required.
Following a debate in the House of Lords it was agreed that ‘the Government needs to take control of the narrative of what qualifies as eligible R&D’. The House recommended that, as a minimum, HMRC and BEIS work together on a new awareness campaign aimed at providing SMEs with accurate information about what is, and as importantly, what is not R&D.
While all reputable advisers will be in favour of increased efforts from HMRC to reduce abuse of the R&D tax incentives (something we agree is important if the incentives are to continue to thrive), these operational changes – especially the ‘300 new R&D staff and helping businesses get their claims right first time’ – appear to be failing many SMEs who have made accurate claims in good faith.
While these counter-measures are well intended, in our experience, the compliance checks which are run by HMRC’s newly-created ‘R&D compliance team’ vary wildly in the quality of their checks in terms of thoroughness and accuracy. Companies are likely to receive letters littered with errors, half-finished sentences, or questions and comments which hardly appear to have acknowledge the information that a company will have already provided. Worse still, crucial passages of legislation are often misquoted or misinterpreted.
HMRC makes important distinctions around types of non-compliance: to be classified as fraud, a caseworker needs to have determined that a claimant company deliberately ‘set out to misrepresent their circumstances to get money to which they were not entitled’. HMRC’s use of the term ‘non-compliance’ encapsulates the full range of behaviours from being careless in your claim preparation, to making an honest mistake, all the way through to deliberate non-compliance.
Following the House of Lords consultation, there was concern ‘about the evidence […] that suggested HMRC staff dealing with R&D claims are not sufficiently knowledgeable to assess what qualifies as R&D, and are therefore not well equipped to help claimants in this respect’. The House recommended that HMRC and BEIS (who issue the guidelines for R&D tax credits) work together to improve its access to scientific and technological expertise when assessing whether a particular activity represents an advance in science or technology.