Has the ticking non-compliance time bomb in R&D incentives gone off?

Investment in innovation is front and centre of the UK's industrial strategy. The research and development (R&D) tax relief regime is key in ensuring that national spending on R&D meets the government's target of 2.4% of GDP, enabling the UK to be a world-wide leader of innovation. Historically, potential claimants were encouraged to utilise the regime and HMRC arguably applied a relatively light-touch approach to compliance. The growth in take-up of the regime was once taken as a positive indicator that it was working as intended. However, over time the perceived paucity of checks and balances gave rise to concerns that the regime could be open to abuse.

Why are stakeholders concerned with the regime?

Up until a few months ago, HMRC estimated that fraud and error in R&D claims accounted for 3.6% of total claim value for the 2020-21 tax year. This equates to a loss to the exchequer of £336m. More recent updated analysis indicates that the actual figures are significantly higher. A sample of 500 claims relating to the same period showed that the level of non-compliance was 24.4% for the small and medium-sized enterprise (SME) regime and 3.6% for the large company R&D expenditure credit (RDEC) regime. If replicated across the total population of R&D claims, this would equate to £1.13bn of total claim value.

HMRC has since commented further on these figures, estimating that 50% of claims included errors, rising to an astonishing 75% for the lowest value claims.

These startling statistics have added to the growing pressure from government and the media for HMRC to act and regain control over the cost to the exchequer.

How has fraud and error impacted HMRC’s approach to claimants?

To combat the level of fraud and error, HMRC has dramatically changed its approach to enquiries and penalties. It has doubled its R&D team with over 300 additional inspectors focussing on non-compliance. It is adopting a ‘volume compliance’ approach to review the increasing number of claims, resulting in controversial enquiries and claim rejections which are occurring at a significantly higher rate than ever before, even for those who have made claims for many years.

In the adviser community, there is a growing feeling that HMRC is at best taking an extremely inflexible approach to applying the rules and at worst adopting incorrect interpretations of the legislation and guidelines.

Enquiries are more aggressive and adversarial than ever before. Many enquiries resulting in swift conclusions that are rarely in the taxpayer’s favour and the subsequent pursuit of the maximum possible penalties. This is leaving companies feeling the pain of large repayments or additional payments to HMRC.

The underlying concern is that, whilst this approach catches some of the incorrect claims and helps identify some of the ‘bad actors’ amongst R&D advisers, genuine claimants are suffering significant collateral damage. Many stakeholders have highlighted this, including professional bodies such as the Institute of Chartered Accountants of England and Wales (ICAEW) and the Chartered Institute of Taxation (CIOT). It appears to be a price that HMRC is willing for good claimants to pay in order to get the regime under control.

What are the new compliance requirements and how are they impacting claimants?

To mitigate against incorrect claims, on 8 August 2023 HMRC introduced a new online R&D claim submission portal to facilitate the provision of an additional information form (AIF). The AIF establishes minimum obligations for supporting information, introducing mandatory provision of technical narratives for specific projects and formalising the process for gathering financial information. Additionally, to clearly designate responsibility for the claim, the identity of both the agent and the responsible senior person in the company must be provided.

Despite significant noise in the specialist R&D agent community, many claimant companies were seemingly unaware of the changes. 50% of claims made in the first month following the introduction of the new requirements were rejected due to the lack of an AIF. More must be done by HMRC and responsible agents to ensure that claimant companies are kept up to speed with the ever-changing regime.

What steps can claimant companies take to mitigate risk?

1. Review claim process:  All claimant companies will need to update their claim process to meet HMRC’s new requirements and should consider asking for support from trusted agents.
2. Re-assess the risk-level of claims: Companies should consider how risky their claim really is. HMRC increasingly holds the directors responsible.
3. Get trustworthy support for enquiries: Companies should consider how experienced the team dealing with the enquiry is, as the rejection of a claim and associated penalty won’t just impact the current period but will make future claims much more difficult.

We are entering a new era within the R&D regime. There has been a dramatic change in what is required to submit a successful R&D claim and HMRC’s approach to ensuring compliance. The days of ‘risk-free money’ with no documentation and little responsibility are, rightly, gone. Claimant companies should make sure they are getting the support required to make accurate, ethical, sustainable claims, or the consequences could be severe.

If you have any questions regarding R&D incentives, please contact Constantine Costas or your usual RSM contact.