Is it time for R&D tax reliefs to be overhauled?

The UK is home to a resilient technology industry, remaining a global leader despite economic uncertainty. There is optimism among our 300 business leaders, but many would have been hoping for more to come out of the Autumn Budget. In particular, 44% of our survey respondents wanted to see more changes to innovation tax reliefs to provide greater levels of funding for UK technology companies. 

The government-backed innovation tax reliefs scheme, including creative tax reliefs, patent box, and research and development (R&D) reliefs, offers substantial cash savings for UK businesses and helps drive further innovation. However, recent changes to these schemes have created uncertainty, making long-term investment decisions challenging for businesses. With HMRC’s increased focus on tackling non-compliance, questions are raised around the impact of these measures on legitimate claims. The stringent compliance checks, while effective in reducing fraud and aiming to maintain the integrity of the scheme, may inadvertently discourage genuine claims.

Are technology businesses benefitting from the current R&D regime?

Only 50% made an R&D claim, with 2% not making any claims at all. Given that the sample included software and AI businesses, we would expect the number of claimants to be higher. It therefore raises the question of whether businesses are missing out on some of the money that could be available to them or whether the complexity of the scheme and increased scrutiny have acted as a deterrent.

Against a backdrop where business leaders were optimistic for improvements to the scheme, but no major changes were made, there is also an increasing reliance on the R&D regime. It is set to become ever more important for unlocking vital funding, with Innovate UK grants being harder to access than they were previously. 

Businesses would have been hoping the Labour government would have done more to emphasise funding and focus on driving growth, but there has not been that commitment yet. Hopefully more announcements will come further down the line, which the government has alluded to. Time will tell whether additional investment plans are shared once the logic behind the funding is finalised, or if this is more of a trend. 

SME’s facing more challenges and tech companies experiencing lengthy delays

We found that 40% out of the 300 respondents have submitted a claim that is still pending, with 37% having had their claims challenged and declined by HMRC. 

For accounting periods starting on or after 1 April 2024, the RDEC and SME tax credit schemes merged, aiming to simplify the regime. However, the inclusion of an “intensive regime” reintroduces some of the complexity policy makers said they were keen to remove. The new regime's 15% benefit rate makes the UK less competitive compared to France and Ireland, which both offer a 30% rate. For the UK to remain a leading place for technology businesses to call home, it is essential that more is done to support innovative, scaling businesses. 

This also means the smallest companies are facing an increasing number of challenges. HMRC claims that up to 20% of companies will be challenged each year. We found that for businesses with a turnover between £2m - £49.99m, 44% of claims were declined, with a further 32% of respondents having claims approved before they were retrospectively challenged, resulting in repayment. Anecdotally, we are speaking to companies with valid expenditure that are choosing not to claim due to the potential costs involved in defending claims through enquiries, and the amount of time they can take to resolve. Some companies have even raised the prospect of moving their development work out of the UK altogether!

The statistics published by HMRC highlight the (original) urgent need to address non-compliance in R&D tax relief claims, with an estimated error and fraud rate for R&D tax credits in 2021/22 being 17.6% overall, and an alarming 25.8% among claims by small and medium-sized enterprises (SMEs).

For larger businesses with a turnover from £50m to £500m, we found that 36% had a claim challenged and declined, and 32% had their claim originally approved before being challenged, resulting in repayment. Although smaller companies appear to be under increased scrutiny, larger companies can still be challenged. 

The emphasis on smaller companies aligns with HMRC’s analysis, which found it was generally the smaller companies’ claims that tended to include more fraud and error. However, large companies’ claims will not avoid a similar level of scrutiny over the next few years. HMRC needs to gain comfort that the regime is being used correctly by all companies and the only way to achieve this is through the detailed review process many smaller businesses are currently subject to.

For tech start-ups and new businesses in the space, this increased scrutiny means businesses must expect to be challenged on claims early on. Ultimately, while the drive to tackle non-compliance is essential (and supported), it must be balanced with fair and transparent practices that support legitimate claims. The integrity of the data and the methodologies employed by HMRC need careful examination to ensure that they do not inadvertently hinder the very innovation that R&D tax reliefs are designed to foster.