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A Disaster for Innovation – The Research and Development Relief Perfect Storm

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The UK R&D Tax Credit allows companies that undertake innovative activities and qualifying R&D projects to claim corporate tax relief and/or tax credits on qualifying R&D expenditure.

The aim is to encourage innovation in the UK by providing an exemption from qualifying R&D expenditure, effectively reducing the cost of R&D work for eligible businesses. This has enabled businesses to invest in vital R&D aimed at achieving scientific and/or technological progress, often resulting in increased jobs and expertise in the UK. It is recognised globally that without business innovation, economies will not grow, so reducing the R&D tax exemption and discouraging eligible businesses from claiming could leave the UK behind other major global economies.

R&D tax relief has been in place for over 20 years, but in the last two years there have been huge changes, including a significant increase in HMRC enquiries. Over the life of the R&D schemes, the number of companies claiming R&D tax relief has increased significantly, partly because companies and their advisers have become more experienced and skilled at identifying eligible R&D activities, but also because some companies, often misled by rogue R&D advisers, have gone beyond the limits of the legislation, making inflated and fraudulent claims.

Historically, HMRC’s inquiry rate was 1% and the vast majority of R&D claims were dealt with with little or no questions asked. That all changed two years ago with the introduction of HMRC’s R&D Enquiries Team. It was widely accepted in the accounting and tax profession that change was necessary to tackle exaggerated and fraudulent R&D claims, however the consequences of HMRC’s heavy-handed approach to inquiries, combined with changes to legislation that reduced the amount of relief available, have had a disastrous impact on genuine claimants and have the potential to cripple the UK economy and innovation.

The ISBC unit was primarily made up of new, inexperienced R&D staff, and although the inquiry process rightly sought to target companies that were making exaggerated and deceptive claims, HMRC’s approach to the volume of inquiries also targeted genuinely eligible companies, who fell into lengthy inquiries, with HMRC in some cases ignoring evidence and denying companies the opportunity to discuss their R&D claim in person, instead adopting a narrow-minded approach to denying genuinely eligible companies this vital tax relief.

In other HMRC levies, when inquiries are opened, there is usually a HMRC officer/inspector present, which allows for a level of understanding, direct communication and collaboration between taxpayers, advisers and HMRC to ensure the correct amount of tax is paid, enabling fairness and confidence in the inquiry process, in line with the Taxpayers’ Charter. Unfortunately, this is not the case with the ISBC unit where the names of the HMRC officers conducting the inquiries are not provided, reducing accountability and redress where serious errors are made.

Understandably, the accountancy and tax profession and its professional bodies have been extremely angry at HMRC’s failures and the negative consequences this has had on businesses that are already doing qualified R&D. Some businesses have fallen into serious financial difficulty, and many have thrown in the towel, deciding not to challenge HMRC’s decision to reject their claims, because they do not have the resources to fight the power of HMRC. Businesses do have the option of appealing against HMRC’s decisions in a tax tribunal, but doing so is costly and time-consuming and many businesses, particularly start-ups, cannot afford to do so.

It is easy to ignore the significant and cumulative negative impact that underinvestment in innovation by businesses is likely to have on the UK economy in the future. With thousands of legitimate R&D firms subjected to an unfair and unjust investigation process, and the negative consequences this has brought, many have had no choice but to cut back on the resources they spend on innovation or stop innovating altogether. While tax revenues from HMRC rejecting legitimate claims may appear to have increased in the short term, the long-term negative impact on economic growth and associated tax revenues could be devastating, with consequences for all industries and supply chains.

The Chartered Institute of Taxation (CIOT) has written extensive open letters of complaint to HMRC about serious failings in the current R&D investigation process. However, despite HMRC’s acknowledgement of its own lack of training and serious errors, not enough is being done to address HMRC’s failings, or to deal with unscrupulous R&D consultants.

The reduced tax relief available, the increasing costs required to support R&D claims, coupled with the increasing risk that HMRC will refuse to grant R&D tax relief to genuinely eligible businesses, has significantly deterred businesses from investing in innovation, creating a perfect storm and potentially disastrous impact on future growth in the economy.

It is now more important than ever for genuine R&D claimants to ensure they are working with experienced and trustworthy R&D tax advisers. Working with their advisers throughout the year to develop their R&D strategy, understanding the complexities of R&D schemes and the evolving requirements and capturing evidence in ‘real time’ is now essential, to support their R&D claims and mitigate investigation risk. Gone are the days of the ‘lightweight’ approach at the end of the accounting year and it is vital that businesses choose the right R&D advisers and challenge the advice they are given. If something sounds too good to be true, it often is. But with the right advisers, expert advice and a strong R&D strategy, businesses can navigate the complexities of R&D schemes to ensure their claims stand up to this intense and rigorous scrutiny if HMRC makes an enquiry. This in turn will help restore confidence in R&D tax relief schemes and encourage the innovation and growth that the UK economy needs.

About the author:

Rory Fothergill is an experienced Senior Manager in R&D and Tax Advisory at JS Accountants and Business Advisors. He has extensive experience supporting businesses with R&D claims, advising on how to enhance and protect claims, advising on R&D systems and processes, and successfully handling R&D queries at HMRC. Rory and JS also provide specialist R&D support and advice to clients of smaller partner accountancy firms, ensuring that their clients also benefit from comprehensive R&D support from experienced and qualified professionals.

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