His Majesty’s Revenue and Customs (HMRC) has been upfront in its efforts to scrutinise R&D tax relief claims, implementing much more red tape recently, particularly following the autumn statement.
In comparison to previous years, HMRC is taking a much firmer approach to any claims that are suspected as fraudulent or misleading. As such, there has been an increase in rejections and, by extension, uncertainty for many businesses that have legitimate reasons to claim. As the Tax Adviser magazine outlines, even leading tax professionals are criticising HMRC’s current ‘confrontational’ manner.
This more stringent approach leaves many business owners second-guessing whether their R&D activities will be considered genuine under closer inspection. The new HMRC criteria is leading many to consider avoiding claiming altogether, while others are facing cash flow shortages in the wake of new claim rejections for activities that were once authorised.
Therefore, to avoid any misconceptions, it’s prudent to understand the common reasons why HMRC may reject a business R&D tax relief claim. This short guide is here to help company owners understand the changes so they can make more robust applications, and avoid easy mistakes in the wake of HMRC’s increased stringency.
What is R&D Tax Relief?
Before proceeding, it’s important to understand the purpose of R&D (research and development) tax credits.
Put simply, if your company carries out research and development in some capacity, you may be eligible for tax relief through either the Small to Medium-sized Entity (SME) Scheme or the Research and Development Expenditure Credits (RDEC) Scheme.
Achieving these credits allows companies to deduct qualifying costs from their taxable profits, thus reducing their tax liabilities.
Quite often, business owners entrust specialist third-party accountants and tax specialists to aid them in their R&D tax credit claims. Attempting to submit them on your own, without any prior experience or familiarity with the process can lead to mistakes and rejections. With the profoundly more stringent criteria that HMRC have recently implemented, you may need to consider seeking special tax advice before submitting your claim.
Why are More R&D Claims Being Rejected?
Since the 8th of August 2023, tighter rules have been implemented, including:
- Identifying advisors who have assisted with the claim(s)
- Pinpointing appointed, responsible internal people within the organisation itself
- Scrutinising a wealth of detailed, extensive supporting information
As such, many believe that legitimate claims are being forcibly rejected, while genuine claimants are being stone-walled by an inherently more bureaucratic system.
HMRC has recently estimated that £500 million (4.9%) of R&D tax credit relief is wrongly claimed through error or by fraudulent means. In many cases, this has involved so-called ‘boutique’ firms who professed to be R&D experts despite possessing very little to no experience in this sector. Many of these companies have been reported to be submitting exaggerated, erroneous, or deliberately misleading R&D tax credit claims in return for healthy savings. These R&D boutiques are now being more vigorously targeted by HMRC.
They cite several reasons for such increased scrutiny, in summary:
- Concerns about abuse of the relief
- Need to protect public funds
- Desire to ensure claims match scheme criteria
Detractors and critics argue that while erroneous claims cannot be entirely eliminated, applying more red tape for everyone deters legitimate claimants and creates more uncertainty for smaller claiming businesses.
Common Reasons for R&D Tax Relief Rejection
Even prior to this toughening on R&D tax relief abuse claims, some businesses were often the victims of their own doing. These mistakes regularly result in claims being rejected, so understanding how to avoid tripping up can help mitigate them.
Incorrect Claim Amounts
Many claims are rejected for claiming excess or ineligible costs not meeting R&D criteria. HMRC will scrutinise which costs qualify but will do so with a refined focus now compared to years past.
Examples of costs often wrongly claimed:
- Subcontracted activities and workers
- Consumed materials and utilities
- Clinical trial subjects
- Apportioned software
- Independent research contributions
- Other indirect activities
Keeping detailed logs and records of how costs contribute to your research, findings, and experiments will be key in forming your claim.
Unbalanced Accounts
Another common reason for rejection is unbalanced accounts with mismatches between entries. As with any bookkeeping and accounting processes, it’s vital to ensure your income and outgoings are consistent and transparent, with clear entries that signify specific processes that you have undertaken.
Non-Eligible R&D Costs
As well as including ineligible costs, businesses sometimes attempt to claim non-R&D expenses like prototyping, commercial production, and sales activities. It’s vital to understand what constitutes being eligible for relief when conducting your activities, but ideally, before they get underway. When it comes to submitting your claim, make sure that you only claim costs directly involved in your specific R&D project(s).
Undocumented Grant Funding
If your R&D project received any grant funding or subsidies, you must declare this and subtract it from any tax relief claim, or HMRC may reject your claim.
HMRC's Tougher Stance: An Overview
While unlawful and illegitimate claims should rightly be scrutinised and prevented, it would be unfair to ignore the concerns that HMRC’s recent crackdown is causing businesses. The recent tightening of criteria has deterred many businesses from claiming tax relief that they are legitimately entitled to.
Some key concerns around HMRC's stricter approach include:
- Rejection rates rising faster than expected
- Lack of feedback to businesses on reasons for rejection
- Breakdown of goodwill and trust between HMRC and taxpayers
- Insufficient guidance that creates uncertainty around qualifying criteria
- Lack of direct engagement between claimants and compliance team representatives
- Disproportionate time and costs of challenging HMRC, thus leading many businesses to ‘accept their fate’
- Inappropriate penalties are applied in cases where HMRC deems no substantial R&D has taken place, asserting carelessness and demonstrating a lack of flexibility
- Risk-averse culture discouraging valid claims
What Can Businesses Do Now?
The CIOT (Chartered Institute of Taxation) recently warned that HMRC’s inflexible and ‘volume compliant’ approach is counterintuitive to genuine R&D tax credit claims, due to the complex nature of the relief and the highly intricate consideration in determining what constitutes a valid project. If this approach continues to manifest, it could lead to wider economic investment in valuable R&D and innovation, something which the UK economy has prided itself on.
More transparency, feedback and guidance from HMRC could provide reassurance and understanding, while still tackling erroneous claims. Open communication channels are pivotal in helping businesses clarify any uncertainty around their R&D activities, with clear next steps that they can take, if necessary.
Following guidelines carefully and being prudent with claims is advisable in the current climate. However, with the right preparation, companies conducting genuine R&D should not shy away from claiming the valuable tax relief they are entitled to.
The guidelines and strategies outlined in this guide help to solidify why HMRC is taking a much tighter approach recently and what common pitfalls can look like. In turn, hopefully, there is enough material to digest so that you can make an R&D tax relief claim with increased confidence, knowing that you have legitimate reasons for doing so.
