Lee Sharpe considers how HMRC’s campaign against poorly-founded research and development relief claims may be undermining genuine claims and probably government policy.
Readers will be aware that HMRC has long had concerns about research and development (R&D) claims under the small and medium-sized enterprise (SME) regime, particularly those that resulted in a ‘real money’ tax credit payable to the claimant company. This article sets out how HMRC’s approach to R&D claims has changed over the years.
Long, long ago…
The SME R&D regime was introduced for companies over 20 years ago. A few years later, in or around 2006, HMRC opened seven specialist R&D centres to help companies identify tax-eligible R&D projects, and to compose their claims accordingly. My dealings with the members of HMRC’s Manchester team were largely positive – they were there to help. Those were the days!
Over the years since, I have dealt with claims ranging from a few thousand pounds to several million, from food processing to lighting to creating short-life radionuclides for medical tests. Claims have proliferated in the wider world, with specialist firms setting up to advise on and manage claims at significant volume.
So far, so good. Except, it seems that not all such specialist firms were equal, and some claims have apparently been quite ‘adventurous’. Those HMRC R&D teams were apparently unable to cope with the surge in volume and have since disappeared from view, arguably when their assistance and attention were needed most.
More recent history
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In October 2018, the Chancellor announced a cap on the payable tax credit, by reference to the company’s PAYE or National Insurance contributions bill. This was just six years after the original PAYE cap had been abolished but now, the cap was 300% of the company’s corresponding PAYE or NICs liability and there was a £20,000 claim de minimis before invoking the cap. Furthermore, the cap was not engaged where the company passed certain tests to show it was actively developing meaningful intellectual property in-house. The new cap took effect from April 2021.
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In practical terms, that measure was overtaken by a fresh requirement that all corporation tax (CT) returns involving a claim to SME credit (or the large firm credit) include new CT600L supplementary pages, for all submissions on or after 1 April 2021 (although the new details were quite straightforward).
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The tax-only uplift to qualifying SME expenditure incurred from 1 April 2023 was cut from 130% to 86%, and the rate of payable credit then applied to surrenderable losses arising therefrom was cut from 14.5% to 10% (although there were again protections from some of these new restrictions for ‘R&D-intensive companies’ that spent a significant proportion of their total business expenditure on qualifying R&D). In contrast, the credit for large company claims increased, as did the categories of qualifying expenditure, and even the range of qualifying activities.
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For periods starting on or after 1 April 2023, the company must lodge advance notice online that the company intends to make an R&D claim if this is their first claim or their previous claim was more than three years before the current claim notification window. The notification window ends six months after the end of the accounting period of claim; for example, a late-ish claim in the second half of the usual repair window for the previous year’s return will not have been made in the three years before the current claim return window, and it may be that advance notifications are required for the current year, and consecutive periods. The reason behind this is supposedly to discourage companies from making last-minute ‘abusive’ claims.
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Also, for any returns submitted on or after 8 August 2023, the company has to lodge a separate additional information form, again online, with a significant amount of detail about its R&D activities. This new submission must be made on or before the corresponding CT return itself is filed for each return that includes a claim (e.g., two such forms for a long period). If the form is not submitted as required, HMRC will process the CT return but ignore the R&D claim in it.
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For periods starting on or after 1 April 2024, the SME scheme has been merged into the ‘large company’ scheme, that offers lower returns, in spite of its recent enhancement (the ‘old’ SME R&D regime basically lives on, however, for those especially qualifying R&D-intensive companies).
On their own, these measures might give SME companies the impression that their R&D claims had seriously fallen out of favour. But there was more.
When too much is not enough
Meanwhile, HMRC initiated a sweeping campaign of enquiries targeting SME R&D claims that, according to the CIOT, had led to “a breakdown of goodwill and trust between HMRC[,] and taxpayers and their agents” by mid-2023. The CIOT warned that HMRC had adopted an inflexible and confrontational approach, that was discouraging legitimate claims.
This warning largely echoed a House of Lords report from January 2023, which referred to criticisms that HMRC was “failing to take account of information already provided by claimants, included poorly focused questions, and a reluctance to engage with taxpayers and their agents”. The Lords’ report also expressed concerns that HMRC was failing in its Charter obligations to apply staff with sufficient expertise to deal with taxpayers’ claims, and to treat taxpayers fairly.
Simple as ‘I-S-B-C’
It has transpired that HMRC has tasked some of its ISBC (individual and small business compliance) teams to process bulk enquiries into SME R&D claims. ISBC are the teams that deal with the ‘One Too Many’ letter campaigns, such as where interest appears to have been omitted from tax returns or where landlords have had the temerity to try to claim a repairs deduction for replacement boilers (for more on this issue, see the article That Old Boiler, from Property Tax Insider for June 2024). To put it another way, ISBC teams deal with repetitive, straightforward cases that do not require extensive and specialised tax technical knowledge, such as R&D claims.
While acknowledging teething issues with its volume work on R&D enquiries, HMRC asserted that roughly 75% of small R&D claims were non-compliant. However, HMRC’s Chief Executive has since attended a Treasury Committee hearing in late April 2024, and one or two points are relevant here:
Firstly, he admitted that only a small proportion of those non-compliant claims actually have no R&D relief due at all; the majority do have a credible claim, but HMRC disputes the amount of relief due.
Second, in terms of expertise, he asserted: “…my people are tax inspectors. They are not software engineers or rocket scientists and they meet a vast range of claims in areas in which they do not have expertise”. This is oratorical sleight of hand; the tax profession, the Lords and SME businesses do not want HMRC’s tax inspectors to be rocket scientists, nor did they ask for it. What they want is officers who understand the technical side of the tax regime into which they are enquiring – in this case, R&D.
In fact, it is worse than this. I have come across one or two enquiries under the ISBC whose letters have graduated from simply cutting and pasting stock paragraphs denying relief (even to the point where the copied text still refers to the ‘wrong’ taxpayer) to generic arguments that the company’s various R&D efforts offered no meaningful advance in the relevant field of technology, etc., so the tax claim must fail. But surely this is precisely the kind of judgment call that only a competent professional specialising in the field of software, or rocket science, etc., could be qualified to make.
Conclusion
The Lords’ 2023 report referred to the government’s latest (2017) target that UK spending on R&D be incentivised to reach 2.4% of gross domestic product (GDP) by 2027. With HMRC’s able assistance, the UK seems destined to fail this relatively modest goal once again. What is particularly galling is that HMRC’s statistics appear to assume that all companies that simply give up the fight never really had a genuine claim in the first place. I suspect these separate notifications and reports at (4) and (5) above feed new computer programmes at HMRC, likely using machine learning (AI) to review claims and highlight those HMRC should scrutinise further. But I am not convinced that HMRC’s conjected new software design ‘meaningfully addresses a technological uncertainty’, this time in the field of taxation; likely the opposite.
