Recap – what is R&D tax relief?
R&D tax relief allows businesses to claim tax breaks on certain expenditure related to research and development projects.
In summary, the work which qualifies for R&D relief must be part of a specific project aimed at making an advance in science or technology. The project must relate to a business's trade - either an existing one, or one that it is intended to start up based on the results of the research and development.
To qualify for R&D relief claimants need to explain how a project seeks to advance a new process or product or improve an existing one. It must be apparent that the project had to overcome uncertainty and that such uncertainty could not be easily worked out by a professional in the field.
There are two R&D tax credit schemes in the UK:
- the SME scheme (which delivers approximately 33% of qualifying expenditure as refundable tax credits); and
- the Large company scheme (RDEC) (which delivers 10.5% of qualifying expenditure as refundable tax credits).
Qualifying for these schemes can be complicated, especially if business structures are more complex.
You can find more information about how to claim R&D Relief here.
Making the most of these reliefs should be an easy decision for any business as, largely, any investment or project which results in improvements may qualify for some form of incentive. The outcome does not have to be a completely new product or process. Simply investing in a product or service to make it more efficient, cheaper or more sustainable may be enough to qualify for some R&D support.
It is likely that the level of relief claimed in the future will increase, with the Office for Budget Responsibility predicting that the reliefs claimed will increase from £7.7 billion in 2021-22 to £11.9 billion by 2026-27.
The problems from HMRC's perspective
HMRC's primary concern in the operation of these reliefs relates to abuse and/or "boundary-pushing" in claims being made. In their 2019-20 accounts, specific provisions were made to include R&D tax relief, due to the relatively high estimated level of error and fraud. The accounts estimate error and fraud across both schemes as 3.6% of the cost of the reliefs (c. £311 million).
Because the reliefs allow for a payable credit rather than a future deduction, it is easy to see why they are attractive for possible abuse.
In this regard, HMRC are particularly concerned about the role played by some self-named advisers who promote "claims-handling", who often have no background in tax, 'pressure-selling' their services to businesses to submit questionable claims and being paid on a commission basis. You can see how this model would be attractive to businesses as they may view a claim as cost-free and, therefore, be willing to take the risk of making a questionable claim on a costs/benefit analysis. Of course, this does not absolve the claimant from responsibility for making incorrect claims as it is the business which must certify that its claim is correct, and bears the ultimate responsibility for erroneous claims.
HMRC are also conscious of driving relief towards innovation in the UK as opposed to overseas companies, with a particularly keen eye trained on subcontracting to third parties who are based overseas. HMRC intends to ensure that future claims will only be allowed where the work is carried out in the UK.
However, there are some exceptions which have been identified. UK-based companies would still be able to claim tax reliefs on the costs of software and consumables sourced overseas, as well as payments to volunteers for clinical trials overseas and payments for data and cloud services sourced overseas, as these are considered inputs to UK activity - and, we expect, as long as they relate to the research & development activity. Again, claimants will need to certify the validity of their claims to HMRC and demonstrate that the offshore work is directly attributable to the R&D activity. The most straightforward way of doing so will be to ensure clear traceability throughout the supply chain and by maintaining accurate contemporaneous records.
The solutions proposed by HMRC
As mentioned in a previous article on this topic, HMRC has increased resources to try to tackle perceived abuse, including creating a new cross-cutting compliance team focused on abuse, scrutinising claims in detail, and litigating cases in the Tribunal where HMRC believe that claims for relief should not be allowed.
That said, HMRC believe that additional resource alone will not suffice; they say that they require additional measures to provide assurance over the use of taxpayer funds. HMRC's intention is to "design" out abuse and boundary-pushing whilst aiming to limit the impact on compliant businesses.
The government, therefore, intends to implement the following changes:
- All claims will have to be made digitally (except in the case of companies exempt from the delivery of online company tax returns);
- Claims will require more detail. The examples given by HMRC thus far include: what expenditure the claim covers, the nature of the advance sought, the field of science or technology, and the uncertainties overcome;
- Claims must be endorsed by a senior officer of the company;
- Companies must inform HMRC in advance that they plan to make a claim (timeframes unclear); and
- Claims must include details of any agent who has advised the company on compiling the claim.
The changes are planned to come into effect from April 2023.
We expect that the intention behind moving to an all-digital medium of submitting claims (in the vast majority of cases), which requires more detail than the current regime, is to assist the new cross-cutting compliance team. If the new claims process is followed properly, it will provide the HMRC officers with all of the relevant information to assess claims at their fingertips and will also allow for the use of technology assisted reviews.
There is also a clear message that HMRC intend to clamp down on unscrupulous agents promoting "claims-handling" services, as referred to above, by having them named on each claim on which they have advised. This will make it easier for HMRC to collate data regarding consistent offenders. And, by ensuring a senior officer of the claimant business endorses each claim, HMRC's clear intention is to ensure that ultimate accountability in respect of abuse and "boundary-pushing" is signposted to the claimants.
While 3.6% of total relief costs attributed to error or abuse might seem like a forgivable margin, the reality is that it represents £311m of taxpayer money which should be allocated elsewhere.
Therefore, it is understandable why HMRC seek to limit abuse. This will, however, be a challenging task. They must strike a balance between tackling abuse, and avoiding placing too much administrative burden on compliant businesses, especially those businesses which may have to take significant steps to "onshore" their R&D activities, in case it has the opposite of the intended effect, i.e. discouraging R&D expenditure in the UK.
Given the relatively short turnaround time for the introduction of the new measures proposed by HMRC (April 2023), it is hoped that more precise details will be provided far in advance of implementation so that businesses have sufficient time to review and put systems in place. This will enable them to navigate the new system and provide stakeholders with sufficient time to provide feedback to HMRC, and to suggest further exceptions which may be appropriate to achieve HMRC's aims.
In any event, it is essential that businesses keep full and accurate records or supporting documentation pertaining to reliefs sought, in the event that they find themselves subject to a HMRC enquiry or assessment. Should you find yourself subject to an enquiry or assessment, please do not hesitate to contact a member of our Tax Disputes & Investigations Team for full assistance.