HMRC’s new approach to R&D Tax Credit enquiries explained

Guest article written by Richard Edwards , Founder of The R&D Community

The world of R&D Tax Credits has been shaken to its core by HMRC’s new approach to enquiries.

Starting towards the end of 2022, they appeared to start targeting companies by SIC code and claim size. Many R&D advisors started to report getting multiple enquiries based on templated letters that largely ignored any supporting narrative that had been supplied with the claim.

Even more worryingly, HMRC’s attitude during enquiries was suddenly much more cynical, with their starting assumption apparently that none of the client’s work qualified for relief.?

Deadline extensions were reduced to only a few weeks, and case workers almost universally pushed back on claims using standardised arguments. It was almost as though they’d been thoroughly trained in how to say "No" to claimants, but not how to say "Yes".

This was an abrupt change in tactics from HMRC. Previously, R&D enquiries had usually involved a bit of give and take on each side. After a bit of horse-trading on the numbers, the client usually agreed to reduce the claim, and for their part, HMRC accepted that at least some of the company’s claim was valid. This doesn’t seem to be the case anymore, with the majority of enquiries now resulting in the claim being rejected in its entirety.?

R&D advisors of all stripes have been rocked back on their heels. Many felt that HMRC was challenging claims that had previously been considered solid, with more than one advisor telling us “If this work isn’t considered to be R&D, we don’t know what is!” Anxiety spiked sharply, both amongst companies worried about their future claims and advisors who were left questioning their commercial models – and even the viability of their business.

How HMRC is trying to deny relief

From reviewing dozens of R&D enquiry letters over the past few months, a few patterns become apparent. The following are some of the most common justifications for HMRC denying relief.

• “There was no project in place”
• “The aim of the project was commercial rather than technological”
• “There was no contemporaneous evidence that the project took place”
• “The people running the project were not Competent Professionals”
• “The people running the project were experts in their sector/business, but not in an area of science”
• “The claimed advance seems to have been achieved before by other companies”
• “The advance was for your company, not for the industry as a whole”
• “We don’t think that the claimed advance was appreciable”
• “We think that the claimed advance could have been achieved by competent people as part of their day-to-day job”
• “The challenges you’ve detailed are not technical uncertainties”
• “We think that the claimed uncertainties could have been resolved in a readily deducible way”
• “The work was done under contract for an SME, so you can’t claim”

And so it goes on. The strong impression you get is that HMRC is looking for reasons to deny relief in as many cases as possible, and as quickly as it can.

Why is HMRC acting like this?

The first reason is likely to be that HMRC has gotten some seriously bad press recently. A series of articles in The Times highlighted abuses of the R&D scheme – something that many principled advisors had been openly talking about for years. This press campaign coincided with a House of Lords Sub-Committee investigating the changes that HMRC had proposed to improve the scheme – with its report being pretty critical of how HMRC polices (or had failed to police) R&D tax relief.

So, part of this new approach may simply be an over-correction. In trying to dispel the perception that they were historically too lax with the scheme, they are now trying to be super-vigilant and rigorous in their Compliance Checks. In doing so, they’ve gone from one extreme to another.

The second reason might be more political. HMRC has committed to publishing the results of its Mandatory Random Enquiry Programme (MREP), which will provide a more accurate estimate of the level of fraud and error within the SME R&D scheme. This will appear in HMRC’s 2022-23 Annual Report and Accounts, expected in the summer.

I suspect this will show that a very high percentage of recent enquiries (e.g. 90%+) involve a difference in the pre- and post-enquiry qualifying expenditure. In other words, they’ll be deemed to contain an ‘error’. It is then a simple hop for HMRC to extrapolate those findings to the whole scheme, using the data to conclude that the SME scheme is irretrievably riddled with error (and some fraud) and that it should be binned in favour of a new, unified scheme based on RDEC (which is also likely to be less costly to The Treasury, funnily enough).

How long is this situation likely to last?

In terms of how long this deeply unsatisfactory situation is going to last, my guess would be that the number of new enquiries will settle down after HMRC publishes the results of its MREP programme in the summer. By that point, the Government will have all the ammunition it needs to justify closing the SME scheme and rolling it into a new and less costly scheme based on RDEC.

The noises from the Government certainly suggest that they are pretty set on the idea of unifying the SME and RDEC schemes, aiming for a start date as early as 1 April 2024.?

If they base the new scheme on RDEC, as seems likely, that would remove a very common flashpoint between HMRC and R&D advisors during R&D enquiries – subcontracting.

What’s the issue with subcontracting?

This is one of HMRC’s biggest hammers when it comes to squashing claims. Currently, HMRC is insisting that any time your client is doing R&D to fulfil a contract it has with another SME, your client cannot claim relief. Not under the SME scheme, not under RDEC – not at all.?

Although the reason for this is sound – they are trying to avoid both the subcontractor and their customer claiming for the same work – this approach is overly simplistic and produces some absurd results in practice. For example, our members have reported situations where HMRC has said that:

• Their client (SME B) cannot claim because it was acting as a subcontractor to SME A, and
• SME A cannot claim because it had no project to advance science or technology.

This creates a situation in which R&D has clearly taken place, but neither the customer nor its subcontractor is permitted to claim for it!?It’s hard to believe that this is what the designers of the scheme had in mind when they created it – and I suspect that HMRC’s interpretation of the legislation would be up-ended at a Tribunal.

This must be creating as many headaches for HMRC as it is for advisors, which is why I think the new scheme will be based on the RDEC. This will resolve the subcontracting issue by preventing relief on the costs of limited company subcontractors while allowing the subcontractors themselves to claim. That would certainly be the cleanest and simplest way to avoid “double-dipping”.

What can we do in the meantime?

If you’re in the business of preparing R&D claims and are having issues with enquiries, there are a couple of things you’ll probably want to do fairly quickly.?

The first is to create some internal resource within your team by dedicating at least one person to managing and coordinating those enquiries. If you want to give them a head-start, you can download our free guide “How to handle an R&D enquiry: A complete guide to HMRC’s most common questions, and how to answer them in 2023 ”.?

Secondly, you may wish to review your sales and marketing efforts and steer them away from sectors that are less traditionally associated with R&D. There seems little doubt that HMRC is using SIC codes and your clients’ websites as part of their risk assessment, so focusing your efforts on the stronger sectors is likely to be a smart move. (Maybe it now is about white coats and test tubes after all!)

Conclusion

HMRC’s current approach to enquiries is completely unsustainable. It makes no long-term sense for HMRC to cling to such a rigid and inflexible interpretation of the legislation, so we have to assume that this storm will eventually pass.?

Things are likely to get better when the Government introduces a new (and hopefully simpler and less ambiguous) R&D scheme, possibly from 1 April 2024.?

Until then, R&D advisors are going to have to demonstrate an excellent grasp of the complexities and subtleties of the guidance if they are to avoid falling foul of an over-zealous HMRC.

Richard Edwards is the Founder of the The R&D Community Ltd which provides high quality training, insight & support for R&D Tax Credit advisors and accountants who want to improve their knowledge and service to SMEs.

Richard can be contacted at [email protected]