How to deal with an enquiry into your R&D claim, when you didn't use an advisor

Receiving a letter from HMRC saying that they are opening a compliance check (aka an enquiry) into your companies tax affairs to ensure the right amount of tax is being paid, along with details of potential fines if they find any errors can be quite daunting for business owners, especially when they haven't used an advisor to assist with their claim so don't know who to ask for help.

Due to HMRCs increased compliance efforts with regards to R&D claims some business owners, some of which have been claiming for years, have recently received such a letter from HMRC and reached out to me for advice on the best way to deal with a situation which has them quite worried, so I thought it might be useful to provide some pointers on the best way to correspond with HMRC should they open an enquiry into an R&D claim you have prepared yourself.

Well first and foremost, don't panic or start to worry about what might happen, HMRC open random enquiries and at the moment they are opening a lot, so just because your R&D claim was selected for an enquiry it doesn't mean HMRC believe there is anything wrong, or that your claim isn't genuine, it just means they would like some additional information to satisfy themselves that everything is correct.

The first letter HMRC will send informing you an enquiry has been opened into your R&D claim(s) will also request some more information about your claim, typically information about the project(s) and the costs being claimed.

For each project HMRC usually ask for details of the projects uncertainties, the advance being sought, why this was not readily deducible to a competent professional and details of the baseline technology. They may also ask for a project timeline, competent professionals details and a breakdown of the costs being claimed.

When responding it's important to remember the member of HMRC staff reading you response won't be technically trained in your field, so avoid using industry jargon or deliberately trying to make things sound complex, as this will make it much harder for them to understand your project(s) and approve them.

Once you have written your response, it's also a good idea if you can get a friend, family member etc. who doesn't work in your industry to read it to ensure it makes sense to them, as if it does then it's likely HMRC will understand it also.

It might seem obvious, but always be honest with HMRC, you aren't a tax professional and in my experience HMRC are fairly lenient when companies have prepared their own R&D claims. So, if you find that you have claimed for a cost which you now realise isn't allowable, explain in your response that this was a mistake don't try to cover it up, likewise if you realise that a project you thought did qualify you now think doesn't, just tell HMRC and adjust your R&D expenditure accordingly. The more honest HMRC see you being the less chance there is that they will issue a penalty.

So lets dig a bit deeper into the common areas HMRC typically ask for more information on during an enquiry.

Project Timeline

This section is designed to show HMRC that you understand at what stage qualifying R&D work starts and when it ends, along with some dates so HMRC can be assured the the qualifying R&D was undertaken during the accounting period in question.

Below is an example project timeline and whilst yours will differ, it should still have the Pre R&D, Qualifying R&D and Post R&D sections :

Pre R&D (March - July 2021)

Planning and setting out objectives and project goals

Attempting to reach the project goals using existing methods or knowledge

Researching publicly available technology which we might use to reach our project goals

After finding we could not reach our goals using any existing methods or publicly available technology, the project’s technological uncertainties were identified by a competent professional

Qualifying R&D (August 2021 - June 2022)

Initial design work

Development of several new components

Integration of the new components into a prototype system

Extensive testing

Redevelopment to resolve issues during testing

At this stage the projects technological uncertainties were successfully overcome

Post R&D (July 2022 onwards)

Installation

Routine maintenance

The Projects Uncertainties

For this section the mistake a lot of people make is thinking that more is better and so try to come up with a dozen uncertainties, where in most cases a handful are much easier to define and explain.

HMRC only care about genuine scientific/technological uncertainties and so having less makes it much easier for the member of HMRC staff checking your claim to understand.

A scientific/technological uncertainty is almost always a question, and it's the question your technical folk asked themselves after they had tried to get the project finished using their existing knowledge and publicly available technology.

For example, if a company was attempting to increase the power of a standard 1.6litre engine from 130bhp to 450bhp and after trying all of the known ways to achieve this, remapping the engine, adding a turbo etc. they could only get to 400bhp they might decide this was close enough in which case no qualifying R&D has been undertaken, if however they decide to continue without knowing if their desired improvement is actually possible, the uncertainty would be "Would it be possible to develop technology capable of increasing the power from a 1.6litre engine from 130bhp to 450bhp?"

Or an uncertainty can be a bit more complex, such as "Would it be possible to develop technology capable of increasing the power from a 1.6litre engine from 130bhp to 450bhp, without increasing engine emissions?"

Avoid waffle in this section, your uncertainties should be very clear, concise and easy to understand.

The Advance Being Sought

This section should relate to your projects uncertainties, in that if you can find a way to overcome the uncertainties what will this mean? What will you have created?

Using the example uncertainty above the advance might be "Technology capable of increasing the power output from 1.6litre engine from 130bhp to 450bhp without increasing engine emissions"

One common mistake I see often is that people relate the advance to their industry and not to science/technology and this will result in the project being disallowed.

For example, I reviewed a claim under enquiry earlier this week where one of the advances was listed as "Our industry is very slow in adopting technology, so whilst other industries have had custom built CRMs for years we haven't and so if we could create such a thing, this would be an advance"

The above doesn't represent the type of advance HMRC are looking for, in this case the advance would have to be in computer science, not the industry in which the software is intended to be used.

The Baseline Technology

Baseline technology is the term used by HMRC to define the level of technology already available at the start of the R&D project, against which the advance being sought is measured.

Using the engine project example again, the baseline technology would be "Technology capable of increasing a 1.6litre engine from 130bhp to 400bhp" as that was what you know you could achieve using existing engineering methods and technology at the start of the project.

Competent Professional Details

So what do HMRC mean by a Competent Professional? Well there is no official definition but ideally HMRC are looking for someone with a relevant qualification in the field of science/technology the claim is being made, along with years of industry experience.

For example for an engineering based claim a competent professional might have a degree in engineering and 5+ years industry experience working in an engineering role.

The competent professional doesn't need to be a member of staff, they could be a subcontractor engaged by the company to work on the project.

As the rules for R&D tax relief say that only a competent professional can identify a projects uncertainties, if no competent professional worked on the project to identify the uncertainties, then no qualifying R&D can have taken place.

Why The Knowledge Sought Was Not Readily Deducible To A Competent Professional

For this section HMRC are asking why couldn't your competent professional easily work out how you could reach your project goals, as if they could no qualifying R&D would need to take place.

Usually the answer to this question will relate to the pre R&D stage of your project timeline, so you might say "After attempting to reach the project goals using existing method of engineering and then by researching currently available technology we might use and finding none suitable, it became apparent that the knowledge sought would not be readily deducible by a competent professional"

Breakdown Of The Costs Being Claimed

If you didn't already provide HMRC with a breakdown of the costs you are claiming for, or if you did but didn't split the costs per project, then this is what HMRC are asking for to ensure the costs being claimed fit into allowable categories of R&D expenditure.

For each project you should provide details of the costs using the following headings Staff, Subcontractors, Externally Provided Workers, Software, Consumable and Transformable items.

Hopefully this article has helped you better understand what exactly it is HMRC are looking for when requesting more information during an enquiry, and the best way to provide this to them.

Provided HMRC are happy with your answers to their first letter, usually they will send a second letter asking for even more information, which I will cover in my next article "The dreaded 2nd HMRC enquiry letter"