How to handle an HMRC R&D Tax Credit enquiry - the first steps

Hundreds of companies right across the UK have recently been receiving ominous-looking letters from HMRC headed “Check of the Company tax return”.

In a worrying development for many CFOs, the letter is described as a “compliance check opening notice [which] tells you I am going to check the Company Tax Return for the period shown above”.

The next paragraph - “What I am checking and why” - mentions the company’s claim for Research & Development Relief. This means that HMRC has officially opened a compliance check, or enquiry, into an R&D Tax Credit claim and that they are requesting further information to verify that the claim has been made correctly.

These letters will come as a shock to most companies who may well have believed that HMRC’s oversight of R&D Tax Credits was so lax that their R&D claim had become just a routine part of their annual accounting process.

So what has gone wrong for so many companies and what can they do about it?

Why HMRC is increasing the number of R&D Tax Credit enquiries

As I have written before, HMRC has been stung by criticism regarding the enormous levels of fraud and error in the R&D scheme so it is now devoting a large amount of resource into ensuring that R&D claims are accurate, as well as hoping that word will spread amongst businesses that applying for R&D Tax Credits is no longer the routine process that it once was.

Companies now need to be very careful to ensure that their R&D claims are completely accurate, and in particular that the activity being put forward as qualifying R&D is actually Research and Development as defined by HMRC in the “BIS Guidelines”.

R&D Tax Credits in the UK are exceptionally generous by international standards.?Indeed, on some measures, the SME credit is the most generous scheme of its kind in the world.

Because of this generosity, the scheme has become open to abuse so the Treasury is becoming focussed on more effective targeting of the scheme as well as looking for HMRC to take a stricter application of the rules to ensure that the scheme is working as it should.

Many companies are now being caught out by what they had assumed was a very lightly-regulated regime but which belatedly appears to have some very complex and stringent features – of which the heightened level of HMRC enquiries is the most obvious manifestation.

Once an enquiry letter is received, what should a company do?

It is always advisable to get things right first time so the first thing the claimant should do upon receipt of an enquiry letter is to ask HMRC for an extension to the deadline.

The average length of time between HMRC sending an enquiry letter and the deadline it sets for receipt of the required information is currently around 5 weeks.

This is not generally enough time for the claimant to put together a robust case (although this does depend on the depth and complexity of the questions being asked).?To give enough flexibility therefore, the company should write to HMRC to request an additional month or so in order to adequately address the questions.

Get some expert help

The next step is to ensure that the claimant has access to professional expertise from someone who is an expert in handling an HMRC enquiry.?

This importance of this cannot be stressed enough.

• ?If the company completed its own R&D claim in-house, then it should seek recommendations for the services of an expert R&D Tax Credit advisor, and preferably one that employs ex-HMRC inspectors that have worked on the R&D team within HMRC.
• ?If the company used an accountancy practice or an R&D specialist advisory firm to complete its claim then it should immediately forward the enquiry letter to the relevant accountant or advisor and ask them what degree of expertise it has in defending such enquiries.

It is critical that the company then goes on to deeply probe the accountant or advisor’s experience and expertise.

Very often, an accountant or R&D advisor will fatally misjudge the extent of the enquiry problem by believing that the HMRC questions can be easily addressed.?They may even become protective of their client relationship and be unwilling to hand over the enquiry to a more appropriate third-party, perhaps because they fear that their poor knowledge of the scheme may be exposed to their client.?They may even be concerned that their own lack of expertise could have contributed to the HMRC enquiry being raised in the first place.

If there is any suggestion that the R&D advisor does not have the capability to handle the enquiry, then the claimant should seek outside specialist help in the form of a recognised expert.

Failure to engage with an expert who has experience in handling HMRC enquiries could significantly jeopardise a successful resolution to the enquiry.

What specific expertise should you look for?

By some estimates, there are up to 250 specialist R&D Tax Credit advisors in the UK, plus a multitude of accountancy practices with varying degrees of expertise.

Only a very small proportion of these have the in-house capability to defend an HMRC enquiry. ?So how would a claimant go about finding a suitable expert?

This somewhat depends on what the area of focus for the HMRC enquiry is.?The letter will state whether HMRC is seeking further details on either “Research & Development activities” or “Costs and calculations”.?Often it is a combination of both.

Remember that the stakes are potentially very high so ideally your professional advisor should have expertise in both the relevant field of technology and of tax.

The best way to establish the extent of the expertise this to ask the advisor for the following details:

• The names and professional credentials of their technologists who are qualified in the same field of technology as the R&D claim.
• The names and professional credentials of the tax experts who will be working with you on the enquiry.
• The name of their nominated ex-HMRC inspector who will be advising on the enquiry. (Note: be sure to establish that the inspector worked on R&D Tax Credits at HMRC. Several R&D advisory firms have been touting that they employ ex-HMRC inspectors however some worked exclusively in departments entirely unrelated to R&D and have no actual experience of R&D Tax Credits).
• At least two case studies of previous HMRC enquiries which they have managed to a successful conclusion - ideally, they will provide contact details so you can talk to the reference about their experience.

How will the expert be remunerated for the enquiry work?

For regular R&D Tax Credit work, most R&D advisors work on a contingency fee basis.

This is unlikely to be the case for handling an HMRC enquiry into an R&D claim on which the advisor was not initially involved.?

In fact, I would be very wary of engaging for this kind of enquiry work on a 100% contingency basis as you won’t be confident that the advisor is deploying their best - and most expensive - resources to resolve the enquiry.

Fee structures can vary, with some charging an hourly rate whilst others might offer a fixed fee.?Some might charge on a “per letter” basis so that each letter written to HMRC is charged for individually.

Regardless of the charging structure, it is important to realise that HMRC will probably appreciate the fact that a claimant has engaged with a professional advisor to resolve the enquiry as it will make their job considerably easier.?The questions are much more likely to be answered in a format that allows the inspector to quickly get to the point and to make informed decisions.

For this reason, I would advise that the claimant incorporates an engagement for future claims into the arrangement.?This will demonstrate to the inspector that the advisor is committed to the claim and has fully ‘bought in’ to the validity of the claim.

The possibility of an engagement for future R&D claims can be part of the remuneration for handling the initial enquiry.

What are the chances of successfully resolving an enquiry?

This largely depends on whether the claim was defensible in the first place and, if it was, how the claimant and the advisor go about addressing HMRC’s questions.

Many of the questions posed in the enquiry letters are standard and generic however, those questioning whether there was a true advance in science or technology can prove very complex and time-consuming to answer.

There has been much speculation on whether once a tax enquiry has been opened HMRC staff look to justify the enquiry by getting some kind of positive, even partial ‘result’.?

There is no evidence that this is the case on an individual claim basis and if an inspector’s questions are answered effectively then in all likelihood the enquiry will be closed with no action being taken.

Having said that, HMRC enquiry teams will be aiming for a ‘strike rate’ that justifies the existence of the enquiry team so there may well be pressure over time to deliver a certain level of successful (from HMRC’s perspective) compliance checks.

In any event, the best way to mitigate the risk of an entrenched HMRC enquiry is to seek expert help from a specialist advisor with the relevant experience.

Look out for my next article which will focus on the nature of an enquiry itself – and what measures can be taken to minimise the risk of enquiry being opened in the first place.

Rufus Meakin is a long-standing business development expert for R&D Tax Credits and a passionate believer in raising standards across the UK R&D claims industry.