New report calls R&D Tax Credits a “failure” (and what to do about it…)

An explosive new report this week from the Centre for Business Research at the Cambridge Judge Business School has cast serious doubt on the effectiveness of the UK's ￡7.3b R&D Tax Credit scheme.

The report asks the question "is the UK’s flagship industrial policy a costly failure?" and points out that, as a percentage of national income, self-funded R&D being undertaken in the UK economy is estimated to be between 10% and 15% LOWER than before R&D tax credits were introduced.   

The report’s key argument is that the way that R&D Tax Credits currently operates has little impact on the level of R&D that companies undertake. It estimates that the "additionality” ratio in the R&D scheme for SMEs is around 1.0 meaning that ZERO additional R&D spending is being generated as a result of the mechanism.

It cites figures suggesting that if the original aim of R&D Tax Credits was to encourage more UK R&D spending by businesses already in the UK, along with an increase in inward R&D investment from overseas, then this flagship policy has been a costly failure.

The report claims that delivering on the long-standing goal of increasing the UK’s R&D spending to 2.4% of GDP will be impossible without new policies and that the ￡8.4b annual cost of the R&D Tax Credit and Patent Box schemes could be better spent elsewhere – and that the situation would be aided by reducing the scope of the R&D scheme and by abolishing the Patent Box altogether. 

Echoing some of the questions raised in the Government’s review of R&D tax reliefs announced in the 2021 budget, the key recommendations in the report are to:

• Restrict R&D Tax Credits to UK expenditure only
• Restrict R&D claims to BERD expenditure
• Reduce fraud and error in R&D tax credit claims
•  Cancel the automatic subcontractor subsidy in the RDEC
• Abolish the Patent Box completely
• Replace EU Horizon grants with a similar UK scheme

The fact that reports like this are being written – complete with forewords by heavyweight ex-cabinet ministers such as Greg Clark – just goes to show how parlous the state of the R&D Tax Credit market is, a position of which many R&D Tax Credit advisors are blissfully unaware.

This is by no means the first report to make the case that the R&D scheme is not value for money however, in my experience, the truth is more nuanced. Having undertaken thousands of meetings with organisations large and small, I have found that for every company for which the R&D scheme makes little difference to the amount of R&D they do, there are many others for whom R&D Tax Credits are an essential part of their growth and development, without which they would probably never have got off the ground. 

The key benefit to the way the R&D scheme currently operates is its simplicity. However, this comes at a cost: huge amounts of over-claiming, whether unintentional or deliberate.

The report makes reference to HMRC’s recent estimate of the cost of fraud and error in the R&D scheme of ￡311m in 2019-20 and this reinforces my own concern around the amount of obvious over-claiming that is taking place. 

Even the ￡311 million figure is widely considered to be an underestimate of the real total, partly due to the existing HMRC methods for detecting error and fraud being inadequate. I believe that ￡311 million may just be the tip of the iceberg as I have seen many claims that are riddled with basic errors. One recent example brought to my attention was of a company that submitted an R&D claim with the assistance of its accountant that contained over ￡1m of largely bogus R&D costs with the real figure of qualifying R&D being closer to ￡200k. 

Fortunately, this was spotted by HMRC and was the subject of a rigorous enquiry, however far too many spurious and inflated claims are being submitted and much of this is down to the very light-touch approach to claim reviewing that HMRC appears to have taken.

Some of the examples of R&D projects that a handful of advisors and accountants are saying can be claimed for are pushing the boundaries way beyond any acceptable definition of R&D. 

Pay-out for these dubious claims seems to be virtually automatic.

Rather than restricting the overall scope of the scheme as suggested in this report, I would recommend strengthening conformance with the existing rules. I would strongly argue that submission of a technical report should become mandatory and that HMRC should increase its resource in terms of weeding out some of the bogus and inflated claims that are being submitted. This scrutiny should be increased across the board – for claims of all sizes – as much of the over-claiming seems to be being done at the smaller end of the range. All companies making R&D claims, large and small, need to take the rules of the scheme more seriously.

If this were to happen, then many of the overly aggressive R&D specialist advisors and accountancy firms would either have to up their game or abandon the scheme. One idea mooted in the current Treasury consultation is to require a senior person at each claimant company to take responsibility for the content of their claim. This would be a welcome step in the right direction as it would stop claimants being able to hide behind the excuse that “my accountant told me it was all okay to do it”.

If HMRC fails to take action, the risk is that the entire scheme is brought into disrepute and is seen as an easy target for scammers. This would increase pressure from various tax reform pressure groups and academics to abolish the scheme altogether. 

The R&D scheme needs to be seen to be working effectively. Due to a distinct lack of operational oversight at HMRC, I don’t believe that this is currently the case. 

This situation leaves the scheme wide open to the kind of criticism contained in this report. I believe that this is something that the whole R&D Tax Credit advisory market should be very concerned about.

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.

With privileged access to senior ex-HMRC inspectors, scientists and Chartered Tax Advisors, I specialise in large and complex R&D Tax Credit claims where robust HRMC compliance is essential.

Rufus can be contacted to discuss any aspect of your R&D Tax Credits claim on 0794 110 3285