R&D Tax Credits: how likely is an HMRC enquiry?

• "My R&D claim is now just a routine part of our annual accounts"
• "Our claim is too small for HMRC to be interested in checking"
• "I've been claiming R&D for years without submitting a technical report”
• "The chances of an HMRC investigation are so remote that I just put our entire development team in the claim"
• "I've been claiming R&D for the same project for 6 years with no issues at all"
• "Our claims are "approved" and paid every year by HMRC so I have nothing to worry about"
• "Everybody knows that HMRC never checks anything - they just pay out automatically!"
• “The Government has told HMRC to rubber-stamp every R&D claim to support the economy through COVID-19”
• "It's all fine. My local accountant says he will defend our R&D claim if HMRC starts asking questions"

I've heard variations on these statements from companies claiming R&D Tax Credits literally thousands of times over the last decade and a half. But as the number of R&D claims submitted has sky-rocketed in recent years, reaching nearly 70,000 estimated submissions in 2018, how true are some of these assertions today?

It has been obvious for several years that many R&D claims are either inflated way beyond their true value or, in some cases, entirely bogus. It was also abundantly clear that HMRC adopted an exceptionally relaxed approach to claim reviews and many spurious claims were known to have slipped through the net and been paid out to companies. 

However, following estimates that ￡311 million of claims for R&D Tax Credits in 2019-20 should never have been paid, HMRC is now taking action and has announced the recruitment of an extra 100 new staff specifically to work on checking R&D claims, starting with 2020 claims. HMRC is also establishing a revised risk screening process to support the review of R&D Tax Credit claims submitted by companies as well as accelerating plans to implement a random enquiry programme. 

This step-up in compliance acknowledges the reality is that there is almost certainly significant over-claiming taking place within the R&D Tax Credit scheme and it is guessed that the true figure is well in excess of the ￡311m estimate.

It is certainly beyond doubt that many claims with basic errors have gone unexamined, a situation acknowledged in a severely critical National Audit Office report that accompanied the 2020 HMRC annual report and accounts. 

However, this past failure by HMRC means that the fact that a claim has not been examined to date should not be taken as any indication that it is satisfactory.

If problematic claims are detected by HMRC, the company could be subjected to a review of its tax records for up to six previous years and this can be extended if it is believed that deliberately misleading transactions have been submitted.

So, with HMRC stepping up its examination of R&D Tax Credit claims, just how likely is that that companies will face an enquiry?

In some respects, it depends in which sector the R&D claim sits. R&D projects based around the development of software are particularly at risk as the indications are that even within the last 6 months, HMRC has come to believe that many software-based claims should not have been submitted and that these are more likely to face an enquiry.

Claims relating to engineering and construction are also being examined more closely, particularly for companies that undertake one-off, bespoke projects for individual clients as these may fall foul of new guidelines that place restrictions on subcontracted R&D.  

Certainly, many companies involved in the Construction and Civil Engineering industries are finding that their R&D claims are not sailing through as they once did.

Also at significant risk are those companies that have been persuaded by spurious R&D advisors that they are undertaking qualifying R&D when they are clearly not. This type of rogue advisor is operating on the basis that HMRC has a “light touch” approach to claim evaluation, that smaller claims are just nodded through and that only a small fraction of larger claims will come under scrutiny.  

Clearly the nature of the R&D and the sector in which it sits is relevant to an enquiry, however the presentation of the claim documentation is probably the major contributing factor to whether HMRC is likely to take more than a passing interest in an R&D submission.

Probably the most common flaw is a failure to adequately spell out the precise nature of the technical advance. Whilst a report may be produced which describes what was built and why it is a good commercial idea, companies consistently neglect to describe the actual advance in science or technology. Very often this is to hide the fact that there is no real technical advance. 

Another factor that increases the likelihood of an HMRC enquiry is not distinguishing between activities that are "challenging" and "uncertain". “Uncertainty” is present when a competent professional in the relevant field of technology could not readily deduce a solution. On the other hand, something may be “challenging” by being complex and having a lot of moving parts to deal with, but it cannot be claimed to be “uncertain” because, given enough time, it is perfectly solvable. 

What makes something truly uncertain is when a competent professional in the field can't just methodically work their way through it with any certainty. To be clear, activity which is technically uncertain may be claimable as R&D, but something which is merely a challenge will not be.

Applicants should read and re-read their claim document to make sure that it contains clearly described advances in science or technology along with the technical uncertainties that had to be resolved.

So assuming you have a fit-for-purpose technical report and your financial calculations are consistent with the scheme rules you won’t get an HMRC enquiry, right?

A couple of years ago, the answer was “probably not”, and almost certainly not if your claim value was less than ￡100,000. This is no longer the case. I am aware of one claim that HMRC is investigating that where the tax credit was valued at less than ￡15,000. 

The recruitment drive that HMRC undertook in 2020 means that they may have stepped up the number of enquiries at least threefold over the previous year. 

There are 3 R&D Tax Credit teams currently operating within HMRC which until recently had around 50 staff in total. It is estimated that each inspector could perhaps handle up to 30 enquiries per year, giving a total of 1,500 enquiries per year, which represents around 2% of the total. With the addition of 100 new inspectors, the capacity will have risen to between 4,000 and 5,000 enquiries per year, which is approaching 7% of the total submissions.

In addition to an increasing number of enquiries HMRC now has the resource to spend more time reviewing submissions. For an average-sized claim, each inspector would previously have spent anywhere between 5 minutes to an hour reviewing each claim. They now have significantly more resource available to increase this review time. Any larger claims valued at over ￡100,000 will certainly come under much more rigorous scrutiny.

An HMRC enquiry is certainly much more likely than it was a year or even six months ago.

What can you do to minimise the risk to you and your clients? I’ve spoken with many companies over the years who either prepare their own “DIY” R&D claims or use their accountants to handle their claims.

With the increased levels of HMRC scrutiny, it is clearly preferable to work with specialist advisors who have the right technical staff on board to assist.

My strong recommendation to anyone already claiming or considering claiming R&D Tax Credits is to work with a reputable specialist advisor which employs ex-HMRC staff such as MSC R&D.

At MSC R&D, we have two ex-HMRC inspectors, including Gavin Bate who was the former HMRC technical lead for the R&D Tax Credits and co-author of the Guidelines defining R&D for tax purposes.  

A number of clients have already benefitted from Gavin’s expertise in resolving complex HMRC issues so please get in touch below if you want to know more.

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 HMRC compliance is essential.

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