The rising cost of R&D Tax Credit compliance
With HMRC recently revealing that over 20% of all R&D Tax Credit claims are now subject to a Compliance Check (enquiry), it has never been more important for R&D claimants to be fully covered by their advisor in the event of an HMRC enquiry being opened.
Until relatively recently, HMRC’s enquiry rate was less than 1% of all claims so R&D advisors and accountants could afford to provide “fully inclusive” enquiry support where any additional enquiry work is included in the main R&D claim preparation fee at no extra cost.
As most firms would have had very few enquiries to deal with, this was a relatively low risk add-on to their service.
Since late 2022, this situation has been turned on its head with some accountants and R&D specialists reporting that over half their entire claim portfolios are under HMRC enquiry.
Providing fully inclusive enquiry support is rapidly becoming uneconomic for many firms.
Some firms have decided to withdraw from the R&D claims market entirely whilst others have continued to operate but have told clients they are unable to defend the enquiry and that they should simply repay the claim and treat it as a loan from HMRC.
Others have introduced additional charges, on top of their contingency fee, to cover the rapidly escalating costs of engaging in lengthy and complex arguments with HMRC, with no guarantee that the R&D claims will be paid.
Magic money tree running out of money
Many in the R&D advisory industry fail to grasp the scale of the financial predicament faced by the Chancellor and which has led directly to HMRC’s drive to deal with R&D Tax Credit fraud and error.
The ex-Chancellor Philip Hammond recently told the Times newspaper that, behind the scenes, R&D Tax Credits had already become a “No 1 fiscal concern” while he was Chancellor between 2016 and 2019.
With R&D Tax Credit fraud and error estimated to cost the Treasury ￡1.13 billion annually, yesterday's Budget forecasts from the Office for Budget Responsibility (OBR) stated that the Chancellor's "headroom" for tax giveaways was only ￡8.9 billion so, in theory, cleaning up R&D Tax Credits entirely would have created nearly 13% of additional headroom for the Government in a (probable) election year.
These are comparatively big numbers which go some way to explaining HMRC’s combative approach to R&D Tax Credit compliance checks.
HMRC has estimated that its increased R&D Tax Credit compliance activity has raised ￡250 million in 2022-23 so the Chancellor will undoubtedly be pushing HMRC to redouble its efforts meaning there is little chance that the current spike in R&D Tax Credit enquiries will abate any time soon.
This means that R&D advisors need to prepare for the current high rate of HMRC enquiries to become the “new normal”. Many will be faced with a choice of having to charge for enquiry work or going out of business.
Are R&D advisors changing their approach to charging for enquiry work?
The ability of R&D advisory firms to handle HMRC enquiries has long been a commercial feature of the R&D Tax Credit market. Many advisors would promote their expertise and the fact that enquiry support was “fully inclusive” in their fee.
Given the recent 20-fold increase in the HMRC enquiry rate, I became intrigued as to the sustainability of a fully inclusive enquiry support model so I conducted a LinkedIn poll of R&D advisors and accountants to see how many are now charging.
On the face of it, it would appear that most firms are still providing full enquiry support. This is reinforced by the fact that many of the 15% of responses indicating that they charge extra were from the type of mid-tier accountancy practices that are more likely to charge a fixed fee for the initial claim preparation with any enquiry work being charged in addition.
However, it turns out that my poll was overly simplistic and that the results mask some subtle changes introduced by a number of advisory firms.
I wrote an article last year outlining the case of a Fintech company that was the subject of an appallingly shoddy HMRC enquiry into its claim. Whilst the claim was eventually paid in full, it took 13 months and over 500 hours work by the advisor (MSC R&D), the cost of which was fully covered in its initial fee charged to the client.
Many R&D advisors are either unwilling or unable to continue to absorb these costs and have begun to introduce extra charges. Some examples of charging models now believed to be employed include:
It is unclear whether these firms are giving sufficient prominence to these extra charges during the client engagement process.
This development is a gift to other R&D firms who are beginning to use these additional enquiry costs to differentiate themselves in competitive situations, principally by arguing that the firms charging extra are not confident in standing behind their work or that the fees are open-ended with the possibility of ruinous amounts of consultancy work being charged with no guarantee of success.
An expert R&D advisor’s view
I spoke with a leading expert in the R&D advisory field to get their opinion and found that the issue is not clear-cut.
Patrick Totty , Managing Director at R&D advisory firm Liberty Collins, who has been in the field for 15 years, believes that the commercial terms of R&D Tax Credit advisors have been a battleground since the incentive was introduced, as they are in any competitive market.?
Patrick told me that “removing enquiry defence from an engagement is one mechanism for R&D advisors to offer commercially more attractive terms than competitors. When this is clear in the engagement agreement, the legal position is – to my mind – also quite clear: clients are willingly entering into an agreement where enquiry defence is specifically excluded in return for lower overall remuneration to the advisor. This is no different to many other tax and accounting services and advisors would expect to charge more for any enquiry defence.
“However, within the R&D sector, the issue is more nuanced.
“There is open acknowledgement that there remain a significant number of bad actors in this space who advise clients outside both the spirit and letter of the legislation.?
“This has been the cause of the current crisis for both claimants and advisors within the R&D Tax Credit sector, going back over a significant period. If enquiry defence is to be specifically excluded from an engagement, what does that say about the advisor’s commitment to high standards – particularly if the principal remuneration method is based on a percentage of the claim value?
“One could infer that removing enquiry defence only further encourages abuse of the incentive and should therefore be called out as such.
“That said, HMRC’s volumetric approach to Compliance Checks is causing significant extra costs for advisors who do not charge for defence. Those advisors who take pains to ensure that everything is done correctly, in accordance with legislation and PCRT, are being asked/expected to carry the cost for a problem not of their making. This in turn creates a ripple effect where giving advice is no longer commercially viable below a certain threshold, ?unless enquiry defence is removed from the engagement.?
“A vicious circle that is another negative consequence of HMRC’s approach to R&D Tax Credits over the past 18 months.
“I’m not sure there is a clear answer as to whether defence ought to be included.? A clearly written engagement agreement seems to be the only answer that I can think of that doesn’t rely upon subjective argument thereafter”.
Expertise matters more than lip service
Ultimately, genuine R&D claimants are looking to file accurate and responsible claims that meet the legislative requirements and which will not be the subject of an enquiry. If an enquiry is opened, then they want their advisor to help them defend it under terms that were clearly contracted for and without any ambiguity.
Perhaps a bigger issue that R&D claimants tend not to probe is whether their advisor has the necessary expertise and track record to successfully defend an HMRC enquiry in the first place.
It’s very easy for an advisor to say they fully include enquiry defence in their fee but quickly gloss over the likelihood of a successful enquiry outcome for the claimant.
After all, in most cases, it would be more advantageous for an R&D claimant to pay their advisor additional costs for enquiry support if this resulted in the enquiry being resolved rather than having fully inclusive support where a claim is rejected.
My advice to any R&D claimant is that they ask their prospective advisor these questions:
As an example of industry best practice, MSC R&D has access to 4 ex-HMRC inspectors with a total HMRC tenure of 70 years between them.
MSC R&D’s unrivalled R&D Tax Credit claim preparation teams combined Chartered Tax Advisors, Chartered Accountants and PhDs in a variety of disciplines.
This gives MSC R&D's clients amongst the highest levels of HMRC compliance support in the entire R&D advisory market. And of course, it's fully inclusive.
Article written by Rufus Meakin
Rufus Meakin helps companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.
If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to call me on 0794 110 3285.
Corporate Tax Partner & Specialist in Technology Tax Breaks and Corporate Tax Planning, Head of Corporate Tax at Randall & Payne LLP
8 个月A really good article Rufus. I was very interested to see your comment that HMRC have revealed at least 20% are under enquiry - can you point me to this source please? Fully agree and sympathise with all the other comments, undoubtedly bad claims are being thrown out but if in order to achieve that you have to throw every claim out… well, enough said I feel.
Business Development Director at SmartMed Global
8 个月I have seen genuine companies withdraw their application and in some instances have moved operations to other countries. Govt want to encourage tech companies and increase productivity but what they are doing is the opposite.
Director at R&D Consulting
8 个月Including enquiry defence can be a tricky one at present due to the way the ISBC are handling enquiries, with even solid claims being dismissed on less than genuine grounds meaning ADR, a SOLS review etc. are necessary and this has to be factored in when considering if it's worth serving a company. This is seriously preventing decent advisors from engaging smaller SMEs leaving them to the mercy of the dodgy advisors who are still massively inflating R&D expenditure to ensure they still make a decent fee.
Trusted tax adviser specialising in R&D claims for manufacturing and engineering SMEs
8 个月Great article as always Rufus! This precise conundrum is what gives me sleepless nights. To include enquiry defence in your contract terms or not? That is the question! As Patrick Totty points out there are pros and cons whatever way you decide. What is in no doubt is that a combination of greed and fraud perpetrated by the cowboy firms (and we all know several ) and the slow reaction of HMRC to the problem has caused this chaos which will in my opinon is quickly destroying R&D done by SMEs in this country!