Tackle R&D Tax Credit fraud instead of punishing “blameless SMEs” - Lords Committee

Confusion reigned at Westminster this week as a Government minister appeared to contradict the Chancellor’s reason for downgrading its flagship R&D Tax Credit scheme for SMEs.

As I wrote last week the Treasury appears to want to stifle growth amongst the UK’s most innovative SMEs by reducing the generosity of R&D Tax Credits rather than by getting to grips with the fraudulent, spurious and inflated claims that have plagued the scheme in recent years.

R&D Tax Credit advisors are notorious for complaining about changes to the R&D Tax Credit regime because it doesn’t suit their own business models.?

This time however they are entirely right to sound the alarm as the changes announced by Chancellor Jeremy Hunt in his Autumn Statement are demonstrably unfair to R&D-intensive SMEs who face enormous blanket reductions to the payable R&D Tax Credit rate.

This was an issue explored by the House of Lords Finance Bill Sub-Committee on Monday through questions to witnesses from HMRC and the Government.

There was clear scepticism amongst the Lords concerning the reductions of up to 55% to the SME scheme at the same time that the benefit to large companies is being increased by 50%.?

It was suggested by the Lords that SMEs were well-known to be more R&D-intensive than large businesses yet the R&D Expenditure Credit available for large companies will in future be nearly double the R&D Tax Credit available to small businesses in a break-even position.?

This is a momentous reversal of decades of Government policy targetted towards incentivising SMEs as the growth engine of the economy.?

The witnesses struggled to answer the Lords’ questions about why "blameless” SMEs were being penalised in the Autumn Statement by having their R&D Tax Credits reduced by nearly half at a stroke from 1 April 2023.

A particular problem faced by the witnesses was that the Chancellor had directly linked the cuts to fraud and abuse in his Autumn Statement when he told the Commons:

“I have also heard concerning reports of abuse and fraud in R&D tax relief for SMEs so I have decided today to cut the deduction rate for the SME scheme to 86% and the credit rate to 10%”.

Any reasonable reading of this statement would conclude the SME R&D Tax Credits have been cut principally for reasons of abuse and fraud.

Yet the key Government witness to Lords Sub-Committee, Financial Secretary to the Treasury Victoria Atkins MP, struck a noticeably different tone by denying that fraud and error were the main reasons for the reductions to the SME scheme.

Ms Atkins confirmed the switch from supporting SMEs towards higher benefits for large companies:

“We looked [in the Autumn Statement] to really drive forward the RDEC scheme [for large companies] and also to tighten up the SME scheme”.?

This is due to HMRC figures published in 2019 and 2020 which apparently show much lower levels of additionality for the SME scheme (￡0.60-￡1.28 of additional R&D for every ￡ put in) compared with the large company scheme (￡2.40-￡2.70 of additional R&D for every ￡ put in).

Lord Turnbull was unconvinced by the line taken by Ms Atkins, as his opening question demonstrated:

“…all SMEs are now facing a lower rate, penalising equally those who are entirely diligent about the [R&D] claims that they make and those who take a chance with HMRC.?And the alternative could have been that rather than reducing the rate, [HMRC’s] “challenge rate” could have been increased so you're trying to find the ill-judged or chancy applications and disqualifying them rather than reducing the rate for all companies, including those who are entirely scrupulous about their applications”.

Ms Atkins replied:

“It may be that the media scrutiny…in recent weeks is at risk of giving the impression that we have made these decisions solely to combat fraud. That is not the case. We have done this very much because we want to increase value for taxpayers in relation to the [RDEC] scheme we know shows the most benefit” .

Possibly recalling that it was the Chancellor himself who had given everyone the impression that abuse and fraud were behind the cuts, Lord Turnbull pressed on:

“You are taking money out of one pot – the SME pot – and putting it in the RDEC pot. [This] comes out of those companies that have got an entirely blameless record of the quality of the application they put in”.

There was a total failure by any of the witnesses to address this issue.?

Ms Atkins decided to ignore the question entirely and, incredibly, went on to suggest that “legitimate” SME claimants should actually be grateful for the new measures being put in place as they would ensure that they are “paid properly what they are owed by the taxpayer!”

This exchange revealed a major inconsistency in the Treasury position.

On the one hand, the Chancellor blames the cuts to the SME R&D scheme entirely on “concerning reports of abuse and fraud” yet from 1 April 2023, HMRC is introducing widespread measures to combat these problems.

Once the anti-fraud measures kick-in, and rogue R&D advisors and spurious “claim farms” are taken out of the market, then it can be assumed that the number of R&D claims by SMEs will be drastically reduced.

Bizarrely, the witnesses were keen to boast that the UK has the highest number of companies claiming R&D Tax Credits in the OECD.?

It seems a bit odd on the one hand to trumpet the large number of R&D claims being made in the UK whilst also suggesting that many of these claims are entirely bogus due to lax oversight of the scheme by HMRC.

The trouble with the Chancellor's statement pinning all the blame on fraud and abuse is that if the fraud and abuse problem is solved then perhaps the R&D Tax Credit rate for SMEs needn’t be reduced.

I believe that this is the reason why Ms Atkins backtracked by focussing mainly on the results of HMRC surveys.?

It is also possible that Ms Atkins has been influenced by a now outdated report from the Cambridge Judge Business School -?rumoured to be required reading at the Treasury - which stated that SME R&D claimants mostly think of R&D Tax Credits as being like an unexpected legacy from a long-forgotten Aunt in Australia rather than an essential component of a start-up’s funding model.

It is of course entirely understandable that the Chancellor has to be seen to be taking action with ￡469 million said to be lost to fraud and error in 2021-22 alone, along with awkward media stories of bogus claims for blueberry-flavoured croissants and vegan pub menus.

This is acutely embarrassing for both the Treasury and HMRC but to penalise high-tech, high-growth SMEs in this way is a staggering admission of failure.

Does the Treasury really believe that businesses won’t mind??That they won’t change their investment decisions – and more importantly locations??This is surely wishful thinking.

Perhaps the Treasury is aware that it has over-reacted with these planned reductions as it has been suggested that R&D-intensive SMEs might require additional support which they are open to discuss this with trade bodies such as the CBI and Federation of Small Business.

On behalf of all legitimate SME R&D claimants, let's hope that the Chancellor and the Treasury see sense and re-consider some of these frankly illogical cuts to a highly beneficial scheme that has been instrumental in the UK becoming second only to the US in terms of start-up investment globally.

Rufus Meakin is a specialist in helping 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.