TaxWatch: R&D Tax Credits from an outsider's perspective

Sarah Walton of investigative think tank TaxWatch has written an exclusive guest article for my R&D Tax Credit Insider newsletter.

TaxWatch is an influential UK charity dedicated to compliance and sound administration of the law in the field of taxation and they are currently looking at some of the issues around R&D Tax Credits.

Sarah Walton worked for HMRC as a fully qualified tax inspector for many years. She is experienced in conducting civil investigations into complex cases of tax fraud and avoidance involving all types of taxes and taxpayers.

Sarah is now a researcher for TaxWatch, looking at important issues around tax policy and administration from different perspectives, with a view to raising awareness of problems and potential solutions.

Guest article written by Sarah Walton, TaxWatch

What do R&D Tax Credits achieve?

R&D tax relief is an important government policy intended to incentivise businesses to incur expenditure on R&D that is ultimately expected to bring economic benefits.

Efficient operation of the system behind it is vital to achieve this.

One issue around tax reliefs more generally is that, once introduced, their costs and benefits generally get much less scrutiny than other direct government spending, even if they end up costing significantly more than forecast. It is critical that what is essentially government spending is producing beneficial results for the taxpayer alongside the claimant businesses.

There has long been debate about whether and how much R&D tax relief benefits the economy. Most R&D advisors have stories of businesses that would not have been able to fund their innovations without the reliefs, and the generally held view is that businesses bring forward their R&D investment due to a greater appetite for risk resulting from the existence of the support.

However, it also seems clear that at least a proportion of claims are made in relation to expenditure that was incurred without the businesses being aware of the relief so they could not have been incentivised to carry out that R&D.

The complexity of the schemes means many businesses and their ordinary advisors do not feel able to make claims themselves. This has resulted in the large market for R&D claims specialists in the same way that the increasing complexity of tax generally has increased the tax advice market.

Of concern for R&D relief is the clear growth of firms of advisors using inappropriate marketing and promotion to persuade businesses to make unreasonable claims, taking a percentage cut in the process.

It seems to be well accepted (and confirmed by HMRC estimates of fraud and error) that a proportion of the relief has been going to businesses who do not qualify, along with the fees to their advisors, in some cases a significant percentage of the claim. Recent years have seen little in the way of scrutiny from HMRC which has presumably encouraged more of this approach.

A further cut of the pot also goes in interest and fees to finance companies offering upfront loans against future receipt of claim repayments. It is understandable that businesses wish to improve their cashflow when waiting for repayments. However, the reliefs were not intended to support businesses changing their croissant recipe along with their associated advisors and finance companies.

These concerns have led to the legislative changes coming in this year, including the reduction in benefits in the SME scheme, which will ultimately impact genuine R&D claimants and their advisors alongside the less reputable end of the market.

‘Problem’ advisors

This article will not rehearse the extreme examples of R&D projects claimed to be eligible for relief by a variety of less reputable advisors but it is clear that these are the source of significant numbers of problem claims.

The changes to legislation requiring pre-notification of claims six months after the end of the accounting period will go some way to preventing speculative backdated claims that appear to be part of the ‘overmarketing’ problem.

The requirement to identify advisors compiling the claims alongside a responsible officer within the claimant business is also expected to improve compliance. However, the first pre-notifications won’t happen until around September 2024 and it will be getting on for two years before HMRC are receiving information in a digital format to enable proper targeting of risk assessment. This is plenty of time for many more spurious claims, which could lead to further losses in the region of ￡1bn based on most recent estimates of fraud and error, which would further discredit the system.

Many people within the industry have been advocating for compulsory professional regulation for R&D advisors (and more widely in the tax adviser industry).

Research has shown that 80% of advisors that are not members of professional bodies have no professional qualification, which is surely unusual in the financial services industry and gives rise to significant risks to both clients and HMRC. However, consultation last year on improving the tax advice market resulted in no changes and intentions for a further consultation that has not yet appeared.

In the meantime, problem advisors, who are generally unregulated, are continuing to abuse the system and potentially cause financial damage to those unwittingly accepting their advice if boundary-pushing claims are eventually refused.

The issue of regulating tax advice is obviously a complex one and there is no straightforward answer but the fact that HMRC is still failing to deal properly with problem agents results in poor outcomes for everyone involved in R&D reliefs. It is therefore critical that targeted compliance efforts against problem advisors are stepped up prior to the new legislation kicking in.

HMRC approach and resources

TaxWatch recently submitted evidence to the Public Accounts Committee enquiry into managing tax compliance following the pandemic and many of the issues raised are relevant to how R&D policy is formed, how it works in practice and how HMRC handles compliance.

The report highlights issues with increasing complexity of tax legislation alongside the closure of the Office for Tax Simplification, reductions in the numbers of tax professional staff in HMRC and inexperienced staff working in compliance, lack of long-term funding and resourcing for compliance, and lack of evaluation of new legislation and different compliance approaches.

?Recommendations included:

• urgently explaining the new mandate to be given to HMRC and the Treasury to simplify the tax code
• committing greater funding to compliance given its positive return on investment
• putting in place long term resource planning to ensure a consistent and robust compliance response
• putting in place a programme of evaluation in relation to all new legislation and compliance projects
• considering what other action can be taken against problem advisors.

As Malcolm Henderson said in a previous article , the majority of staff at HMRC want to provide good customer service, and the experience held within the previous specialist R&D units encouraged claims where they were due as well as ensuring compliance with the rules.

Obviously that level of support has been overwhelmed by the huge increase in the numbers of claims, and the current rush to tackle compliance concerns has resulted in the reported scattergun approach to identifying risks and inconsistent treatment between different officers.

Of particular concern is recent evidence from the Institute for Government that between March 2016 and March 2022 there has been a reduction of 8,160 Full Time Equivalent (FTE) staff working within the tax profession in the civil service.?A reduction of that level of highly qualified staff within HMRC obviously impacts on their performance across all sectors and will almost certainly affect the department’s approach to R&D compliance.

There is clearly a concern in the R&D industry that HMRC’s approach to compliance is not working. It has been suggested that compliance staff are not properly trained for the role and do not have enough experienced support to advise on the R&D definition. There appears to be a general feeling that they are often challenging the wrong cases, costing businesses time and money and creating a disincentive to make future claims.

The definition of R&D belonged to the Department for Business, Energy, and Industrial Strategy (BEIS). That definition is a specific difficulty as it is vital for establishing eligibility but is not a tax concept.

The original R&D teams had sector specialists who were available to assist with applying the definition. It is not clear whether those roles still exist, except for software cases where staff from the Chief Digital and Information Office (CDIO) are providing guidance. However, this raises the question of whether there are non-tax professionals within government who would be better able to test claims against the eligibility definition, alongside the tax compliance staff dealing with other aspects.

It seems clear that without a significant improvement in HMRC’s compliance performance on R&D cases, the schemes are likely to suffer further damage impacting on the overall benefits to the economy.

Conclusion

TaxWatch is trying to raise important tax issues both within government and the wider public with a view to addressing problems preventing the operation of a fair and honest tax system.

We are very interested in experiences of continuing overpromotion of R&D reliefs and problems with HMRC compliance and would welcome any comments on these aspects of the current R&D market.

In particular, we would be interested to hear any suggestions for ways HMRC could improve its approach to compliance in the short and long term, in particular in relation to applying the R&D definition.

Sarah can be contacted at [email protected]

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.