What do directors need to know?

For many small businesses R&D Tax Credits are valuable tax breaks or refunds that can help them financially while they actively invest in research and development. 

Innovating and solving scientific and technological problems can be expensive, which is why SME R&D relief for small and medium sized businesses and Research and Development Expenditure Credit (RDEC) for larger companies are so important. 

SMEs that make a profit can get an additional 130% deduction against qualifying costs, potentially reducing their Corporation Tax burden (For example – for every £100 spent on R&D, £230 can be deducted from taxable profits.)

Loss making SMEs have the option of surrendering their losses for a payable cash credit of up to 14.5% of the loss. 

Businesses claiming under RDEC receive a taxable credit of 20% on qualifying expenditure. 

Claiming R&D credits used to be complicated but straightforward but recent developments mean HMRC are taking a tougher stance on applications now than ever before which directors need to know about before making any future claims. 

Why are HMRC R&D enquiries becoming more frequent? 

Following a series of media investigations highlighting abuses of the R&D scheme which many advisors and financial professionals had acknowledged was happening, a report from a House of Lords Sub-Committee was published which was critical of how HMRC policies had failed to police errors and fraud and demanded that changes were made to improve the scheme. 

Any new compliance checks and implemented changes were always likely to be pursued vigorously but HMRC agreed to publish the results of their Mandatory Random Enquiry Programme (MREP) which would provide a more accurate estimate of fraud and error within the SME R&D scheme. 

In the first sample of 500 random R&D claims surveyed HMRC found that 25% of claims were ineligible, 19% of claims had errors and 10% were outright fraudulent. 

This means that just over half of all claims had outstanding issues that warranted further investigation.

In probable anticipation of increased recovery action, the number of compliance officers employed by HMRC has increased fivefold – going from 30 to 200 so they now have far more resources to follow up enquiries than ever before. 

What to expect from an HMRC enquiry

Due to these perceived new challenges, many small businesses are opting not to claim due to the potential hassle, risk and expense of any inquiry. 

The Chartered Institute of Tax (CIOT) have voiced their concern over the situation asking HMRC to address several issues with their approach including communications, caseworker rejection criteria and penalties, all of which deter legitimate claims and hinder SMEs’ growth. 

Communications have been flagged that due to the increased volume of enquiries, the lines of communication with HMRC now largely occur through email or letter only. 

So if you have claimed for R&D tax credits but are due to be the subject of an enquiry – in the first instance any enquiry will now begin with an initial contact letter. 

HMRC will set out the reasons why they’re investigating the claim and will request further information either in writing or via a conference call.  

From this point onwards, the structure of an enquiry can vary. 

While some R&D tax claim disputes can end here, it’s unlikely that this will happen. Chances are, HMRC will continue to work back and forth with directors to fill any gaps in the claim. 

This means they may:

  • Receive a follow-up letter that will ask more question based on the information you’ve provided
  • Be asked to attend a physical or virtual interview

If there is going to be an interview then preparation is absolutely critical. 

All the information should be thoroughly understood and all evidence should be examined beforehand so that all arguments such as industry baselines, technological advancements sought, limitations of knowledge and work undertaken to resolve technological uncertainties can be understood by the layperson. 

This is important as the HMRC case worker is unlikely to be an expert in the specific field the business operates in.

It’s also reasonable to assume that the new mindset is based on looking for reasons to deny a claim rather than grant one so any possible areas of contention should be tackled first. 

Any enquiries can be raised up to 12 months after any payout and up to 20 years after a payout if fraud is suspected. 

Depending on the results of any enquiries payouts can be reduced or outright refused. Penalties can be levied and prosecution is possible if fraud is proven. 

It may be possible to have penalties ultimately overturned and dropped if the directors have cooperated fully, maintained a full, open and professional dialogue and the disagreements regard technical disagreements.  

Responding directly to the reasons given for any penalty with a detailed account of steps taken to exercise reasonable care and compliance. This can include confirming that the business read and understood HMRC’s guidance and sought professional advice when applying it to their R&D activities.

R&D Tax Credits can be absolutely critical to a business and it can almost feel like an affront if every effort has been made in an application but it is then the subject of an enquiry. 

This is why directors should always use experienced and knowledgeable help and expertise to help look at the business at the earliest opportunity to establish not just eligibility but also help build the tightest possible case to get the funds you deserve and are legally entitled to.