Will R&D tax credit changes work?

R&D tax relief changes could put off the wrong claimants and suppress innovation.

R&D tax relief schemes have been the subject of multiple reforms over the years, while continually evolving to align with technological advancements and government areas of focus.

Successive governments have said they want to ‘incentivise investment’ and as such, R&D schemes must be regularly updated, reviewed and amended to ensure they remain competitive and robust.

The two schemes – Research & Development Expenditure Credit (RDEC) – aimed primarily at large companies – and SME R&D tax relief – aimed at small and medium-sized enterprises with fewer than 500 employees, work slightly differently from each other. RDEC allows eligible companies to claim up to 20% of R&D spend as of April 2023 while under the SME R&D tax relief scheme, eligible businesses will benefit from an ‘additional deduction rate’ of 86%. Loss-making companies that are R&D intensive can benefit from a 14.5% reduction.

But from April 2024 the two schemes are set to merge. This is intended to simplify R&D tax relief and reduce fraudulent claims which have become a huge problem in recent years.

Official HMRC figures show increasing levels of R&D claims along with rising fraud: In 2020/21 there were 89,300 claims compared to 43,665 between 2015/16, with a 24.4% fraud rate between 2020 and 2021 for SME scheme and 3.6% for the RDEC scheme.

Under the new scheme, all eligible businesses – regardless of size or number of employees – will be able to claim for R&D tax relief at a rate of 20%.

For loss-making companies wishing to claim for R&D tax credits in the merged scheme, the deduction will be 19% – a change from the current 25% rate for RDEC.

Recent changes to R&D schemes also include:

• Inclusion of pure mathematics, datasets and cloud-computing costs within HMRC’s R&D definition.
• Implementation of enhanced tax relief for R&D-intensive companies of 14.5%, where total R&D spend accounts for 30% of total expenditure.
  • Currently, the threshold definition of R&D-intensive companies is 40% of total expenditure.
• Requirement to submit new R&D claims digitally.
• Introduction of ‘additional information’ form as a mandatory requirement for new R&D claims, which requires detailed information on R&D projects and cost breakdown, company information and approval and sign-off from Senior R&D Officer.

SMEs will need to start preparing as soon as possible in order to make the transition to the newly merged scheme.

Meanwhile, HMRC has been implementing an anti-fraud approach to historic, current and future R&D claims, investing significant time and resources in investigating applications and taking action where appropriate. However, there have been concerns from many in the industry that HMRC is rejecting otherwise legitimate claims and putting many businesses off altogether.

The Chartered Institute of Taxation warned last July that HMRC’s new tough approach was resulting in large numbers of legitimate claims from businesses carrying out ‘genuine research and development’ being rejected, resulting in a ‘breakdown of goodwill and trust’ between HMRC, taxpayers and their agents. The institute said the policy was undermining the original policy intention of encouraging and incentivising R&D.

But what do accountants and AAT members think about the new scheme? We spoke to those with experience with R&D claims for their views on whether the changes will reduce fraud and what impact the new system will have on businesses investing in R&D.

The ‘Additional Information’ document for R&D claims will help more than merging the schemes

Thomas Hayden, Research & Development Director, Moore Kingston Smith

Mathematically, merging the two R&D schemes may give the impression fraud is reducing because the scheme itself is being cut down. But the behaviours and issues which cause fraud are not being addressed, so fraud isn’t really decreasing – it just looks like it is.

However, there has been a recent change which will have a big impact on fraud. Last year HMRC implemented an ‘additional information’ form which is fantastically put together. It makes it very difficult for people to boundary-push.

Usually, boundary-pushing with R&D definitions is where fraud and error comes in. But the questions on the form are worded in such a way that it’ll be obvious that the claim doesn’t meet the criteria.

Personally, I’ve never really understood why the UK has different definitions of R&D from what other OECD countries use. Most countries use the definition in the Frascati Manual which is an internationally recognised methodology for collecting and using R&D statistics.

Overall, I think the changes to R&D have resulted in a lot of collateral damage. I’ve had lots of conversations with overseas tech and science businesses that have changed their minds about setting up in the UK. The scheme is seen as very unstable and there have been drastic changes over the past 3-4 years.

Also, the UK scheme doesn’t compare as favourably with other countries now. In France, the SME R&D scheme provides a 30% net rate reduction but in the UK, it’s 18%. So if you’re an Indian company and you want a R&D hub in Europe, you’re not going to go to the UK, are you?

So this is all really problematic. The optics really aren’t good – it makes it look like the UK does not want to encourage innovation.

Verdict: The newly-introduced ‘Additional Information’ document for new R&D claims will make a bigger impact on fraud reduction than merging the two R&D schemes but overall the scheme has become politically unstable.

R&D changes should be risk-based instead

Vipul Sheth, Chartered Accountant and Managing Director, AdvanceTrack

The government wants to create a unified scheme to streamline the R&D process and prevent more fraudulent activities. However, one size doesn’t fit all and these changes seem disproportionate for many taxpayers.

The changes predominantly come from the fact that a minority of unscrupulous providers looked at RDEC/R&D as an area to make money from. They therefore weren’t applying the same professional scepticism over claims.

But while I do think fraud needs to be addressed, it should be risk-based. I can’t help but feel that this new approach is like using a sledgehammer to crack a nut.

The new system is likely to increase administrative duties, which could be time-consuming and cause resource issues for smaller businesses. In terms of historic claims, not all businesses are represented by agents, good or bad.

A risk-based approach would have been more appropriate, identifying agents that have not had a good history of compliance and allowing those with a strong compliance record the ability to work with the clients both efficiently and ethically by fast-tracking those claims.

Verdict: The R&D changes seem disproportionate overall and instead should be risk-based.

The merged scheme won’t prevent fraud, but will deter legitimate claims

Iain Wheat, Senior Tax Manager, UHY Hacker Young

HMRC estimated that fraud and error accounted for more than £1bn of R&D claims. Although the merged scheme may go some way to reducing fraud, I don’t believe it will significantly dent the total incidences.

However, the recent introduction of the additional information form could help reduce fraudulent claims, given that a claimant company must provide details of a named officer at the company. This should reduce the amount of claims submitted without the knowledge or understanding of the company making the claim.

But the merged scheme may also deter genuine R&D companies from claiming due to increased red tape from reporting requirements. New claimants must make an advance notification to HMRC before a claim and must submit the additional information form. This creates a significant amount of additional work and professional costs, which some companies may think are not worth the hassle.

And from our experience, HMRC has been reluctant to enter into discussions with claimants and it’s increasingly difficult to request an in-person meeting to discuss issues. In some instances, this leads to companies accepting HMRC’s decision on whether the claim is legitimate or not as they don’t have time to spend fighting their case. This results in genuine claims for relief being lost.

Verdict: The merged scheme won’t reduce fraud and will deter genuine companies from making R&D claims.

Would you like to contribute to future articles like this one? If so, please get in touch with Annie Makoff-Clark at [email protected].

Annie Makoff is a freelance journalist and editor.