The Treasury is edging towards merging R&D schemes – what does that mean for SMEs and accounting?

Last week saw the latest episode in the ongoing debate around the UK’s regime of R&D tax reliefs. One of the knottiest issues to resolve is whether to continue with separate schemes for large businesses and SMEs. There are arguments on both sides but there are legitimate concerns that merging the schemes will make it harder for smaller businesses to access the reliefs they’re entitled to. 

So what happened? The House of Lords sub-committee on the Finance Bill issued its report into the state of play of the UK’s R&D support system. It looked at a range of issues: the definition of what is – and isn’t – R&D, how the regime is designed and administered, how well understood the scheme is and the level of abuse and fraud.  

The Committee’s report will form part of the ongoing Treasury consultation into the future of the R&D relief scheme in the UK. It drew on the input of a range of stakeholders with AAT taking a leading role in giving a front-line view of how the profession engages with R&D reliefs.  

In my evidence to the committee I explained how AAT’s input was based around protecting consumers and encouraging HMRC to provide a greater level of detail and clarity to the purpose, process and guidance of R&D tax relief.

The debate

Under the current regime, SMEs can claim an additional tax deduction of 130% of qualifying R&D expenditure on top of the normal 100% deduction. Meanwhile, larger firms are covered by the Research and Development Expenditure Credit (RDEC) which provides relief by way of a credit, rather than as an additional tax deduction. 

The clarity of a single scheme is appealing to some, especially as it relates to cutting misuse. The current system is vulnerable to abuse; as the committee chair Lord Hurley pointed out, “Fraud and error are costing the taxpayer over £450 million each year.”  

That represents 4.5% of the total cost of R&D relief, an increase on HMRC’s estimate of 3.6% in each of the preceding two years. Crucially, the Revenue reported that the majority of fraud and error emanated from the SME scheme. 

On the other side, there are those that believe the complexity of what R&D is and how it relates to different businesses demands a more nuanced approach. Some fear merging all R&D relief will make it more difficult for smaller businesses to access the reliefs to which they are entitled.  

They argue such a change could risk the UK falling further behind in the global race to build an innovative economy for the coming decades. Certainly when we look how other countries – in Europe, Asia and the US especially – support their companies to invest in R&D, the urgency becomes clear.

Making our voices heard

Reading between the lines, it appears that the Treasury is erring towards merging the schemes under one umbrella. Given that, it’s imperative that the accounting profession gets involved in the discussion.  

What do accountants need from a reformed R&D relief system? What works in the current framework, and what needs to change? How are businesses using it, and what do they need in order to get the best out of the system?  

As with any significant regulatory change, it’s not just about the destination, but also the journey: getting the transition right is crucial to success. As we told the committee at the time, designing a transition that allows enough time for businesses – and accountants – to prepare for the change will be vital.  

This remains a significant issue for all businesses – our job now is to shape the direction of travel to ensure whatever emerges from the process is right for accountants, their clients and the UK’s economic future. 

That’s why we are calling on out members to speak up. The committee report draws heavily on our input, proof that there is willingness among regulators to listen to constructive feedback and input. As the Treasury consultation gathers pace, we are determined to ensure that the voice of the profession continues to be heard.

If you would like to share your views and feed in to AAT’s response to the consultation, please contact [email protected].

Adam Harper, AAT’s Head of Public Affairs & Public Policy, assesses the causes and remedies for HMRC’s underperformance.

The recent Public Accounts Committee report on HMRC performance paints a stark picture of the strains within the UK tax system.  

Although HMRC collected £731b during 2021-22 – its highest ever tax take – it fails to collect 5% of the tax owed annually. The PAC also notes that HMRC “Only expects to recover around a quarter of the estimated £4.5 billion lost to fraud and error in its COVID-19 support schemes.” 

Staff redeployment hamstrings compliance

Returns from compliance activity have fallen by £9 billion. Measured as a percentage of total revenues, they are a full percentage point lower than the pre-Covid level of 4.2%.

Like many public services, a lack of resources lies at the heart of HMRC’s problems.

The drop in compliance-related revenue arises from decisions to redeploy employees in the compliance team to other priority areas, from Brexit to Covid relief schemes. This led to a 9% reduction in compliance team staff.

As Covid bit, HMRC paused many inquiries into suspected non-compliance, except in cases of potential fraud or criminal activity, closing 29% fewer cases in 2020/21 than in the previous year. 

AAT members suffer the consequences

AAT members are witnessing this state of affairs first-hand. Anecdotally, they report hours spent hanging on the phone to HMRC, ending with an unsatisfactory conclusion in some cases, thanks to poorly trained call centre staff.   

This isn’t likely to improve soon. NAO chief Gareth Davies said, “It is concerning that HMRC’s planning indicates that non-compliance may grow following the pandemic. The next two years are critical, and swift action is likely to be needed to stem potential losses”.  

HMRC admits the problem will take time to solve. Its 2021-22 annual report stated: “The tax debt balance is likely to remain above the pre-pandemic average of 2.4% of tax revenues for some years”. 

Under-resourcing has to be tackled 

The PAC was clear: HMRC simply doesn’t have the level of resources needed to meet current compliance demand and maximise the tax revenue that it recovers from fraud and error.  

With lower funding, service levels are dropping as the Revenue struggles to meet its remit. The impact of that is made clear by the reduction in yield. And while the pandemic was a genuine black swan event, there’s no doubt that HMRC staff and systems were already beginning to show the strain. 

HMRC has a difficult but vital job

HMRC faces a difficult job in the current climate. It plays a huge role in supporting businesses in the UK. Its expertise and dedication are not in doubt, and its responsiveness to the continued crisis has been admirable under the circumstances. But customers’ needs aren’t being met, which is hugely damaging.   

Anger over pay levels amid the cost of living crisis has led HMRC staff to back a strike. Although the ballot failed to meet the necessary 50% turnout threshold, if the vote from 47% of staff is anything to go by, those within the organisation can see it failing to serve its purpose adequately.  

That anger won’t go away: without adequate resourcing, even well-intentioned professionals can only do so much. They need the right tools for the job – including training – to deliver a return on spend.  

A report published in December by the National Audit Office showed the average tax compliance officer generated around £1.1m in tax revenue in the year 2021/22. That had dropped from £1.3m per staff member on average in the five years before the pandemic.

Cutting HMRC resources is a false economy

HMRC staffing levels have dropped from 25,500 to 19,500 in recent years.  At the same time, the UK faces generational challenges: 10% inflation is comfortably above rates in France, the US and Germany, while the IMF recently singled it out as the only G7 economy that won’t grow in the next year.  

With growth forecasts cut, inflation rampant and the cost of living crisis showing no real sign of abatement, AAT says that failing to properly resource HMRC is a false economy.   

If we fail as a country to collect enough tax, yields will inevitably drop, creating a vicious circle of funding shortfalls leading to underinvestment, inefficiency and further reductions in yield. 

Investment needed now  

Investment in a fully functioning and effective tax collection system is clearly needed now. All healthy economies that prioritise tax efficiency commit the right level of funding to it over a sustained period, investing in training, headcount and technology to address the demands of a changing tax base.   

If the UK is serious about its desire to climb out of recession and become a world-leading economy again – and wants to support its businesses, big and small – then it cannot achieve that without a fully functioning tax collection system.  

Return on investment 

Teachers, nurses, doctors and firefighters are all making a compelling case for investment in their services. But HMRC’s business case has an advantage – investment can pay for itself many times over.  

The head of HMRC has disclosed that for every pound spent on customer compliance, £18 is recovered. Giving evidence to the PAC, Chancellor Jeremy Hunt responded: “I hope he maintains that 18:1 ratio. If he can do even better, I will consider giving him even more money.” 

Conclusion  

HMRC has a few weeks to try to persuade the Chancellor it can meet his challenge. Equally, in the budget run-in, the Chancellor needs to be asking himself where else he could find an investment that could give him – and the country – an 18-fold return in a time of financial need.