R&D tax fraud, error and non-compliance

R&D tax fraud is a serious thing, but most of what’s occurring is error and non-compliance. In light of R&D changes and new laws, diligent companies are liable to make errors despite taking care when preparing an R&D claim. ForrestBrown is here to help you understand changes to the incentives, the context behind them and the importance of remaining compliant. In this article, we look at the extreme end of non-compliance; R&D tax fraud and what companies should be aware of.

What is R&D tax credit fraud?

R&D tax fraud refers to deliberate non-compliance with the legislation governing the incentives. It can take different forms:

• companies submitting fraudulent claims, overvaluing or fabricating R&D; or
• advisers submitting fraudulent claims on their behalf.

HMRC has a responsibility to ensure that funds are correctly awarded to eligible innovative companies and is focused on fighting fraud anderror with all the powers at its disposal. It expands on the definition of R&D fraud: “To be classified as fraud, a caseworker needs to have found evidence that the claimant deliberately set out to misrepresent their circumstances to get money to which they were not entitled.”

Examples of R&D fraud

Over the years, HMRC has prevented numerous criminal attacks on the R&D system involving fraudulent or hijacked businesses. It has in turn blocked millions of pounds in fraudulent claims and arrested perpetrators.

There have been some blockbuster cases of R&D fraud that have grabbed headlines over the years, like the Convergica case. This involved a fraudster using his business to claim £29.5m in tax relief against a purported £137m spent “on developing an IT healthcare system for two countries in the Middle East”.

In 2020, six men were arrested after an investigation into a suspected multimillion-pound R&D tax relief fraud scheme. More recently – in October 2024 – HMRC undertook searches in multiple locations as part of an ongoing investigation into alleged fraudulent activity in R&D claims. These are though the most spectacular examples that slip into the public sphere.

As the tax advice market is unregulated, there are also cases where unscrupulous advisers have made fraudulent claims without their client’s knowledge. As R&D claims are made via the self-assessment process, it is the company that would first be informed of an enquiry by HMRC. If the company was unaware of the agent’s actions, it would need to be able to clearly show this to HMRC.

What is the extent of fraud in R&D tax relief?

Error and fraud in R&D tax relief was estimated by HMRC to be 16.7% of all claims across both reliefs in 2020 to 2021, totalling £1.13 billion. This was significantly higher than the previously published estimate of 3.6% (£336 million) for 2020 to 2021. However, HMRC’s Annual Reports and Accounts 2023-2024 indicate that the error and fraud figure has since declined to around 7.8% for 2023/24 – though the figures are currently estimates. We will cover the issues with the statistical reporting of error and fraud below.

Of the overall figure for error and fraud, error makes up a large proportion. These range from mistakes to failure to take reasonable care – with deliberate non-compliance making up just a fraction. Given the recent changes to the incentives, non-compliance is more likely.

One way to get an indication of the breakdown of fraud and error is to examine HMRC’s Mandatory Random Enquiry Programme (MREP) data, for claims made by small and medium enterprises (SMEs). The latest set of data – covering MREP2 – was published in October. It revealed that in 2021 to 2022, around half of claims from SMEs were non-compliant in part or in full, and 30% of claims were non-compliant in full. 

HMRC’s analysis of this data highlights that the largest reduction in the value of claims was where expenditure was below £20,000. Analysis of Standard Industrial Classification (SIC) sectors also showed that the greatest reduction in the total value of claims was in sectors that typically would not expect to see large volumes or values of R&D claims, notably the arts, entertainment and recreation, and hospitality.

Although R&D fraud is rare, errors in R&D tax relief claims have become increasingly common, driven by a lack of awareness among companies of the process and their obligations. This has encouraged spurious R&D advisers willing to take advantage.

The compliance environment is though ever changing and HMRC has published additional guidance (GfC3) for claimants that does highlight the expectations and obligations. These changes combined with regular updates to the incentive (such as mathematics becoming a qualifying science, data and hosting costs becoming allowable expenditure and recent rate changes) mean that companies are more likely than ever to make an unintended mistake.

R&D tax fraud statistics

Statistics around error and fraud in R&D tax relief have been plagued with controversy. Historically, the National Audit Office’s (NAO) reports on HMRC’s annual accounts had identified costly amounts of error or fraud in its R&D figures.

Data published by the Office of National Statistics (ONS) seemed to back this up, painting a fairly dismal picture of R&D tax incentives over a number of years. The annual BERD stats that are used to measure the UK’s total investment in R&D highlighted a large gap between R&D expenditure reported in the survey and the figure shown in HMRC’s data, underpinning claims for R&D tax relief.

At first glance, this discrepancy seemed to imply that spurious claims were relatively widespread with relief being awarded for projects that weren’t R&D according to the BERD survey. HMRC’s response to this was to run a mandatory random enquiry programme, using that data to update its estimate of error and fraud to over £1bn. This process triggered many of the changes to the incentives discussed in this article and will be negatively impacting some of the UK’s most innovative businesses claiming R&D tax relief.

Inconsistencies with BERD, ONS and HMRC R&D statistics

On reviewing its methodology in 2022, the ONS discovered material flaws in the survey population. This forced it to retrospectively revise its figures. The amount it then published was much more closely aligned with HMRC’s reporting for R&D tax relief.

It then set about updating and improving its methodology to produce a more accurate picture of UK business R&D spend. Figures released in February 2024 continue to paint a more positive picture.

With more accurate ONS data, all parties are in a better position to reflect on the changes introduced and the efficacy of non-compliance measures to ensure that eligible businesses still benefit from the incentives.

Why is fraud an issue?

Fraud and error can result in a significant mismatch between the cost of R&D tax incentives and the innovation generated. R&D tax relief is funded by public money, so there is a responsibility to ensure that it is correctly administered to meet the incentives’ intent. These incentives remain a powerful way of supporting innovative businesses and bringing about positive change in society, stimulating growth in key sectors and the economy as a whole. Non-compliance and abuse undermine this and risk adding an additional compliance burden to legitimate companies.

Measures to tackle fraud and error

HMRC has taken several actions to tackle fraud and error, including increasing its compliance efforts significantly in recent years.

A first wave of changes included the PAYE/NIC cap, updated software guidance and the introduction of the CT600L submission requirement, as well as significantly increasing the number of new compliance officers. More recently, HMRC has continued its efforts to reduce error with more significant changes as outlined below.

Increased compliance efforts

HMRC has increased its capacity and mechanisms to investigate non-compliance. It created an anti-abuse unit in July 2022 with a focus on identifying deliberate non-compliance and criminal activity. The Fraud Investigation Service (FIS) also has a division which focuses on R&D claims and investigates claims with an aim of addressing fraud.

There are now different units within HMRC of non-compliance workers, dedicated to specific business types: Large Businesses (LB), Wealthy and Mid-sized Business Compliance (WMBC), and Individual and Small Business Compliance (ISBC). These units each raise and process enquiries. Alongside enquiries, there are other compliance activities such as nudge letters.

Notification of claims

For accounting periods commencing on or after 1 April 2023, a company intending to make an R&D claim is required to notify HMRC in advance via a claim notification form. This form must be submitted within six months of the end of the company accounting period.

The need to pre-notify only applies to companies new to claiming R&D tax relief or those that haven’t filed a previous R&D claim within the three-year period ending six months after the end of their accounting period. There is a transitional provision that adds complexity to this rule regarding claims filed by amendment after 1 April 2023 that companies must also be aware of. For regular claimants, no notification is required.

Details required for claim notification include a senior internal R&D contact within the company, a high level summary of the planned R&D project and contact details of any agents involved in preparing or making the claim.

If a company is required to notify but fails to do so within the six-month time limit, it will not be eligible to file an R&D tax claim for that period. This represented a significant change for those new to R&D tax relief, who were previously able to look back to two prior accounting periods when making their first R&D claim.

The additional information form

HMRC introduced the additional information form (AIF) as a measure to reduce the amount of R&D fraud. Since 8 August 2023, companies have been legally required to provide supporting information for their R&D claim via this online form. This requirement is true of SME and RDEC schemes and the new merged and ERIS schemes.

Failure to submit the AIF in advance of your Corporation Tax return means your claim will not be processed. The supporting information required includes a description of the R&D projects, the total qualifying expenditure being claimed for each project, and a summary of qualifying expenditure by cost category, with qualifying indirect activities (QIAs) separated out. There is also scope to provide further information.

SME rate reduction

The SME rate reduction, which came into effect on 1 April 2023, decreased R&D tax relief rates for SMEs, with loss making SMEs seeing the largest reduction in potential benefit from 33% to 19%. This compared to a historic RDEC rate of 13%, which was increased to 20% at the same time.

Given the generosity of the old SME rate, concerns had been raised that the higher rate offered might make claims more susceptible to fraud. Bringing the SME rate into line with RDEC has reduced that possibility.

ForrestBrown insights

Although R&D tax fraud grabs the headlines, it is error that is more prevalent. Companies may be claiming erroneously without realising. This is because R&D is a complex area that typically requires support and advice from a specialist adviser.

HMRC’s compliance clampdown has affected all companies, not just those making errors or claiming fraudulently. Enquiries are more prevalent and labour intensive.

We need to be careful that compliance activity does not deter legitimate claimants. The relief must be protected from abuse, but not at the expense of genuine R&D. Balance is critical.

There is a lot of change to the administration of R&D reliefs – not keeping your methodology up to date could lead to HMRC rejecting your claim.