In April, the government discreetly addressed the House of Lords’ inquiry into R&D tax relief. The government’s response provides hints on current thinking as we wait for further proposals on a merged R&D tax incentive.
In this article we delve into some of their key statements and offer some suggestions in reply.
Enhancing R&D tax relief: House of Lords report and government response
The Finance Bill Sub-Committee of the Lords’ Economic Affairs Committee conducted an inquiry into the draft legislation that was published on ‘L-day’ in July 2022. A comprehensive examination was undertaken after a request for written submissions. The Sub-Committee also listened to oral testimonies from witnesses (including from ForrestBrown) representing professional bodies for the tax and accountancy profession, along with business and industry associations.
House of Lords report – key findings and recommendations
The House of Lords’ inquiry, the result of which was published in January 2023, scrutinised recent changes to the R&D tax relief scheme, revealing some shortcomings in HMRC’s approach to administration and compliance. These included inconsistencies, inadequate consideration of claimants’ information, unfocused and inefficient enquiries, and a lack of constructive engagement with innovative businesses, taxpayers, advisers and agents. The report presented 56 insightful conclusions and recommendations to enhance the effectiveness of R&D tax relief schemes for beneficiaries across industries.
Unveiled amidst minimal fanfare, the government published a concise 17-page response on April 13, 2023. This response, tucked away on the committees’ website, sheds light on HMRC’s future strategies concerning R&D tax relief. By analysing the government’s response, we gain valuable insights into their thinking and the potential directions for refining the existing schemes. These insights provide a foundation for future discussions and improvements to R&D tax relief.
The report by the House of Lords Economic Affairs Finance Bill Sub-Committee published on 31 January, and the subsequent government response, mark important milestones in the ongoing efforts to improve the R&D tax relief schemes both for business and the taxpayer.
The publication of the Lords’ report was an opportunity to address valid criticisms raised and consider a range of recommendations. It provided HMRC and the government with an opportunity to effectively streamline the claim process, foster innovation, and provide greater support to businesses engaged in R&D.
It was encouraging to receive confirmation that the government recognises the important role that R&D plays in driving innovation and economic growth. As the UK’s leading specialist R&D tax relief consultancy, ForrestBrown sees first-hand the positive impact R&D tax relief incentives have for businesses across the country.
At a time of unprecedented change for R&D tax relief, we welcomed the Lords’ report. It provided a timely review of the latest measures announced and we supported the majority of the recommendations made as did the government in its response.
However, there were several recommendations which were not accepted that we believe are worthy of further consideration, particularly to inform design of the proposed single scheme for R&D tax relief. We explore these suggestions below, grouping the broader detail into three key themes for improvements to R&D tax relief:
The current guidelines and definitions for R&D tax relief are convoluted and outdated. We recommend a comprehensive review of the guidelines to provide clear and practical examples, which would be of particular benefit to the digital and technology sectors.
This review should be conducted regularly, with a commitment to updating the guidelines at least every five years. Additionally, the Advance Assurance process should be extended to cover claims for RDEC, and the conditions for applying for Advance Assurance should be reconsidered to remove unnecessary barriers.
The approach to reform R&D tax relief should also be simplified. The Autumn Statement in November 2022 saw the slashing of the SME rate. The Spring Budget then provided a response to the subsequent backlash from this measure by adding a whole new rate for ‘R&D intensive’ SME’s, rather than just reverting the decision or walking back a proportion of it. It is not clear how this prioritises simplicity – something innovative businesses of all size have been calling for.
We agree that adding a level of additional complexity is necessary to protect against fraud. But these measures need to be judged against the overarching policy objective of R&D tax reliefs, which is to encourage specific investment behaviours. In particular, the government should carefully consider the impact of proposed restrictions on overseas R&D expenditure, as in its current form it could reduce rather than increase UK R&D. Despite the 12-month reprieve on this measure, businesses with a global footprint tell us that the threat of it is already having a negative impact on UK R&D investment decisions.
If the future of R&D tax relief is a single scheme, we should be focusing on long term stability to help provide certainty and foster innovation, rather than changing rates for a short period of time which can only add to the burden of complexity.
At ForrestBrown we would suggest the government act as the Lords’ inquiry recommended, by:
- setting out a clear plan and timeline for the introduction of a single scheme;
- within that plan reviewing and updating the definition of R&D (including examples);
- addressing how subcontracting will be dealt with within the single scheme model, through more open consultation on different options;
- and what case there is for different rates of relief for small/large businesses AND priority sectors/projects,
- exploring how Advance Assurance could help minimise erroneous claims.
The lack of transparency and consultation in the decision-making process is a matter of concern. Whilst HMRC has rightly raised concerns about errors and fraud, and pointed to abusive behaviour from a minority of R&D agents, there has been no mention of moving forward with the consultation on regulating the professional tax advice market.
The measures designed to target error and abuse within the relief do so indirectly, by seeking to improve the data HMRC has available with which to target its compliance resources. An obvious direct action to improve the quality of R&D claims by addressing fraudulent and unethical behaviour would be to improve the quality of R&D advisers, by regulating the tax advice market.
Professional tax advisers are an essential part of the tax system in the UK, and effective engagement between HMRC and tax advisers is critical to the success of incentives like R&D tax relief – good tax advisers help businesses to get their claims right. The tax industry itself is motivated to improve standards and work alongside HMRC in addressing poor behaviours. Industry, business and government should work alongside each other to make this a reality to benefit the taxpayer as well as UK plc.
Our immediate recommendations include:
- renewed engagement between HMRC’s agent strategy team and the tax and accounting professional bodies, to seek consensus on appetite for a stronger regulatory framework for the profession;
- a new round of consultation on raising standards in the tax advice market, seeking views from stakeholders on what’s going wrong and options for improvement;
- to improve transparency in understanding potential error and fraud in R&D tax reliefs fully, the government should disclose the results of the sampling exercise that is designed to help develop a new methodology to distinguish between error and fraud;
- HMRC should introduce a code of conduct for members of the R&D Communication Forum, including a disciplinary process for poor behaviour. This will facilitate greater trust in this forum and enable more collaboration between HMRC and R&D advisers.
The complexity of the guidelines and the lack of accessible information hinder SMEs from understanding and accessing R&D relief. We urge HMRC to undertake a comprehensive review of its published guidance, making it more user-friendly and accurate.
This review should involve meaningful engagement with representative bodies from accountancy, tax, and business sectors to ensure the guidance meets the needs of SMEs.
The re-launch of the Advance Assurance process for SMEs could provide far more companies with a direct communication channel to discuss their R&D claim with HMRC. HMRC should use various communication channels to promote its uptake effectively, while considering the additional resource commitment required. The principle of redeploying some compliance resources towards preventative activity such as Advance Assurance including further written guidance and webinars could pay dividends.
Additionally, the government’s response fails to address the need for an open-ended consultation on possible changes to R&D tax relief. Stakeholders should be invited to provide suggestions for change, rather than responding to predetermined proposals.
The Lords’ report called for an awareness campaign – which is what ForrestBrown recommends – targeting efforts to educate businesses on how to access relief as well as what does and does not attract relief. This would provide positive engagement, designed to level relief at genuine R&D, with a balanced approach to compliance.
Working together: fostering innovation, remaining competitive
In conclusion, we strongly recommend that the government takes immediate action to simplify the guidelines, develop the regulatory aspect of the incentive by shining a light on future consultations and decision-making processes, and enhance communication to ensure the effectiveness of R&D relief – the government’s primary tax policy lever for incentivising business R&D activity.
By doing so, the UK can continue to foster innovation and remain competitive in an ever-changing global landscape.