Tackling R&D tax abuse and improving claim compliance

On 20 July 2022, draft legislation was published by the government, which included important changes to research and development (R&D) tax incentives. Announced in autumn 2021, these adjustments are due to be introduced for accounting periods beginning on or after 1 April 2023. The draft legislation includes changes to both the R&D Expenditure Credit (RDEC) and SME R&D tax relief.

Measures taken within the legislation include an extension of the scope of R&D relief to allow data and cloud computing expenditure, as well as an update to the definition of R&D to include pure mathematics. Alongside this, a refocus of relief towards innovation taking place within the UK will affect companies with an international presence.

In addition to these changes, HMRC is reinforcing its commitment to addressing error and fraud in R&D tax relief. This involves the introduction of several new measures that aim to tackle abuse and improve compliance.

The legislation is due to be reflected in the Finance Bill 2022-23. It is still in draft format, so may change between now and April 2023 when it is due to be enacted. To ensure your business is adequately prepared, you need to understand what the changes are and consider what you may need to do before the legalisation takes effect.

What R&D compliance measures are being introduced? 

Several new compliance measures have been announced to aid the tackling of abuse within the R&D incentive. Only some of these have been addressed in the draft legislation, primarily because not all of these measures require new legislation to be introduced.

More detail is needed on a number of these measures to clarify the practicalities on implementation, so we expect to hear more in the coming months.

Pre-notification of R&D claims

This was one of the more widely reported changes announced last autumn. From April 2023, if a company intends to make an R&D claim they must now notify HMRC in advance (of making the claim, not of carrying out the R&D!). The legislation has confirmed that the notification must be within six months of the end of the company accounting period. Find out more about the R&D claim notification form and the key considerations.

The notification requirement only applies to those new to claiming R&D tax relief, or those companies that haven’t claimed for a period of three years. Many companies make a claim each year, for R&D projects which span accounting periods, or because they start new R&D projects regularly. For these regular claimants, no notification will be required.

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 is a significant change for those new to R&D tax relief, who previously will have been able to look back to two prior accounting periods when making their first R&D claim.

The draft legislation does not set out the information to be provided with the notification, nor the mechanism by which this notification will be made. It is expected this will be provided in secondary legalisation before the enactment date.  

Provision of additional information

A point which may surprise some: it has never previously been a legal requirement to provide supporting information alongside an R&D claim. Many companies do provide HMRC with a description of their R&D projects and an analysis of their R&D expenditure, but a substantial proportion do not.

This makes targeting HMRC’s R&D compliance activities more difficult, so from 1 April 2023, companies will be legally required to provide supporting information. If they do not, their claim will not be valid.

While the draft legislation introduces this legal obligation, it does not set out what information is required, in what format, and how this should be provided to HMRC. All of these details are left to HMRC to set out.

It is very likely that the supporting information will include a description of the R&D projects and a breakdown of the R&D expenditure included in the claim.

HMRC powers to remove erroneous R&D claims

Alongside the changes above, the draft legislation bestows extended powers on HMRC to remove erroneous R&D claims. If HMRC “reasonably believes that a claimant company has failed to comply with a requirement relating to the making of the claim”, it can remove the claim.

It is likely that this power will only be used when a company has failed entirely to meet either the notification requirement or the requirement to supply additional information. However, as we do not yet know what information will be specified, there is still some uncertainty regarding the scope of this change and whether it might catch some unprepared companies out.

The legislation confirms that there is no right of appeal where HMRC exercises this power. However, if the relevant time limits haven’t passed the company can re-submit its R&D claim.

Although not included in the draft legislation, these measures have also been announced and are expected to come into force at the same time:

Other R&D compliance measures

Digital R&D claim submissions

From April 2023, all corporation tax returns containing an R&D claim, including amended returns, will only be accepted if filed through HMRC’s online tax return portal. Most R&D claims are filed this way already, as HMRC moves towards a more digital approach to tax in general.

Senior officer endorsement

R&D claims will need to be endorsed – or signed off – by a named senior officer of the claimant company. This change is designed is to encourage businesses to check their R&D claims carefully before submission.

HMRC has found during enquiries into R&D claims that some companies have limited understanding of the details of their R&D activities and costs. This change is targeted squarely at such cases.

R&D agent details needed

Where a company uses the services of an R&D agent, they will be required to provide the details of the agent. This measure will give HMRC clearer data on R&D agents and will, we expect, enable HMRC to focus its compliance activities more effectively.

Why are the changes happening?

The latest HMRC annual report and accounts estimates the level of fraud and inaccuracy within R&D claims for the period 2021-2022 to be at £469m – an increase of £133m from the previous period.

In response – having identified a pattern of irregular claims in April 2022 – HMRC reinforced its commitment to tackling error and fraud within R&D tax reliefs through announcing the acceleration of the creation of their R&D Anti Abuse Unit (announced in the autumn 2021 Budget).

Measures also implemented included the establishment of a threat risk assessment process for all R&D claims, as well as additional payment identification and verification controls for all R&D payments.

In May 2022 the Research and Development Communication Forum (RDCF) were contacted by HMRC to inform members they were pausing the processing of all claims whilst they investigated irregular claims made in the previous period. HMRC has since extended its timeframe for processing the majority of tax credit claims, from 28 up to 40 days.

A number of companies have received letters directly from HMRC’s Fraud Investigation Service (FIS), in which the claimant has been informed that although HMRC has not opened a criminal investigation into suspected fraud, they reserve the right to do so. However bold this may seem, it is a clear demonstration of HMRC’s intent to improve its effectiveness in combatting fraud and erroneous claims within the scheme.

Read the latest updates from HMRC’s 2023 and 2024 annual report.

ForrestBrown’s view on changes to tackle R&D tax abuse 

It has been widely reported that HMRC has come under pressure in recent years to address error and fraud in R&D tax relief claims. It is likely that every reputable accountant and tax adviser has at least one horror story involving a company receiving poor R&D tax advice from a rogue agent.

There are also valid questions regarding the targeting of money spent on R&D tax reliefs. From as far back as 2014, expenditure on which R&D tax relief has been claimed has exceeded the ONS’s annual estimate of business expenditure on R&D. Despite this, HMRC’s clampdown on error and fraud comes as a recent change of tack, following audit comments made in HMRC’s 2019-20 annual report.   

While there is much to be welcomed in these reforms, there is still more to be done to deliver the wide-ranging review of R&D tax reliefs, as promised when HM Treasury launched the R&D tax consultation in March 2021.

The obligation of a company to pre-notify HMRC of its intent to make a claim may have a substantial bearing on new claimants by diminishing the window in which they have to make a claim. It is not clear what information may be required at pre-notification stage, so there is some ambiguity to the efficacy of this measure.

Addressing error and fraud is essential and ForrestBrown welcomes efforts to do so. However it should be remembered that R&D tax reliefs are an important economic tool to encourage UK businesses to invest in R&D. Businesses require clarity and certainty from the government and HMRC for the relief to achieve its goal of increasing overall business investment in R&D.

The upcoming changes to the legislation prove that it is more important than ever to ensure you understand how you may be affected and what steps you can take to ensure your business is ready for implementation. 

Find out about other changes draft legislation recently published by the government. Including changes on the scope of relief for overseas R&D, or delve further into what recent R&D tax relief changes mean for tech companies.

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