07 Feb 2024

SME R&D Tax Relief Assessment by National Audit Office

Ian Davie
Senior Consultant

On January 31, 2024, the National Audit Office published a report assessing Tax Reliefs aimed at stimulating economic growth. The report encompasses various reliefs, including R&D relief, Annual Investment Allowance, plant & machinery for oil and gas, Business Asset Disposal Relief, High-end Television Tax Relief, and Video Games Tax Relief. In 2021-22 alone, these reliefs were estimated to have incurred costs amounting to £14.9 billion. Remarkably, there are an estimated 341 reliefs as of 2023, with a combined cost estimate reaching £204 billion! Staggering numbers. 

In this blog post, I will address the scrutiny surrounding the R&D tax relief, particularly focusing on the criticism aimed at the handling of the SME Scheme by HMRC. During the period spanning from 2015 to 2021, the cost of the scheme exceeded initial estimates by £15 billion.

Issues with the SME Scheme

The report highlights several issues with the SME scheme, including:

  • The unplanned growth of the SME scheme was driven by an increased number of claims 
  • For every £1 spent on the SME Scheme, the economy receives a return ranging from £0.75 to £1.28.
  • HMRC’s own estimate of fraud and error increased significantly from 5.5% (£0.3 billion) to 24.4% (£1.04 billion).

Some the criticisms laid at HMRC in how the SME Scheme has been managed are probably ones we are familiar with, but given that they originate from a Government Audit, they carry significant weight, hopefully urging HMRC to reconsider its current management approach:

  • HMRC prioritised processing the surge in claims instead of tightening controls. 
  • Since 2017, HMRC identified increased tax risks from poor-quality R&D claims, and companies with little UK presence. However, by 2021, HMRC still attributed rising costs to heightened company uptake due to increased attractiveness and awareness.
  • The definition of R&D laid out in the Income Tax Act 2003 and the accompanying DSIT guidelines require expert knowledge to interpret, and some agents aggressively encouraged companies to challenge this definition when submitting claims.
  • HMRC needed to improve training for the increased number of caseworkers (from 88 to 289 FTE) which have been criticised by House of Lords Committee and CIOT (The Chartered Institute of Taxation) for not following HMRC’s own charters and selective application of guidance. 
  • The interpretation of existing guidance was subjective and HMRC has provided further guidance (GfC issued 31 Oct 23) for claimants to improve definitions. 
  • HMRC’s overly optimistic assessment of fraud and error levels resulted in a delayed response. It took an NAO recommendation to prompt HMRC to launch the Mandatory Random Enquiry Programme (MREP) in December 2020, which uncovered higher levels of fraud and error.
  • The costs to HMRC of intervention is high, but not in comparison to the costs of the estimated fraud and error. 
  • At the time of the report HMRC had yet not carried out a formal lesson learnt exercise from its experience with the SME scheme to improve controls for other reliefs. 
  • Lessons identified by the NAO include efforts to mitigate the influence of rogue agents, leading to companies now having to declare the use of tax agents in claims.
  • HMRC has likely underestimated the level of fraud and error for some years and compliance work on older claims may be worthwhile despite costs and difficulties. 
  • Numerous reliefs, not just the SME R&D scheme, fail to achieve their economic objectives, presenting a significant administrative burden.

This last one is quite scathing, HM Treasury and HMRC must ensure that hard lessons are learned from the R&D SME relief, and that they take the steps needed to prevent such a large failure arising again.

 

Conclusion

We know that the SME R&D scheme has been abused, and the NAO has clearly identified HMRC’s role in allowing this to occur. If I can use an analogy here, HMRC was an ostrich with their head in the sand, and from 2021 that ostrich has lifted its head and is now frantically running around in circles creating a lot of dust in its wake.

HMRC needs to listen to the stakeholders, as it claims to be doing, to address these issues in a more organised and informed manner. This is crucial to prevent unwarranted dismissals of legitimate claims based on oversimplified judgments such as “it should be easy to solve” or “no R&D here.”

The NAO did recommend opening compliance checks on older claims, which HMRC can carry out up to 4, 6, or even 20 years retrospectively, depending on the level of negligence. Presently, HMRC seems to view all claims in compliance checks as careless, which is concerning. It’s imperative that HMRC resolves the current chaotic situation, before they start adding more ‘ostriches’, making the current HMRC situation worse.  

The number of staff at HMRC working on R&D compliance has increased by 328%, yet the number of compliance checks opened has surged by 627%. Coupled with the increased workload of risk assessments for new R&D claims, it’s no surprise that HMRC’s response times have ballooned from 30 days to 6 months. We think you’ll agree that’s a lot of ostriches creating tonnes of dust! 

The result of HMRC’s approach is that good companies are avoiding investing in the UK or even relocating their operations abroad, as highlighted in Rufus Meakin’s article cited here. Instead of fostering R&D within the UK, this situation actively undermines the country’s economy.

If you’d like to speak to the TBAT Innovation team regarding R&D Tax Credits, SMEs or your business, get in touch today.

Picture of ostriches

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