HMRC has published revised estimates on the level of error and fraud in claims for research and development tax credit, which estimates error and fraud accounting for over £1billion of expenditure claimed. We discuss how this may impact your R&D claim going forward.
On 17 July 2023, HMRC published revised estimates of the level of error and fraud within the R&D tax relief credit scheme using a completely overhauled method to calculate these figures. The new methodology for estimating the level of non-compliance has changed significantly by using a mandatory random enquiry programme (MERP). Under HMRC's new approach, there have been significant efforts made to reduce fraud over concern about boundary-pushing and abuse, which has already been seen by claimant companies in the form of compliance checks. The published estimates support HMRC's claims that there is an unacceptable level of fraud and risk-profiled claims across different business sectors. Although the statistics will not reflect the recent changes to the scheme, such as the additional information form, the additional checks on clients will be used to quickly assess the validity of any claim. HMRC's hard stance on reducing non-compliance has resulted in HMRC blocking £85 million in fraudulent claims, varying from mistake and failure to take reasonable care through to deliberate non-compliance.
Fraud statistics
In the 2020-2021 period, the number of R&D claims continued to rise, with a total of 89,3000 R&D claims, equating to a total of £6.6 billion expenditure claimed. When reviewing the overall level of error, the updated estimate of the level of error and fraud for both SME and RDEC has increased from the previous estimate of 3.6%, up to 16.7%, which equals £1.13 billion estimated fraud for 2020 to 2021.
What does this mean for future claims?
Specifically, the statistics highlighted that small or medium-sized companies were far more likely to submit non-compliant claims than larger companies, with the percentage of non-compliance increasing to 3.6% in the RDEC scheme, and 24.4% in the SME scheme. This statistic will result in small or medium companies being targeted in compliance checks more than the larger companies as the government made it clear that this level of non-compliance is unacceptable. Therefore, businesses claiming under the SME scheme need to factor in responding to a compliance check as part of their R&D claim process.
In HMRC's sector analysis of Standard Industrial Classification (SIC) codes, the highest levels of compliance were in claims where the main trade classification is 'professional, scientific, and technical activities', followed by manufacturing. Claims with the lowest rate of compliance include Education, Construction, and 'Arts, Entertainment, and recreation". HMRC estimates that only 11% of claims in the Education sector are complaint, whereas 69% of manufacturers were complaint. Given the estimated low level of compliance among sectors such as construction and education, it's likely that future claims for R&D tax relief in these sectors will continue to be under close scrutiny by HMRC. If your SIC code registered with companies house falls within a high-risk sector, you should prepare for a compliance check in the near future, in sectors such as care home or restaurants where HMRC have flagged as being non-qualifying, making a claim will be extremely difficult going forward.
Based on HMRC's updated analysis, as the size of expenditure decreases, the value of the non-compliance expressed as a percentage of the value of the claim, increases. For example, in claims where expenditure exceeded £1 million, around 75% of claims were fully complaint, however, in claims where the expenditure was less than £10,000, over 75% of the value of the claim was non-compliant. Here, the smaller the amount being claimed for, the more likely it was to be non-compliant, which supports HMRC's long-held viewpoint that to be undertaking eligible R&D, you must invest sufficiently. This presents innovative new start-ups with a conundrum. They may not have the resources available to defend their claim in the case of a compliance check, so should they claim or wait until the business is bigger? This will potentially cut off a source of funding for new businesses that are too fearful about making a claim in the current challenging environment.
Our thoughts
HMRC's efforts have been focused on risk-profiling claims across different business sectors. Therefore, it's expected that HMRC will broadly target companies that fit into those 'high-risk' categories. In addition, the fraud statistics published support HMRC's belief that claimants will have to spend money to undertake qualifying R&D, so it's expected that claimants with a small amount of qualifying expenditure will face harsh scrutiny when submitting a claim. Overall, there will be far more red tape for companies looking to apply, and claimants will face significant challenges when preparing a claim to submit the right information. This needs to be factored into making a claim and any budgeting that includes the benefit of an R&D claim. We can advise businesses on how to plan for making a claim at the current time and how to business this into an overall R&D strategy that takes into account the wider changes to the UK scheme.
Claimants who sit inside the high-risk sectors should take expert advice from specialist R&D advisers prior to submitting a claim. It may be that given the extra costs to prepare the claim and potentially respond to a compliance check economically, it might be better to spend this effort elsewhere. Although we support HMRC's efforts to reduce levels of fraud within the scheme, it's concerning that HMRC's aggressive crackdown on R&D tax credit fraud may reduce genuine claimants from submitting R&D claims, and this stance could have a direct effect on innovation within the UK.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
