Parliament’s Business and Trade Committee argues in its latest report, released yesterday, that tax compliance is crushing small businesses.
Aside from concerns about tax levels and thresholds (about which there is much more to say), they cited estimates from the Federation of Small Businesses that “tax compliance costs small businesses 242 million hours and nearly £25 billion each year”.
The administrative costs of complying with tax obligations – coupled with a host of other tax, cash-flow and cost issues – are contributing to pressures on small businesses “comparable to the pandemic”, the Committee says.
The Committee predictably joined the chorus of concern about HMRC’s ‘War and Peace’ call-waiting times, and about the record-keeping and reporting requirements of Making Tax Digital (MTD). They also quoted businesses and trade associations arguing that it’s becoming harder for small businesses to qualify for R&D tax credits, and to navigate the tax credit system.
This is all very different from the headlines just eight months ago, when HMRC’s annual figures for the ‘Tax Gap’ – the amount of tax that goes unpaid through error, avoidance and fraud – prompted complaints that small business tax non-compliance was killing the public purse. “HMRC has ‘lost control’ of small businesses as missing tax hits 40%”, the Financial Times said. Nearly two-thirds of the nation’s tax gap, according to HMRC, was due to small businesses. The revenue authority’s estimate of their missing tax has ballooned from £11.6 billion to £28 billion since 2018, while that of other taxpayer groups has been stable or falling. Meanwhile another parliamentary committee, the Public Accounts Committee, reported that tax evasion was rife in the retail sector and amongst ‘phoenixing’ small companies, and that HMRC was “not sufficiently curious about the true scale” of the evasion.
Source: HMRC
Missing tax, missing context
Are small businesses tax dodgers or tax compliance victims? Can both these stories be true?
There’s no doubt that compliance pressures are real. We can see a post-pandemic collapse of service functions in many parts of the public and private sector, but the HMRC call-waiting statistics compiled in TaxWatch’s latest ‘State of Tax Administration’ report are a classic of the genre (although figures for the last quarter of 2025 tentatively suggest that things may be getting better). We’ve also tracked rising costs and shrinking benefits of MTD.
Source: HM Treasury / NISTA
But some of the administrative burdens the Business and Trade Committee have highlighted this week are not longstanding dysfunctions of the system. They were introduced in the last 2-3 years precisely to stop a tsunami of small business tax non-compliance which has cost the public finances billions in unpaid taxes and overclaimed tax credits. It is this essential context that is absent from the Committee’s report.
The R&D credit system provides the clearest example. The Committee complains that the activities qualifying for the relief are defined too tightly, excluding arts and social sciences research, or non-scientific but growth-generating innovation. And they say that HMRC is taking too long to process claims, adding to pressure on small businesses’ cash-flow:
“Prior to June 2022, HMRC had a target of processing 95% of SME claims within 28 days, this was extended to 40 days to allow for additional checks to be carried out.
Both problems – tougher checks on claims and stricter policing of the boundaries – are the result of HMRC deliberately beefing up scrutiny of R&D credits. This was a response to the dawning realisation around 2020 that the dramatic increase in public expenditure on R&D credits, especially in the ‘Small and Medium Enterprise’ scheme, was not simply due to making the rates of R&D relief more generous, but to massive error and fraud “among the highest reported across all government spending programmes, including those administered in response to the COVID-19 pandemic”, according to the National Audit Office. Warnings about large-scale abuse from the National Audit Office and others – including TaxWatch – went largely unheeded.
Source: HMRC
Key to the problem was HMRC’s ‘pay now, check later’ policy for R&D credits. We saw football clubs claiming R&D credits on players’ salaries on the grounds that the players were engaged in ‘nutritional research’, or businesses claiming R&D credits for installing a fridge. A mini-industry of R&D credit ‘factories’ sprang up offering to make tax credit claims for businesses on commission – some legitimate, but some flooding the system with thousands of implausible claims. At its peak in 2021-22, HMRC audits found that nearly one in five R&D credit claims were either erroneous or outright fraudulent, costing the public purse an astonishing £1.34 billion, nearly four times larger than HMRC’s original estimate of the problem. The R&D tax credit crisis has led to the National Audit Office qualifying HMRC’s accounts in every year since 2019-20.
HMRC attributes most error and fraud to the ‘SME’ version of the R&D tax credit scheme – although it’s notable that HMRC declined to do a random audit process for large business claimants in the same way, instead basing its (lower) estimates of R&D fraud and error amongst big corporates on its internal risk assessments of the largest taxpayers.
Things have improved: in 2024-25, error and fraud was down to a (still significant) 6 percent, or £481 million. This is substantially due to a raft of administrative changes that have lengthened and tightened the claims process: a new ‘Additional Information Form’, restrictions on the ability of tax agents to receive R&D credits on clients’ behalf, increasing compliance checks from around 1 percent of claims to around 20 percent. The number of HMRC staff working on scrutinising R&D compliance has increased from 100 to 500 since 2020.
On the rebound?
Has the pendulum now swung too far the other way? Is HMRC penalising legitimate small business claimants? In 2024, the Public Accounts Committee argued that HMRC’s programme to tackle R&D credit error and fraud “does not sufficiently target those committing serious fraud over those making honest mistakes.” And several recent tribunal cases have found that HMRC wrongly excluded legitimate claims (though in another 2025 case, a small business that had received over £335,000 of ineligible R&D credits was allowed to keep the money because of a two-year time limit for HMRC to query the company’s R&D return).
Nonetheless HMRC’s random enquiry programme found last year that over one in twenty R&D claims were still erroneous or fraudulent, representing nearly half a billion pounds of public money.
There’s always a balance in tax administration between the cost of compliance and getting taxpayers to pay the right tax. And of course it should be easier for taxpayers to get their tax bills right in the first place: the goal the Committee recommends to reduce the cost of complying with the tax system by 25 percent by the end of this Parliament is a good one – though it is in part our tax system’s numerous carve-outs, credits and exemptions for particular industries or activities that makes tax compliance more complex and costly in the first place.
But half a billion pounds of R&D credits wrongly received by businesses last year is roughly the cost of a GP appointment for every child in the UK. That figure alone should give us pause when we hear complaints that HMRC is cracking down too hard on small business tax reliefs. And although TaxWatch has raised questions about HMRC’s sky-rocketing estimates of small businesses’ unpaid taxes, compared to its ‘tax gap’ estimates for wealthier taxpayer groups, nonetheless if HMRC’s figures are even half right then it’s far from clear that the pendulum has swung too far yet.
Main photo by Caroline O’Brien on Unsplash
