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research and development

R&D relief – still not working?

6th April 2023 by Alex Dunnagan

This piece on research and development tax relief was originally published in the R&D Tax Credit Insider newsletter on LinkedIn.

What does the money achieve?

R&D tax relief is an important government policy intended to incentivise businesses to incur expenditure on R&D that is ultimately expected to bring economic benefits. Efficient operation of the system behind it is vital to achieve this. One issue around tax reliefs more generally is that, once introduced, their costs and benefits generally get much less scrutiny than other direct government spending, even if they end up costing significantly more than forecast. It is critical that what is essentially government spending is producing beneficial results for the taxpayer alongside the claimant businesses.

There has long been debate about whether and how much R&D tax relief benefits the economy. Most advisers have stories of businesses that would not have been able to fund their innovations without the reliefs, and the generally held view is that businesses bring forward their R&D investment due to a greater appetite for risk resulting from the existence of the support. However, it also seems clear that at least a proportion of claims are made in relation to expenditure that was incurred without the businesses being aware of the relief so they could not have been incentivised to carry out that R&D.

The complexity of the schemes means many businesses and their ordinary advisers do not feel able to make claims themselves. This has resulted in the large market for R&D claims specialists in the same way that the increasing complexity of tax generally has increased the tax advice market. Of concern for R&D relief is the clear growth of firms of advisers using inappropriate marketing and promotion to persuade businesses to make unreasonable claims, taking a percentage cut in the process. It seems to be well accepted (and confirmed by HMRC estimates of fraud and error) that a proportion of the relief has been going to businesses who do not qualify, along with the fees to their advisers, in some cases a significant percentage of the claim. Recent years have seen little in the way of scrutiny from HMRC which has presumably encouraged more of this approach.

A further cut of the pot also goes in interest and fees to finance companies offering upfront loans against future receipt of claim repayments. It is understandable that businesses wish to improve their cashflow when waiting for repayments. However, the reliefs were not intended to support businesses changing their croissant recipe along with their associated advisers and finance companies.

These concerns have led to the legislative changes coming in this year, including the reduction in benefits in the SME scheme, which will ultimately impact genuine R&D claimants and their advisers alongside the less reputable end of the market.

‘Problem’ advisers

This piece will not rehearse the extreme examples of R&D projects claimed to be eligible for relief by a variety of less reputable advisers but it is clear that these are the source of significant numbers of problem claims.

The changes to legislation requiring pre-notification of claims six months after the end of the accounting period will go some way to preventing speculative backdated claims that appear to be part of the ‘overmarketing’ problem.

The requirement to identify advisers compiling the claims alongside a responsible officer within the claimant business is also expected to improve compliance. However, the first pre-notifications won’t happen until around September 2024 and it will be getting on for two years before HMRC are receiving information in a digital format to enable proper targeting of risk assessment. This is plenty of time for many more spurious claims, which could lead to further losses in the region of £1bn based on most recent estimates of fraud and error, which would further discredit the system.

Many people within the industry have been advocating for compulsory professional regulation for R&D advisers (and more widely in the tax adviser industry)1. Research has shown that 80% of advisers that are not members of professional bodies have no professional qualification2, which is surely unusual in the financial services industry and gives rise to significant risks to both clients and HMRC. However, consultation last year on improving the tax advice market resulted in no changes and intentions for a further consultation that has not yet appeared. In the meantime, problem advisers, who are generally unregulated, are continuing to abuse the system and potentially cause financial damage to those unwittingly accepting their advice if boundary-pushing claims are eventually refused.

The issue of regulating tax advice is obviously a complex one and there is no straightforward answer but the fact that HMRC are still failing to deal properly with problem agents results in poor outcomes for everyone involved in R&D reliefs. It is therefore critical that targeted compliance efforts against problem advisers are stepped up prior to the new legislation kicking in.

HMRC approach and resources

TaxWatch recently submitted evidence to the Public Accounts Committee enquiry into managing tax compliance following the pandemic and many of the issues raised are relevant to how R&D policy is formed, how it works in practice and how HMRC handle compliance3.

The report highlights issues with increasing complexity of tax legislation alongside the closure of the Office for Tax Simplification, reductions in the numbers of tax professional staff in HMRC and inexperienced staff working in compliance, lack of long term funding and resourcing for compliance, and lack of evaluation of new legislation and different compliance approaches.

Recommendations included:

  • urgently explaining the new mandate to be given to HMRC and the Treasury to simplify the tax code
  • committing greater funding to compliance given its positive return on investment
  • putting in place long term resource planning to ensure a consistent and robust compliance response
  • putting in place a programme of evaluation in relation to all new legislation and compliance projects
  • considering what other action can be taken against problem advisers.

As Malcolm Henderson said in a previous piece, the majority of staff at HMRC want to provide good customer service, and the experience held within the previous specialist R&D units encouraged claims where they were due as well as ensuring compliance with the rules4. Obviously that level of support has been overwhelmed by the huge increase in the numbers of claims, and the current rush to tackle compliance concerns has resulted in the reported scattergun approach to identifying risks and inconsistent treatment between different officers.

Of particular concern is recent evidence from the Institute for Government that between March 2016 and March 2022 there has been a reduction of 8,160 Full Time Equivalent (FTE) staff working within the tax profession in the civil service.5 A reduction of that level of highly qualified staff within HMRC obviously impacts on their performance across all sectors and will almost certainly affect the department’s approach to R&D compliance.

There is clearly a concern in the R&D industry that HMRC’s approach to compliance is not working. It has been suggested that compliance staff are not properly trained for the role and do not have enough experienced support to advise on the R&D definition. There appears to be a general feeling that they are often challenging the wrong cases, costing businesses time and money, creating a disincentive to make future claims

The definition of R&D belonged to the Department for Business, Energy, and Industrial Strategy (BEIS) (possibly now Science, Innovation and Technology?). That definition is a specific difficulty as it is vital for establishing eligibility but is not a tax concept. The original R&D teams had sector specialist who were available to assist with applying the definition. It is not clear whether those roles still exist, except for software cases where staff from the Chief Digital and Information Office (CDIO) are providing guidance. However, this raises the question whether there are non-tax professionals within government who would be better able to test claims against the eligibility definition, alongside the tax compliance staff dealing with other aspects.

It seems clear that without a significant improvement in HMRC’s compliance performance on R&D cases, the schemes are likely to suffer further damage impacting on the overall benefits to the economy.

1Raising standards in the tax advice market: Summary of responses and next steps, HMRC, November 2020, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/934614/Raising_standards_in_the_tax_advice_market_-_summary_of_responses_and_next_steps.pdf

2Understanding the characteristics of unaffiliated tax agents, HMRC, November 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1037031/Understanding_the_characteristics_of_unaffiliated_tax_agents.pdf

3Written evidence submitted by TaxWatch, Public Accounts Committee, January 2023, https://committees.parliament.uk/writtenevidence/115783/pdf/

4R & D tax credits: Customer service examined, R & D tax credit insider, 2 February 2023, https://www.linkedin.com/pulse/rd-tax-credits-hmrc-customer-service-examined-rufus-meakin?trk=news-guest_share-article

5Civil Service Staff Numbers, Institute for Government, 15 December 2017, https://www.instituteforgovernment.org.uk/explainers/civil-service-staff-numbers

TaxWatch give evidence at Treasury Select Committee

28th December 2022 by Alex Dunnagan

TaxWatch Acting Director Alex Dunnagan gave evidence to the Treasury Select Committee (TSC) on Monday 19th December highlighting the abuse of tax reliefs.

Written evidence

In November we submitted written evidence to the TSC for their inquiry on tax reliefs, focussing on both Creative Sector reliefs and the R&D reliefs.

TaxWatch’s evidence pointed out that Creative Sector reliefs are costing far more than anticipated, with the vast majority of these reliefs going to large multinational corporations. These multinationals are developing entertainment products that would likely have been produced regardless of whether or not the relief was available.

We also highlighted that companies claiming hundreds of millions of pounds in reliefs are engaging in profit shifting. These multinationals are producing games and films in the UK while claiming relief, then selling the taxpayer subsidised intellectual product at effectively cost price to overseas parent companies. It is these overseas companies, usually US based, which then distribute the product, generating significant profits, and with that, significant Corporation Tax bills outside the UK.

As for R&D reliefs, we pointed out that HMRC’s estimate of fraud and error with R&D relief (£469m in 2021-22) is likely a significant underestimate. While the true scale of abuse with R&D reliefs is not known, it could well costs billions of pounds every year. Without adequate compliance checks, we will simply never know the true scale of fraud and error.

Our evidence also pointed out that there are tax advisers boasting of 100% success rates in applying for R&D relief. There are companies that offer software which auto-generates relief claims, and accountants stating that it is the government intent to provide R&D relief for things such as cocktails and menu updates. This clearly is not the intent of Parliament.

Treasury Select Committee session

In addition to the facts presented in the written evidence, during the oral evidence session, Alex was able to highlight the lack of scrutiny these reliefs receive. There are close to 1,200 reliefs, the majority of which receive little to no government scrutiny. Even the smaller reliefs can have expenditures larger than government departments. Video Games Tax Relief, originally forecast to cost £35m a year, cost £197m in the year ending March 2022. The Serious Fraud Office by comparison had a budget of £74m last year.

The session was attended by Harriett Baldwin (Chair); Rushanara Ali; Anthony Browne; Dame Angela Eagle; Danny Kruger and Siobhain McDonagh. The panel consisted of Alex Dunnagan, Acting Director, TaxWatch; Dr Hosam Al Kaddour, Head of Teaching and Learning, Accounting Department, University of Southampton; Anita Monteith, Head of Taxation Policy, Institute of Chartered Accountants in England and Wales; and Dr Jo Twist OBE, CEO at UK Interactive Entertainment.

TaxWatch welcomes any opportunity to present further evidence on tax reliefs.

The full transcript for the evidence session is available here.

Budget 2021 – Four tax takeaways

2nd November 2021 by Alex Dunnagan

On Wednesday 27 October, the Chancellor Rishi Sunak unveiled his Autumn Budget 2021.

This budget was billed as one looking ahead to the “post-Covid” era, with a lot of focus on growth and the economic outlet. Numerous news outlets have covered the major stories coming out of the budget. At TaxWatch, what we have scrutinised is the perhaps lesser covered tax stories.

1 – Additional Compliance Work

An additional £292m across three years was announced for HMRC, with the goal of ‘bearing down on tax avoidance and evasion’.

The Taxpayer Protection Taskforce, announced in the Spring 2021 budget, is to see an additional £55m of funding next year. This is in addition to the previously announced £100m investment. It is not clear whether this £55m is part of the aforementioned £292m.

This taskforce will seek to recoup money wrongly claimed from pandemic support schemes, such as furlough.1 The spring announcement on the Taxpayer Protection Taskforce stated that it will be staffed by “HMRC operatives” suggesting that staff are to be moved from elsewhere within HMRC.

The March 2021 Budget revealed that the extra spending on compliance would actually lead to less in tax being collected year on year until 2023-24, with one reason given being “impacts on compliance yield reflecting reprioritisation (including to respond to COVID19).”2

Budget 2021 policy decisions (£ million)

HMRC is set to see a “£0.9 billion cash increase over the Parliament to £5.2 billion in 2024-25”. Spending Review 2020 revealed that £1bn would be going to HMRC “to reform and enhance the UK customs system after the end of the transition period, including investment in vital physical and IT infrastructure and additional support for UK traders”.3 So while the £0.9bn cash increase sounds impressive, it’s worth bearing in mind that the vast majority of this will not go towards tackling tax fraud, but rather to deal with the additional complexities surrounding the UK’s departure from the European Union.

2 – Clamping down on promoters of tax avoidance

The budget also revealed that the forthcoming Finance Bill 2021-22 will feature legislation for further measures to clamp down on promoters of tax avoidance.

Section 5.74 of the budget announced that the measures will:

  • allow HMRC to freeze a promoter’s assets so that the penalties they are liable for are paid
  • deter offshore promoters by introducing a new penalty on the UK entities that support them
  • provide for the closing down of companies and partnerships that promote tax avoidance schemes, and
  • support taxpayers to steer clear of avoidance schemes or exit avoidance quickly, by sharing more information on promoters and their schemes.

In September 2020 we submitted evidence to HMRC as part of their consultation “Tackling Disguised Remuneration Tax Avoidance”,4 calling for those who sell disguised remuneration tax avoidance schemes to be investigated for tax fraud.

These proposed measures stop short of HMRC applying the full criminal law to prosecute those who design, operate, and promote dishonest tax avoidance schemes. TaxWatch’s view remains that the best deterrence is to put those who promote fraudulent schemes before a jury.

3 – R&D reliefs need to be made ‘fit for purpose’

Plans to increase R&D investment to £22bn per year, as outlined in the March 2020 budget, have been pushed back from a targeted May 2024 to 2026-27, with the government acknowledging that current R&D reliefs are not fully “fit for purpose.”

It has long been known that the cost of the R&D expenditure credits is far greater than what was originally anticipated, with a February 2020 NAO report highlighting that the actual costs were more than double those forecast.5

Costs compared with forecast for the research and development (R&D) expenditure credit

Sunak stated in his speech that:

“Companies claimed UK tax relief on £48bn of R&D spending. Yet UK business investment was around half of that, at just £26bn. We’re subsidising billions of pounds of R&D that isn’t even happening here in the United Kingdom. That’s unfair on British taxpayers.”

While it’s correct that there are issues with R&D reliefs, the cause of the problem isn’t necessarily research conducted abroad, but whether or not the research is conducted at all.

The total number of claims for R&D tax credits for 2019-20 was 85,900, with £7.4bn in relief claimed on £47.5bn of expenditure. The ONS estimates that businesses only carried out £25.9 billion of privately-financed R&D in the UK in 2019.6 Overseas expenditure can qualify for tax credits, and HMRC previously produced an initial estimate of £4 billion to £7 billion for overseas expenditure in the year ending March 2018. It is highly unlikely that the amount of overseas expenditure in 2019-20 was £21.6bn, the difference between UK R&D and total R&D claimed. Rather, the data points to large scale abuse.

The government said it would set out separate plans to combat abuse of R&D tax reliefs “later in the autumn”.

4 – Climate change given short shrift

With the UK hosting the 2021 United Nations Climate Change Conference, known as COP26, it seemed a little odd that there was so little on climate in the budget. A week prior to the budget, the UK Government had published its Net-Zero Strategy,7 with talk of “Removing dirty fossil fuels from the global economy.”

The chancellor failed to use the word “climate” even once during his budget speech. He did, however, reveal there would be a cut to the rate of air passenger duty on domestic flights, along with the cancellation of the planned rise in fuel duty.

 

Image by mohamed Hassan from Pixabay

 

1 Fraud and the Coronavirus Job Retention Scheme, Taxwatch, 12 May 2021, http://13.40.187.124/furlough_fraud/

2 Budget 2021, HM Treasury, March 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/966868/BUDGET_2021_-_web.pdf

3 Spending Review 2020, HM Treasury, 15 December 2020, https://www.gov.uk/government/publications/spending-review-2020-documents/spending-review-2020

4 TaxWatch to HMRC: Prosecute sellers of disguised remuneration schemes, TaxWatch, 02 October 2020, http://13.40.187.124/hmrc_loan_charge_fraud/

5 The management of tax expenditures, National Audit Office, 14 February 2020, https://www.nao.org.uk/wp-content/uploads/2020/02/The-management-of-tax-expenditure.pdf

6 Research and Development Tax Credits Statistics, HMRC, September 2021, https://www.gov.uk/government/statistics/corporate-tax-research-and-development-tax-credit/research-and-development-tax-credits-statistics-september-2021

7 Net Zero Strategy: Build Back Greener, Department for Business, Energy & Industrial Strategy, 19 October 2021, https://www.gov.uk/government/publications/net-zero-strategy


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