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Research and Development losses - time for a different approach?

The huge losses from error and fraud revealed in HMRC’s latest annual report underline the Chartered Institute of Taxation’s (CIOT) position that the body’s approach to R&D is not working as it should. A new approach is needed, argues Justine Dignam, Director of Incentives and Reliefs at Markel Tax.

In recent years, the R&D landscape in the UK has been shifting, as a string of policy changes have been introduced.

This week, HMRC’s annual report revealed a significant increase in losses from error and fraud in R&D tax relief. For 2020-21, losses are now estimated to stand at £1.13bn, or 16.7% of claims – “significantly higher than the previously published estimate” of £336m, or 3.6%.  

Since the pandemic, HMRC have also been ramping up its investigations into R&D claims. In a report detailing its compliance approach published at the same time as its annual results, the body notes that in the last three years, it has “more than doubled the number of people working on R&D compliance”, adding an extra 300 staff.

Volume compliance

However, these attempts to crack down on R&D abuse have been met with criticism. Earlier this month, the Chartered Institute of Taxation (CIOT) published a letter to HMRC warning the body that its “efforts to get tough on abuse” had in fact led to “a breakdown of goodwill and trust” between it and taxpayers and their agents. 

The letter states that HMRC’s “volume approach” to R&D tax relief does not work well because of the schemes’ complex nature and the technical consideration required to assess claims properly. This approach, it says, has led to HMRC “rejecting legitimate claims” and “stonewalling genuine claimants” until they decide to withdraw their claims. Ellen Milner, CIOT’s director of public policy, said that the effect on legitimate claimants is like “throwing the baby out with the bathwater”. 

“The CIOT letter draws attention to some examples of poor arguments made by HMRC, and hopefully these will now be removed from its templated responses as a result”, says Justine Dignam, Director of Tax Incentives & Reliefs, Markel Tax. “One example is HMRC’s argument that if a company does not consult it before making an R&D claim, the company can be considered to have behaved carelessly. In fact, as the letter points out, case law and HMRC’s own manuals state that this is not a requirement of making a claim. The letter also notes that HMRC do not have the resources to provide this advice.

A new approach?

As it published its latest results, HMRC commented that it was “clear that this level of non-compliance within the R&D tax reliefs is unacceptable.” It also announced that it will “share a further update” on its approach to improving compliance “in winter 2023”. 

However, doubts remain around the effectiveness of HMRC’s approach, and given that fraud and error loss estimates are subject to a two-year time lag, it could be some time before improvements are evident. Is it time for a new approach? 

One way to tackle the problem would be to license R&D claims services providers, says Justine Dignam, Director of Incentives and Reliefs at Markel Tax. “If R&D providers were licensed and audited on a regular basis, it would be easy to identify the providers submitting uncompliant claims and drive them out of the market.” 

Credible providers being subject to the same blanket approach as providers that are known to be non-compliant is seen as unfair, says Justine, and has led to the breakdown in trust that CIOT identified. HMRC’s engagement with credible providers “is a key part of improving standards”.

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