UK R&D criteria to be tightened in system overhaul

UK companies could soon be subject to greater scrutiny and stricter processes when claiming research and development (R&D) tax credits, the government has said.

In draft legislation published this week, HMRC has proposed adding a number of administrative steps to the process of filing a relief claim, with a view to limiting fraudulent and erroneous activity. They include providing the endorsement of a named senior officer, informing HMRC of the claim in advance of its submission, and including the details of any agent who has advised the company on the claim.

HMRC has also proposed an expansion of qualifying expenditure on software and consumables to include data licenses and cloud services, in addition to extending the scope of relief to cover mathematical advances.

According to Jayne Stokes, associate director at R&D tax relief consultancy ForrestBrown, this broadening of scope represents a positive step towards “a modernised definition” of R&D.

“These changes will make a material difference for innovative companies in R&D-intensive and high-growth sectors such as AI, quantum computing and robotics,” she says.

However, Stokes went on to lament the fresh administrative processes stipulated in the draft legislation, arguing that while they may serve to prevent abuse of the system, they could also compromise its intended purpose.

“[The measures] will provide the data HMRC needs to target the error and fraud which risks undermining the positive intent of R&D tax policy. This is in line with ForrestBrown’s calls for better protection of companies in what remains an unregulated market,” she says.

The draft legislation also includes measures to withdraw relief for subcontracted activity taking place outside of the UK. The move will focus the reliefs “more effectively on UK expenditure”, HMRC said in a supporting statement.

However, it goes on to stipulate such claims will be permitted if it is “unavoidable”, citing geography, environmental, population or “other factors” as mitigating circumstances.

According to Matthew Tottey, the head of financial analysts at Research and Development Specialists, HMRC clamping down on this aspect of the system should act as a wake-up call for UK businesses.

“We would encourage companies to review any subcontractors that they engage with abroad to assist with eligible R&D activity. It would be a worthwhile exercise to weigh up the cost of foreign labour versus what could be reclaimed as tax relief,” he says.

Any legislation that encourages businesses to use the scheme for its original purpose is “without a doubt a positive thing” for the industry and the economy, Tottey adds.

But for ForrestBrown’s Stokes, an outstanding concern is that exemptions for workforce cost and availability are not considered in the draft legislation.

“This is a real challenge for innovative tech companies who are facing global competition for specialist talent, and it will hamper the UK’s ability to be part of global R&D programmes and a science and technology superpower,” she says.

Tackling fraudulent activity

In addition to summarising the key points of the new draft legislation, HMRC’s statement also noted the intention to “address unintended consequences in the existing legislation” – an issue that has become increasingly evident in recent months.

For instance, according to research published by national accountancy group UHY Hacker Young earlier this year, it is estimated $867.3m (£725m) in R&D tax relief was underpaid in the 2020-21 tax year. This represents a 16% jump on the £623m suspected to have been underpaid the year prior.

UHY’s estimate is a calculation based on three figures: the total amount spent on R&D by the UK’s largest companies (as reported by the ONS); the total amount of R&D tax relief claimed (as reported by HMRC); and an additional 3.2% to account for “error and fraud” (as recommended by HMRC).

HMRC officially estimates the amount overspent to be £311 million, as per its annual report.

The Revenue also announced in May that it had taken the decision to suspend payment of some R&D tax credits in order to investigate some irregular claims.

As part of its Innovation Strategy, the UK government intends to increase total R&D investment to 2.4% of GDP by 2027.