‘Arbitrary’ new R&D threshold could encourage fraud

The newly amended parameters for receiving the maximum level of Research and Development (R&D) tax relief in the UK have the potential to be restrictive and encourage fraudulent claims, market participants have said.

As part of the 2023 Spring Budget statement earlier this month, Chancellor Jeremy Hunt announced that the rate of SME cashback for R&D-intensive firms would rise to 27%, up from the 19% level set in November 2022. However, the new rate will only apply to businesses whose R&D activity accounts for at least 40% of total expenditure.

According to Adam Park, director at tax specialist firm Zest R&D, the new 40% threshold is an “arbitrary” number which is likely to exclude the majority of the country’s SMEs.

“I think it’s an arbitrary number. I don’t think there’s any real significant benefit to having it, because there’s not many companies that spend 40% of their overall expenditure on R&D, and those spending less than 40% are still creating significant benefit to the economy,” he says.

“For me what they’ve tried to do is set that boundary at quite a high level so it’s difficult to reach.”

Park emphasises the stark contrast in the reliefs on offer, giving the example that an SME spending £500,000 on such activity stands to gain an extra £42,000 as a result of the new rate. This, he says, could open the door to fraudulent claims.

Read more: ‘Further complexity’: accountants split on new R&D reliefs

“You’re probably going to get a lot of companies hitting 30-35% and there’s naturally some subjectivity over the boundaries of what qualifies and what doesn’t. So there’s definitely going to be a subset of companies that are looking at this and thinking about how they’re going to adjust the percentages costs they are including in their claim in some way in order to reach 40% expenditure, and ultimately end up putting in a fraudulent claim.”

This is echoed by Robert Lamb, director at professional services firm Alvarez & Marsal. He points out that, while HMRC has pledged to police the matter more intently, “it can be quite easy to find a bit more R&D spend down the sofa if you wanted to”.

He also refers to the government’s claim that 10,00-20,000 firms fall into the new R&D intensive definition, arguing that there is a degree of uncertainty as to how accurate this is.

“There’s a bit of uncertainty around who those companies are, because in practice you don’t see that many that have such a high level of R&D expenditure. So the question is, does the policy intend to encourage many companies to become more R&D intensive, or is there a whole realm of companies doing huge amounts of R&D that no one knows about?”

A fairer system, Lamb argues, could be to lower the threshold for R&D intensity, and introduce a higher level of relief for expenditure over the threshold, rather than for the entire claim.

SMEs still worse off on R&D?

Similarly, Park argues that SMEs have been severely stung by a series of cuts to the R&D regime in recent months, arguing that “the government should be doing more to encourage R&D”.

The November 2022 Budget saw the deduction rate for the regime’s SME scheme reduced from 130% to 86%, and the credit rate cut from 14.5% to 10%. In contrast, the R&D Expenditure Credit (RDEC – the reliefs infrastructure for higher turnover businesses) scheme was handed a 7% boost (from 13% to 20%).

And though the revised relief rate available to businesses meeting the new 40% threshold is a significant uptick, it still falls short of the 33% rate which was in place prior to the Autumn Budget.

“I regularly speak to loss-making SMEs that rely on the payable tax credit. It’s a noticeable part of their funding that makes a big difference to whether they have enough cash to see them through to being profitable. A lot of early-stage companies are going to be missing that funding.”

But while Lamb also attests to the importance of R&D support for “pre-revenue firms”, he cautions against over-reliance on the scheme.

“There are requirements that say you can’t be a company that depends on making R&D claims to survive. If that’s your only source of income, you’ve got problems.”