Research and development tax reliefs

The UK’s research and development scheme offers generous tax savings to companies, but is it sustainable and are there risks?

As those working within the accountancy industry in the United Kingdom (UK) will largely be aware, the UK’s research and development (R&D) relief scheme offers considerable tax savings to qualifying companies. The scheme for small- and medium-sized enterprises (SMEs) is particularly generous, offering relief totalling 230% of qualifying R&D expenditure and cash rebates for loss-making companies.

The purpose of the relief is to support companies working on innovative science and technology projects in an effort to increase economic growth by promoting innovation. There is a risk, however, that the relief could be perceived as an opportunity for companies to obtain funds in instances where the claim may not be entirely legitimate or as a lucrative opportunity for advisors to promote a tax reduction strategy.

Current climate

HMRC statistics indicate that both the number of R&D claims being made and the total financial support claimed through R&D tax credits have increased drastically since the introduction of the relief in 2000, with a particular surge since 2014. Although the UK government appears to equate increasing R&D claims to increasing R&D investment and innovation, this link may be somewhat tenuous.

Due to the retrospective nature of R&D claims, claimant companies will not necessarily undertake increased R&D activities as a result of making a claim. In some cases, a claim will be made for activities that the company would have undertaken irrespective of the availability of relief. Furthermore, awareness of the scheme has increased significantly in recent years. This is due in part to the fact that the relief is widely promoted by R&D claim advisors, including a number of boutique firms that specialise in assisting with R&D claims in return for a portion of the tax savings generated.

Potential risks

Although the enquiry limit is typically two years or less from the end of the accounting period, discovery powers enable HMRC to make an assessment if they determine that a relief has been given which is, or has become, excessive.

A discovery assessment can be made where the loss of tax was brought about carelessly or deliberately by, or on behalf of, the company and where the HMRC officer could not reasonably have been expected, on the basis of the information available, to be aware of the facts giving rise to the loss of tax. The general time limit for discovery assessments is four years, increasing to six years for cases involving carelessness and 20 years for those involving deliberate action.

HMRC has been known to seek penalties regarding incorrect R&D claims on the basis that the company was careless in failing to obtain professional advice considering the size of the company and the claim.

For companies within the scope of the Senior Accounting Officer (SAO) regulations, the appointed SAO in particular should ensure that he or she is satisfied that R&D claims are accurate as the SAO may be held personally accountable for the failure of the company to submit accurate tax returns.

Potential issues with R&D claims

A range of potential issues can arise when it comes to R&D claims, including:

• Documenting insufficient technical detail to support the claim (for example, presenting the claim in a glossy report that fails to provide the information necessary to evidence its validity);
• Failing to identify appropriate claim boundaries (for example, claiming for an innovative project in its entirety without isolating the elements that meet the relevant criteria, or claiming for projects that span many years using the same supporting narrative, therefore failing to evidence how the project continues to meet the criteria over time);
• Overstating the claim (for example, claiming expenditure for directors’ time where directors have not been directly and actively involved in resolving technical uncertainties);
• Claiming non-qualifying expenditure (for example, consumable costs where the resulting product has been sold to customers. Such costs would have qualified prior to 2015); and
• With software development claims, assuming that a technological environment is indicative of technological uncertainties. It is crucial to ensure that a project is assessed against the qualifying criteria and that the supporting narrative is robust and can withstand the scrutiny of HMRC’s software specialists.

The future of R&D relief

HMRC has been relatively supportive of companies claiming R&D relief to date and enquiries into R&D claims are reasonably infrequent. Consultation undertaken in 2015 sought to improve access to the relief for small businesses and an ‘Advance Assurance’ scheme was introduced for first-time claimants as a means of simplifying the process.

With the UK undergoing a period of significant uncertainty, not least due to Brexit, it is difficult to speculate on future government policy. The benefits of R&D tax incentives and/or support for the scheme could be enhanced in order to encourage companies to operate in the UK, stimulate innovation and increase the UK’s competitiveness.

Alternatively, the spiralling costs of R&D relief could render the scheme a target for cost-cutting measures. If so, the UK could follow in the footsteps of the Republic of Ireland where R&D claim investigation activity has increased and claims are now subject to heightened scrutiny (for example, external experts assisting in the evaluation of claims). Revenue Commissioner investigations have reportedly exposed high levels of abuse of the scheme with over €57 million recouped from R&D claimant companies in the five years to 2017.

The risk of penalties for non-compliance and the potential for increased scrutiny of claims emphasise the importance of ensuring a high level of diligence in the preparation of claims. It is advisable that companies, their directors and advisors ensure that an R&D claim is legitimate, accurate and can be fully supported and justified to HMRC in the event of enquiry.

Cathy Kelly is a Senior Manager at BDO Northern Ireland.