R&D changes will target support better, says tax minister

The sub-committee is this year made up of six members:

• Lord Leigh of Hurley (Conservative) – sub-committee chair, a chartered tax adviser and a former Treasurer of the Conservative Party
• Viscount Chandos (Labour) – who lost his hereditary seat in the Lords in 1999 but was given a life peerage the following year
• Lord Monks (Labour) – a former general secretary of the Trades Union Congress and European Trade Union Confederation
• Baroness Noakes (Conservative) – a former partner at Peat Marwick Mitchell & Co and the first female President of the ICAEW
• Lord Palmer of Childs Hill (Lib Dem) – a chartered accountant, former councillor (London Borough of Barnet) and current Deputy Speaker of the House of Lords
• Lord Turnbull (Crossbencher) – a former Cabinet Secretary and Permanent Secretary at the Treasury and Department of the Environment

This year the sub-committee has decided to focus on the reforms to Research and Development (R&D) Tax Relief in the draft Bill, including how effective the changes will be and whether there will be adverse consequences.

The changes include:

• extending the scope of qualifying expenditures to include the costs of datasets and of cloud computing
• changes to the definition of R&D for the tax reliefs, to remove the exclusion of pure mathematics
• refocusing the reliefs towards innovation in the UK
• requiring all claims to R&D reliefs to be made digitally (except where exemptions apply), and with some additional information
• companies will need to inform HMRC, in advance, that they plan to make a claim

Additionally, at Autumn Statement 2022, the Government announced that for expenditure on or after 1 April 2023, the Research and Development Expenditure Credit (RDEC) rate will increase from 13 per cent to 20 per cent, the SME additional deduction will decrease from 130 per cent to 86 per cent, and the small and medium (SME) sized company credit rate will decrease from 14.5 per cent to 10 per cent.  This is a step towards a simplified, single RDEC-like scheme for all, argued the Government. While not officially part of the Lords inquiry (which predated the Autumn Statement) these changes were also raised during this hearing.

In addition to taking oral evidence from invited witnesses, the sub-committee invited companies which claim R&D relief, their advisers, business and trade/sectoral organisations, and other interested parties to submit written evidence to the inquiry by last month (November).

The inquiry will produce a report containing conclusions and recommendations. Based on previous inquiries we anticipate this will be published towards the end of this month (December) or in January. The Treasury is continuing its review of R&D reliefs.

In this final hearing of this inquiry, held on 21 November 2022, peers asked about the efficiency of R&D reliefs, suggested an alternative approach and queried the benefits of prenotification claims.

Witnesses: Victoria Atkins MP, Financial Secretary to the Treasury, HM Treasury; Nicole Newbury, Director, Wealthy and Mid-sized Business Compliance, HMRC; Matthew Henty, Deputy Director, Enterprise and Property Tax, HM Treasury; Tessa Robins, Deputy Director, CT Innovation and Growth, Business, Assets and International, HMRC.

Sub-committee chair Lord Leigh of Hurley, Conservative, asked Victoria Atkins, Financial Secretary to the Treasury, for evidence that R&D reliefs increase economic growth. Atkins said HMRC have an ongoing evaluation programme about this, and, for every £1 of support, the RDEC incentivised £2.40 to £2.70 of research and development. The SME scheme had lower additionality of between 60p and £1.28 per £1 invested. Matthew Henty, Deputy Director for Enterprise and Property tax in the Treasury, added that there is a strong relationship between R&D and productivity more generally, and that taxpayer support generates more business investment in R&D through RDEC than it does through the SME scheme.

The Financial Secretary said that HMRC will be going after the fraudulent or boundary-pushing behaviour of agents and businesses within the R&D world. However, she emphasised, the debate on the rate changes was “at risk of giving the impression that we have made these decisions solely to combat fraud. That is not the case. We have done this because we want to increase value for taxpayers in relation to the scheme that we know shows the most benefit.”

Crossbencher Lord Turnbull opined that all SMEs are now facing a lower rate, penalising equally those who are entirely diligent about the claims that they make and those who put in ‘chancy’ applications. Turnbull suggested an alternative would be to increase the resources and expertise that HMRC has for looking at the claims at the time they are made.

Henty replied that there is a wider range of things that need to be considered, not just looking at the error and fraud side. Atkins said that, for legitimate businesses, although there may be an extra form that they have to fill in, the practical measures in the draft Finance Bill, including requiring each claim to be supported by a named officer of each company, and advance notification of the claim, will help satisfy the integrity of the scheme.

Viscount Chandos, Labour, was worried about the Autumn Statement R&D changes in relation to the UK’s international competitiveness. Henty replied that most countries do not have unfettered overseas subcontracting supported by taxpayers in those countries. Even with these changes, HMRC will still spend the most as a percentage of GDP and have the highest number of claims of any country in the OECD, said Atkins.

Henty explained to Lord Monks, Labour, that if an overseas-headquartered company is investing in the UK through a UK company and paying corporation tax here, it will be able to claim the R&D tax reliefs for the activity that is happening here. It would not then be able to subcontract it to someone else, maybe another part of its group overseas, following these restrictions, and still qualify. A company can subcontract overseas and take a 100 per cent revenue deduction in the normal way, he continued. It is just that it is not getting, for example in the SME scheme, the super deduction for the activity that is happening overseas, only for the activity undertaken in the UK.

Henty said the Treasury is hearing quite strong messages generally that the above-the-line credit version of the RDEC scheme has a lot of value for businesses.

Baroness Noakes asked about abuse of R&D reliefs. Nicole Newbury, Wealthy and Mid-sized Business Compliance, HMRC, said that, over recent years, HMRC have seen challenges on two fronts: a growth in spurious claims, and the organised criminal attacks they identified in April. On the former, Newbury said HMRC are getting around 60,000 claims worth less than £50,000 a year. That means the additional resourcing on compliance work is not going to solve the problem in isolation, but HMRC, more broadly, are trying ‘new and innovative’ compliance methods such as large-scale one-to-many activity to reduce error and fraud.

The Chair asked if it would help if agents were regulated and, with the proposal for the officers of a company to be named, he asked what of officers of agents and further action against agents? On regulation of agents, the minister said she is “considering that actively”, adding, “I am reading my way into this at the moment and considering the policy possibilities.” On the officers of an agent, Atkins said the fact that HMRC are requiring agents to be declared will help address that.

Tessa Robins, Deputy Director, Corporation Tax Innovation and Growth, Business, Assets and International, HMRC, explained to Turnbull that ‘spurious’ relates to where there is a genuine trade going on, but it does not constitute R&D. HMRC are conducting a mandatory random enquiry programme to identify better the nature of the mistakes being made and when they are spurious, in error or criminal.

Lord Palmer of Childs Hill, Lib Dem, is unconvinced about the benefits of prenotification claims. Tessa Robins countered that they help disrupt what has become quite a prevalent business model by some of the rogue agents, those that are attempting to promote spurious claims typically on a contingent fee basis. And it means HMRC already have some information about potential claimants before the tax return itself comes in. Better than prenotification would be limiting how far you can backdate a claim, said Lord Palmer, which led Robins to say there already are limits in how late you can submit claims.

Matthew Henty emphasised that what the committee were calling ‘prenotification’ was not prenotification of doing R&D but prenotification of making a claim, with the R&D having already taken place. The Financial Secretary added that the Government “might need to look at how we describe this, to make it clear that we are referring to activity that has already taken place… If that is the reaction the committee has had in its evidence, clearly we need to communicate better.”

Newbury said that having a senior nominated officer in the business sign it off will encourage businesses to make sure they are performing due diligence. Robins said: “Alongside the CT return that is submitted now, which forms the basis of the claim, there will be a further electronic form that will require some additional information, including the name of the officer in the company. A CT return submission is a legal document and it is a self-assessment, but unfortunately we are not seeing the R&D element of that being taken as seriously as we think it should be. Therefore, we want them to be signing off that they have reviewed that claim itself.” It will enable HMRC to do far more automated risking, which will help them to do far more effective downstream compliance at scale. As well, HMRC will be able to do more upstream work by helping customers with pre-claim notification six months after the end of the year and supporting customers to not complete spurious claims, added Newbury.

After hearing Newbury’s comments Lord Turnbull commented that he was ‘rather coming around’ to the idea of senior officer sign off. The minister added that she used to prosecute for the Health and Safety Executive and that, in the world of health and safety, “although having a directorial responsibility for health and safety in larger companies does not prevent every accident, it can be very significant in helping a business conduct its affairs in accordance with the health and safety legislation.”

Newbury told the peers about a ‘scaled organised criminal attack’ on the R&D regime in April. That led to a two week pause in payments. From that, HMRC introduced a new ‘hallmarks of fraud risk assessment process’. Of the 1,600 letters HMRC have issued to high-risk claimants – after this fraud attack – 80 per cent have not yet responded (and therefore HMRC have not paid out money to them). When a further 15 per cent have come back to HMRC, HMRC have felt they warranted further investigation because their claims did not look legitimate. But this led Lord Palmer to ask: “Have we gone so far in fine tuning the automation that HMRC is losing the ability to pick out the rogues?” Newbury replied that once the changes come in from April next year, HMRC will have a much better and much richer set of data that they can automate.

Atkins (photographed above) said the Treasury and HMRC need to do better at showing legitimate small businesses that this R&D help is out there for them.

The Chair, Lord Leigh, asked whether, if HMRC identifies a rogue agent, they regard it as their responsibility to advise customers that the agent is a rogue. Newbury replied that HMRC’s specialist R&D compliance teams who focus on SMEs work closely with the agent compliance team. “Our approach is to work with that specialist team to either suspend their access to HMRC accounts or report them to the relevant professional body. As far as I am aware, we do not publicly name and shame. Our legislative powers do not extend that far at the moment, but I would have to go and check that further.”

The Chair seemed surprised that HMRC cannot advise a customer that the particular agent they are using is under investigation or suspicion of fraud. Newbury responded that she is “not aware that we do that and I do not think we have the legislative gateway to allow us to.” She offered to check and write to the committee.

HMRC do a significant number of one-to-one investigations, post claim, into claims that they do not meet the rules, Newbury told the committee. So far this year 84 per cent of those have resulted in additional tax interest or penalties being paid.

HMRC had an evaluation in 2019, and only 18 per cent of SMEs claimants found the application process difficult, said the minister. Over half reported that it was ‘easy’, she said. Robins speculated that around 90 per cent of claims from SMEs go through agents, which is broadly in line with what you see in the wider corporation tax system, she said. HMRC will first produce guidance on the changes, but then publish a more comprehensive review of the guidance overall.

The full transcript of the session is here.

By Hamant Verma, CIOT Senior External Relations Officer