With the UK facing serious financial difficulties and the tax burden higher than at any time since 1950, it might be assumed that the Treasury would be keen to clamp down on companies that attempt to bend the rules of the tax system.
Yet despite serious concerns being voiced by a previous Chancellor of the Exchequer, the Prime Minister appears to have presided over suspected R&D Tax Credit losses of up to £3.5 billion during his time at the Treasury.
The Treasury’s flagship R&D Tax Credit scheme is undoubtedly in disrepute.
With an estimated cost of £7.6 billion in 2021-22 – an increase of 11% from the previous year’s total of £6.8 billion – this generous tax relief has for many years been targeted by some firms who viewed it as a low-risk means of generating cash, regardless of whether genuine R&D was taking place.
Practically everyone in the small business community has heard anecdotal tales of the “innovations” put forward by claimants in sectors such as care homes, children’s nurseries, cocktail bars, pubs and restaurants and some of these have been documented in the national media.
Whilst such excesses have long been common knowledge, incredibly it seems that word may not have reached the ears of Treasury ministers or senior civil servants until reports of bogus R&D claims were published by The Times newspaper in October 2022.
The Times article caused panic in Treasury circles with the Chancellor Jeremy Hunt telling MPs less than 3 weeks after the Times article that he had “heard concerning reports of abuse and fraud in R&D tax relief for SMEs”.
This statement led many to conclude that Hunt had been unaware of the problem until he read it in The Times.
Yet it is hard to believe that this was the first time the Treasury had twigged that some R&D Tax Credit claims were less than credible.
There had been worries for several years that HMRC was allowing industrial scale R&D Tax Credit “claim farms” to run rings around them, often by dressing up routine, business-as-usual activity in technical-sounding language.
But how much did the Treasury actually know about the deep-rooted problems with R&D Tax Credits before the Chancellor’s 2022 Autumn Statement?
Treasury aware of R&D Tax Credit problems for years
The ex-Chancellor Philip Hammond recently told The Times that, behind the scenes, R&D Tax Credits had already become a “No 1 fiscal concern” while he was Chancellor of the Exchequer between 2016 and 2019.
Commenting specifically on the problems with R&D Tax Credits, Hammond said:
“We were certainly on it. It was top of the HMRC agenda issue with me. This is probably the single biggest area in percentage terms of fraud and error in the tax system at the moment”
By the time Hammond resigned on 24 July 2019, it was obvious to everyone in the field that R&D Tax Credits were spiralling out of the Treasury and HMRC’s control.
The number of R&D claims being filed annually increased from just over 50,000 when Hammond became Chancellor in 2017 to over 90,000 by the time Sunak had publicly identified a problem in his Spring Statement on 23 March 2022 when he told parliament that:
“something is not working…so we’ll reform R&D tax credits so that they’re effective and better value for money“.
What Sunak didn’t mention was that he had been Chief Secretary to the Treasury from the day that Hammond resigned in 2019 before becoming Chancellor himself from February 2020 until July 2022.
Did Philip Hammond leave any messages for his Treasury successors outlining his concerns with the way that R&D Tax Credits were being administered?
If he did, they were ignored by Sunak for nearly THREE YEARS until he belatedly promised to take action in his 2022 Spring statement.
With R&D Tax Credit fraud and error being estimated at £1.13 billion annually, the potential losses to the taxpayer during Sunak’s 3-year stint at the Treasury could amount to £3.5 billion.
Some may consider this to be a relatively trivial sum in the overall scheme of government spending (£1.157 trillion in 2022-23) however, reducing the so-called “tax gap” is shaping up to be a hot topic in the forthcoming general election.
The Shadow Chancellor Rachel Reeves this week announced plans to collect up to £5 billion per year in unpaid tax by “taking on the tax dodgers” but some commentators are quite rightly asking “if this is so easy why hasn’t it been done before?”
Perhaps the example of the Treasury failing to act sooner to recover over £1 billion per year of incorrect R&D Tax Credit payments will give Labour some confidence that there might be some relatively easy wins in achieving its aim to narrow the tax gap (ie the difference between the amount of tax that HMRC is owed and the amount it actually receives).
Why this matters
It’s not just that the taxpayer has spent billions of pounds funding bogus “R&D” projects, serious though that would be.
The fact that the problem was allowed to build up unchecked for years is directly responsible for the massive over-correction now being overseen by HMRC, with many legitimate R&D Tax Credit claimants caught up in a seriously flawed and indiscriminate enquiry campaign.
As Philip Hammond explained to the Times:
“With all government bodies, there is a bit of a tendency to overcompensate, the pendulum over-swings, you get beaten up by the public accounts committee or the Treasury select committee. And then you get beaten up because you’re not delivering enough of the policy outcome, you swing back the other way”.
It can be guessed that the more serious the problem, the more severe the over-correction.
In Sunak’s defence, his 3-year tenure at the Treasury coincided with the Covid pandemic, however, as with various Covid support schemes, serious questions should be asked about how up to £3.5 billion of taxpayers’ money was apparently wasted on his watch.
Claire Ralph, Director at the investigative think tank TaxWatch, also believes it is important that lessons are learned from the failures with R&D Tax Credits so that such abuse isn’t allowed again.
Claire told me:
“Whether Treasury and HMRC officials remained unaware of the levels of fraud and error within R&D Tax Credits for protracted periods, or they were aware but swift action wasn’t taken, both are equally concerning.
“The next Government must focus on monitoring the cost of these reliefs, and reforming those that are vulnerable to abuse, otherwise history will repeat itself.”
Article written by Rufus Meakin
Rufus Meakin helps companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.
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