Guest article written by Paul Rosser, Director at Research & Development Consulting Ltd
Since R&D tax relief was introduced over two decades ago, HMRC has annually opened a number of compliance checks – aka enquiries – to ensure that the R&D claim submitted was genuine and the amount of relief being sought was correct.
As the enquiry process was undertaken by experienced HMRC inspectors and could last several months, HMRC typically focused on larger value claims to ensure their limited resources achieved the best value for the taxpayer.
This approach worked fairly well until some R&D consultancy firms started using it to their advantage, submitting lots of questionable claims where the benefit being sought was less than £50,000, knowing the claims didn’t have to be valid as the chance of an enquiry was very low and even if a few of their clients claims did attract scrutiny from HMRC the amount they made in fees from the majority which didn’t, made it a very lucrative practice.
In an attempt to address this issue, at the start of 2022, HMRC hired 100 additional compliance officers meaning they could open a lot more enquiries into R&D claims and we started to see more enquiries being opened into lower value claims, with the process often being handled by these new compliance officers, who HMRC refer to as case workers due to them not being qualified tax inspectors.
Then more recently some companies started to receive notification that an enquiry had been opened into their R&D claim, along with a letter requesting some further information but rather than having a dedicated inspector or case worker assigned to them, they were just provided with a generic email address to send their response to.
This new helpdesk-style approach from HMRC is designed to streamline the enquiry process and facilitate the opening of a lot more enquiries, regardless of the claim value. HMRC have also undertaken a random enquiry program with the focus not only being on stopping invalid claims but also on gathering evidence with regards to which R&D advisors were responsible for the ever-growing number of fraudulent and boundary-pushing claims.
Unfortunately for some accountants, this dramatic increase in HMRCs compliance activities has meant that R&D claims they have assisted with, which historically would have had a very low risk of enquiry, have now been selected by HMRC for an enquiry and even accountants who have dealt with R&D enquiries in the past are finding themselves in unfamiliar territory, due to HMRCs new, very different, R&D enquiry process.
The main way in which the new process differs from that which HMRC have traditionally used is that historically as part of the enquiry process the claiming company would have been given the opportunity to speak with an inspector to discuss the specifics of their claim.
Malcolm Henderson, who was an HMRC R&D tax inspector for many years said
“When we questioned the competent professional on the activities they thought qualified, we found on quite a few occasions that they were very good at telling us what they’d done, but not how they matched the DTI/BIS/BEIS Guidelines. We had to tease those out, successfully on most occasions”
This approach meant that even if the claiming company, or their accountant, didn’t properly understand all the various legislation and guidelines surrounding R&D tax relief the inspector would work with them to ensure the enquiry reached the correct outcome.
The new enquiry process however moves away from the claiming company being able to discuss the specifics of their claim with an inspector, and instead relies on HMRC sending out a series of, often generic, questions with the answers requiring very careful consideration, as if not this can result in a genuine claim being refused.
As some of the questions HMRC ask can be difficult for accountants who don’t specialise in R&D to advise their clients on how best to answer, I’ve provided some tips below which should provide accountancy firms with a basis to more effectively answer some of the questions that HMRC is asking claimants in their enquiry letters.
What information does HMRC request in its letters?
The first HMRC enquiry letter typically requests some further information with regards to each project’s technological uncertainties, the advance being sought, the project timeline, competent professionals’ details and the costs being claimed.
Project Timeline
The project timeline should have Pre R&D, Qualifying R&D and Post R&D (assuming the project has finished) sections, along with dates, as this demonstrates that your client understands at what stage qualifying R&D activities start/end and that the qualifying R&D was undertaken during the accounting period for which the R&D claim has been made.
Technological Uncertainties
For this section the mistake a lot of people make is thinking that more is better and so try to come up with a dozen uncertainties, where in most cases a handful are much easier to define and explain.
HMRC only cares about genuine scientific/technological uncertainties and so having less makes it much easier for the member of HMRC staff checking your client’s claim to understand.
A scientific/technological uncertainty is almost always a question, and it’s the question your client’s technical staff asked themselves after they had tried to get the project finished using their existing knowledge and publicly available technology.
For example, if a company was attempting to increase the power of a standard 1.6litre engine from 130bhp to 450bhp and, after trying all of the known ways to achieve this (remapping the engine, adding a turbo etc) they could only get to 400bhp they might decide this was close enough in which case no qualifying R&D has been undertaken, if however they decide to continue without knowing if their desired improvement is actually possible, the uncertainty would be “would it be possible to develop technology capable of increasing the power from a 1.6litre engine from 130bhp to 450bhp?”
Avoid waffle in this section. Your uncertainties should be very clear, concise and easy to understand.
The Advance Being Sought
This section should relate to your project’s uncertainties, in that if you can find a way to overcome the uncertainties what will this mean? What will you have created?
One common mistake I see often is that people relate the advance to their industry and not to science/technology and this will result in the project being disallowed.
The Baseline Technology
Baseline technology is the term used by HMRC to define the level of technology already available at the start of the R&D project, against which the advance being sought is measured.
So for this section your client should provide some details with regard to what technology was already on the market, or what they knew was technically possible at the start of the project.
Competent Professional Details
Whilst there is no official definition of what makes someone a competent professional, ideally HMRC is looking for a relevant qualification in the field of science/technology that the claim is being made, along with years of industry experience.
For example, for an engineering based claim, a competent professional might have a degree in engineering and 5+ years industry experience working in an engineering role.
The competent professional doesn’t need to be a member of staff, they could be a subcontractor engaged by the company to work on the project.
Why The Knowledge Sought Was Not Readily Deducible To A Competent Professional
For this section HMRC is asking why couldn’t your clients competent professional easily work out how you could reach the project goals, as if they could no qualifying R&D would need to take place?
Usually the answer to this question will relate to the pre-R&D stage of the project timeline, so your client might say “After attempting to reach the project goals using existing method of engineering and then by researching currently available technology we might use and finding none suitable, it became apparent that the knowledge sought would not be readily deducible by a competent professional”
Breakdown Of The Costs Being Claimed
If you didn’t already provide HMRC with a breakdown of the costs your client is claiming for, or if you did but didn’t split the costs per project, then this is what HMRC is asking for to ensure the costs being claimed fit into allowable categories of R&D expenditure.
For each project, you should provide details of the costs using the following headings Staff, Subcontractors, Externally Provided Workers, Software, Consumable and Transformable items.
Once the response to the initial HMRC enquiry letter is sent your client will then usually receive a second letter asking for lots more information and this is usually when people start to worry, as they assume it means HMRC don’t believe their claim is genuine. However the opposite is actually true as typically the second letter HMRC sends is either one rejecting the claim or one asking for more information, so if your client received the latter then it’s a promising sign and nothing for them to worry about.
Some of the questions in this second letter might be specific based on your response to their first letter and commonly HMRC will also ask a set of generic questions, regardless of if you have already answered some of them in your first response.
Some examples of these generic questions, along with some pointers on how to answer them are as follows.
Q “What is the existing product you are measuring each project against?”
For this section, HMRC is asking if there is an existing product your client was looking to improve, or what did they know was technically possible at the start of the project.
Q “What was the gap in technological knowledge or capability which necessitated the commencement of the R&D?”
Now we have defined the project’s starting point in the previous question, your client needs to detail the gap between that and what they were trying to achieve.
Q “What was the state of your platform before the R&D commenced, after the R&D activities completion and how does this compare to the rest of the market?”
This question is to ensure that the advance you were seeking wasn’t just to bring your client’s company in line with others in their sector, but that it represents an advance across the entire market.
Q “Describe the advance or appreciable improvement in the overall field of technology sought or achieved, and its impact on the field as a whole”
For this section you should provide HMRC with details of the advance in technology your client was trying to create.
Avoid talking about how it will help advance their company only, or how it will advance their industry if they don’t work in the same field of technology that the advance was being created in.
“All stages from planning to deployment”
For this section it’s best to provide a project timeline, with dates, for each of the various activities you undertook under the sections pre-R&D, qualifying R&D and post-R&D.
“Individuals’ involvement at each stage”
This section should relate to the staff/subcontractor costs being claimed and provide details of who was involved with the project and what activities they undertook.
You could also combine the previous section and this one, so the project timeline includes the name of the people/companies involved with each activity.
“Contemporaneous project documents that informed and support the R&D relief claim”
If there is any project documentation that would help support the claim then this should be provided, especially any documents which are dated as this helps HMRC establish that the R&D activities took place during the correct accounting period.
Q “Please send a more detailed explanation of why there was no ‘information that was readily available in the public domain, nor is it readily deductible by a competent professional”
For this section, you should provide information about the research your client undertook in an attempt to find a way to reach their project goals without R&D being required and why the information they found was not suitable to allow them to reach your project goals.
Uncertainties
“The uncertainties must be more than challenges or complexities”
Q “Please provide any research and analysis your competent professional undertook to establish that the uncertainties listed on your R&D report and supporting information were uncertainties and not complexities and challenges. Please can they explain how the uncertainties for all projects are of a scientific or technological nature as opposed to routine uncertainty. Refer to Para 13, 14, 29 & 30 BEIS (2004) guidelines when formulating your response”.
“Bear in mind that just because your company does not know if something could be done, does not make it an uncertainty”
For the purposes of R&D tax relief there is a clear distinction between complicated non-qualifying projects and those which qualify as they have genuine uncertainty, so this section is designed to demonstrate to HMRC that the project wasn’t just complicated and time-consuming but that the required uncertainty existed.
The last sentence about your company not knowing if something could be done is to ensure that the uncertainties your client identified were industry-wide and not just due to their own lack of knowledge or experience.
As HMRC mentions specific BEIS guidelines, it’s a good idea to address each of these in turn, as even though a lot of this information you may have already provided putting into context of how it applies to the guidelines will help HMRC see that the project meets the various criteria for qualifying R&D.
Knowledge Baseline
“The baseline must be measured in the field of science and technology as a whole and not just within your own field”.
“Please provide details of the research conducted to establish your baseline for this project”.
“Describe the baseline in technology that the advance sought was being measured against”.
“Baseline technology” is the term used by HMRC to define the level of technology already available at the start of the R&D project, against which the advance being sought is measured.
HMRC would expect your client to have conducted some research at the start of the project, and before undertaking qualifying R&D, to establish what the current baseline is in relation to the technology, not just the baseline for their industry, as only once you know what the technology baseline is can you be certain that what you are looking to develop will represent a genuine advance.
Advance and appreciable improvement
Q “Describe the advance or appreciable improvement in the overall field of technology sought or achieved, and its impact on the field as a whole”
For this section you should expand a bit on the previous answer with regards to the advance your client was seeking to create, ideally provide some details about other potential applications of the technology to show that it’s a genuine advance for the whole field, with uses other than just the one your client was focused on.
For example, if a company was developing technology for use in banks that could analyse billions of customer transactions faster than current technology can achieve to allow them to spot potential fraud quicker, they might describe how this technology could be adapted for use in the health sector to allow patient records to be analysed quicker and potential health issues to be identified sooner.
Content by Rufus Meakin (R&D Tax Credit Insider Newsletter)
Find the full article here
