As the amount of R&D Tax Credit claims under HMRC enquiry jumps to unprecedented levels, many claimants are wondering why their particular claim has been picked by HMRC for enquiry on a seemingly random basis.
Some R&D claimants can quite justifiably point to other claims in sectors which seem highly unlikely to be undertaking R&D and which have been paid out by HMRC without an enquiry being opened. Meanwhile, their own claims, which are rock-solid in terms of qualifying R&D, have inexplicably led to HMRC disputing that genuine R&D has taken place.
It is well-documented that once HMRC has opened an enquiry into an R&D claim, it is extremely difficult and time-consuming to resolve satisfactorily.
As a result, many R&D claimants are throwing in the towel, even though their claim is perfectly valid.
An enquiry (or compliance check) is therefore something to be avoided at all costs as it will usually require the R&D claimant having to persuade technically unqualified yet intransigent HMRC staff that there was a technological advance being sought and that the work involved was technically uncertain for a competent professional in the field to resolve.
How does HMRC determine whether to open an enquiry?
Whilst it’s impossible to know the precise thinking within HMRC, it has long been obvious that certain claims would be at a higher risk of an enquiry than others. For instance:
- Claims filed without any supporting documentation or descriptions of R&D
- Claims where the costs didn’t match up with figures contained in the accounts
- Higher value, first-time claims
- Large increases in R&D costs compared to the previous claim, without any explanation
- Claims for companies with SIC codes in certain sectors
The requirement for all R&D claims to be accompanied by a mandatory Additional Information Form (AIF) from 8 August 2023 has given HMRC access to more detailed data, in particular around why projects are considered to be qualifying R&D for tax purposes.
The AIF also requires claimants to declare their SIC code, so this is something that all companies claiming R&D should now be taking a close look at.
SIC code sifting
It has been apparent for some time that HMRC is checking SIC (Standard Industrial Classification) codes in order to do a quick sift for claimants which are involved in sectors that are unlikely to be undertaking R&D, such as care homes.
This was confirmed by HMRC in its recent response letter to the Chartered Institute of Tax (CIOT) where it stated that:
“[We] undertake targeted activity when large volume risk is identified; for example, in trade sectors where we do not generally see successful claims for R&D, and among first-time claimants within those sectors”.
HMRC actually identifies some of these sectors on its own website:
“The types of claims which are rarely eligible for R&D tax reliefs include those made by:
- care homes
- childcare providers
- personal trainers
- wholesalers and retailers
- pubs
- restarants”
However, I have now seen another list which identifies some additional sectors which HMRC believes would also be unlikely to be undertaking qualifying R&D:
- real estate agents
- textile industries
- the construction industry
- educational institutions
- consultancy firms
This additional list formed part of an official letter from HMRC to a claimant however I have been unable to verify whether it was issued in error or whether HMRC is actively targeting companies in these additional sectors.
If it is legitimate, then the R&D claims of thousands more companies would be at a heightened risk of an enquiry.
If construction firms and consultancy businesses are now deemed by HMRC to be “unlikely to be undertaking qualifying R&D” then this would represent a huge shift.
The construction industry is vast in scale, ranging from one-man-band operations with mainly subcontractors right up to the giants of civil engineering.
It is possible that HMRC is targeting what is undoubtedly a problem at the lower end of the construction sector with all sorts of spurious claims being filed for projects such as domestic loft conversions and kitchen extensions.
But to lump an entire industry together as being one where R&D is unlikely to be taking place seems quite incredible.
(The same could be said for “consultancy firms” which is itself a large and innovative sector where lots of software development takes place).
I would be interested to hear from readers who have any information on HMRC’s compliance approach to these additional sectors.
The problem of inaccurate SIC codes
As reminder, an SIC code is a number that identifies the type of business a company is engaged in.
However, it is very common for companies to have a SIC code which no longer reflects the reality of the business activity.
I’ve spoken with many business owners who are unaware of their own SIC code. In many cases, these were chosen when the company was first registered at Companies House.
“We couldn’t find a code that accurately described what we wanted to do so we just went for something generic” is something I’ve often heard. This can be carried through, year-after-year, with the business description becoming more inaccurate over time.
Within the area of software development, some recent examples of SIC codes I have come across for companies with live HMRC enquiries are:
- 46760 – Wholesale of other intermediate products
- 47190 – Other retail sale in non-specialised stores
- 47910 – Retail sale via mail order houses or via Internet
- 70229 – Management consultancy activities other than financial management
- 96090 – Other service activities not elsewhere classified
Having spoken with the CFOs at each company, they all told me that these SIC codes no longer reflected their actual business activity. In every case, the R&D appears to be qualifying, despite the HMRC enquiry.
My strong recommendation is that every R&D claimant should check their SIC code before a claim to ensure that it is accurate.
Given the “pay now, check later” policy of HMRC, it might well be prudent even for those with claims that have been paid out by HMRC to also check the accuracy of their SIC code.
Article written by Rufus Meakin
Rufus Meakin helps companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.
If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to call me on 0794 110 3285.
Content by Rufus Meakin (R&D Tax Credit Insider Newsletter)
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