This is the first article in my three-part R&D Tax Credit Insider series on how a world-leading R&D incentive was brought to the brink by hype, political complacency and industry inaction.
Part One: The R&D Tax Credit boom that spiralled out of control
The UK’s flagship R&D Tax Credit regime was once widely regarded as one of the most generous and accessible innovation incentives in the world.
During the 2000s and 2010s, it was frequently cited by policymakers, business groups and international organisations such as the European Union and International Monetary Fund as a model for encouraging private sector investment in R&D.
Although precise estimates of the scheme’s true impact were difficult to establish, the Treasury repeatedly seemed to signal its approval as the scheme became gradually more generous over time.
For instance, in its 2014 Autumn Statement, the UK government described the regime as “one of the most competitive in the world”. This was a clear signal of its political backing at the time
Behind the scenes however, HMRC’s statistics were giving a more mixed picture of the economic value (“additionality”) being delivered.
As far back as 2010, an HMRC research report stated:
“Estimates of the return on foregone tax revenues resulting from the introduction of R&D Tax Credits vary considerably. Depending on the techniques employed, £1 of foregone tax revenue stimulates between £0.41 and £3.37 of R&D investment”
An HMRC working paper from 2015 was only slightly less vague:
“From the econometric analysis, the estimated additionality ratios for UK companies indicate that between £1.53 and £2.35 of R&D expenditure is stimulated by £1 of tax forgone”
But by 2020, the case for such a generous SME payable credit appeared to be collapsing. A widely cited HMRC evaluation concluded:
“The econometric analysis suggests that every £1 of R&D tax relief leads to between £0.60 and £1.00 of additional R&D expenditure.”
With the central estimate being a return of just £0.68 for every £1 put in, even in the best-case scenario, the SME scheme had a neutral impact. At worst, it represented a significant loss to the taxpayer.
By 2020, Office for National Statistics BERD data suggested that, relative to national income, self-funded R&D was actually 10%–15% lower than when the R&D scheme began two decades earlier.
How this situation arose
The main underlying problem was arguably political. Successive Chancellors appeared keen to announce further enhancements to an already generous R&D scheme, often without serious regard for oversight, long-term integrity or cost-effectiveness.
High-profile announcements such as those made by George Osborne in his 2014 “budget for the makers and the doers” (a phrase that soon became synonymous with political spin) were often well received by business groups and the media, but there was little evidence of any serious consideration being given to the long-term consequences, particularly in terms of HMRC compliance capacity or scheme integrity.
Over time, this combination of political enthusiasm and weak operational oversight created the conditions for serious abuse.
As the volume of R&D claims surged, so too did concerns over their validity, with growing evidence of inflated, poorly evidenced or outright fraudulent submissions.
Eventually, confidence in the integrity of the scheme began to erode. What had once been a respected and internationally admired incentive was now viewed by many in government as high-risk, poorly targeted and in urgent need of reform.
This was confirmed by the knee-jerk cuts to the scheme and the poorly executed HMRC random enquiry programme which began in earnest in 2022.
When apportioning blame for the catastrophic downgrade of the scheme, it is easy to point the finger at fraudsters, opportunists and accountancy firms that were not competent to provide technical advice.
There is no doubt that they played a central role in hijacking the scheme, exploiting HMRC’s historically light-touch compliance framework.
I’ve written extensively about HMRC’s own role in this, and much of the blame for the scheme’s unravelling can be laid at its door. For years, HMRC failed to enforce the standards required to protect taxpayer funds, enabling dubious advisory firms to file ineligible claims on an industrial scale.
An unspoken pact appeared to form between the Treasury, HMRC, business groups, and much of the advisor community, with no one willing to challenge the scheme’s direction despite mounting evidence of abuse.
As leading tax expert Dan Neidle puts it:
“Tax professionals have been aware of incompetent and fraudulent R&D tax relief claims for years. HMRC must have been aware of the claims too. And HMRC and HM Treasury must have noticed the spiralling number of claims from small business, the increasing number of unregulated firms in the market, and the suspicious sectors for which claims were being made”.
That may be uncomfortable reading for many in the accounting profession and the wider R&D advisory community.
In many ways, R&D Tax Credit advisors were the architects of their own downfall, unwilling to challenge bad practice even as the system unravelled around them.
Even reputable advisors sat on their hands
It is now clear that R&D Tax Credits are amongst the most significantly abused corporate tax reliefs in history.
The scale of losses to the taxpayer is staggering. Dan Neidle estimates the total may reach £10 billion over the lifetime of the scheme.
The warning signs had been evident for years, yet it wasn’t until Jeremy Hunt became Chancellor in 2022 that serious reform of the SME scheme was introduced, prompted by poor additionality outcomes and escalating levels of fraud and error.
As I outlined in my “Evolution of UK R&D Reliefs” series, HMRC had been warned for years about the deterioration of standards.
While some reputable advisors did raise concerns, there was no coordinated effort or widespread push for reform from within the R&D advisory industry itself.
Cowboy firms entered the market, spotting an opportunity to game the system by filing ineligible claims that were unlikely to be checked by HMRC.
Entire armies of cold-calling salesmen were set to work, informing credulous business owners that routine activities could qualify for a valuable tax break, or even “free money from HMRC”.
Some firms employed “boiler room” tactics to entice cash-strapped SMEs into filing bogus or vastly inflated R&D claims. They would sometimes employ one or two technologists to give the business a veneer of respectability. These individuals were often tasked with embellishing routine projects to make them sound like genuine R&D.
The growth of R&D Tax Credit sales was so pronounced that hundreds of graduates who might once have gone into entry-level recruitment roles instead gravitated toward far more lucrative positions in R&D Tax sales.
Mysterious Facebook adverts began to appear, alongside gimmicky online R&D claim calculators that could supposedly “check your eligibility in minutes”. These were often accompanied by implausible case studies showcasing “successful” claims in sectors far removed from science and technology such as gastropubs, cocktail bars, care homes and high street bakeries.
A bizarre mania broke out in which advisors fell over themselves to assure prospects that R&D Tax Credits were not just for “men in white lab coats”.
By the time of Covid, the rampant promotion of the scheme had reached its peak.
It was now widely championed by a growing body of advisory firms and accountants, but increasingly unstable beneath the surface.
A clear sign that things had got out of hand was when some R&D advisors began collecting Trustpilot reviews, reducing complex corporate tax advice to the level of car insurance or a takeaway.
This is one example Trustpilot review from 2022:
“I had an excellent experience with XXX. My contact Andrew looked at my books and gave me an estimate of how much I could claim for R&D and about 5 weeks later the money was in my bank. I didn’t even realise that my company was able to claim R&D so it was a lovely bonus!”
By the time Covid hit, it was clear that the R&D Tax Credit advisory industry was in serious trouble.
The collective madness that had gripped the sector had become a gravy train that it was in no one’s interest to stop.
Coming soon…. look out for part 2 of my “rise and fall of the UK’s R&D Tax Credit scheme series” published on Thursday, 26 June.
Article written by Rufus Meakin
Rufus Meakin works with tech companies to help ensure their R&D Tax Credit claims are accurate and defendable.
If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to book an exploratory call here: https://calendly.com/rufusmeakin-uk/r-d-tax-credits-exploratory-call
