House of Lords raises concerns about SME R&D tax relief complexity

A warning has been fired at the government by the House of Lords, urging it to avoid making changes to R&D tax relief that subsequently put businesses off from using the relief.

Published today, a report by the lords raised concerns that the amount of scale and rate of change to R&D tax relief “has created uncertainty and a lack of understanding … which risks undermining its incentive effect”.

“Businesses will be pleased that the government’s review of R&D tax relief has been completed and that they can now plan ahead with some much-needed certainty,” said Lord Leigh of Hurley, chair of report publisher the Finance Bill Sub-Committee. “However, the government still has a lot of work to do in terms of the early publication of the regulations and guidance relevant to changes and a realistic timetable.” 

The report follows a number of hearings by the sub-committee into the measures in the Finance Bill 2023–24. It covers the bill’s new powers for HMRC to require additional data from employers and individual taxpayers on their workers/employees. Lord Leigh said the sub-committee “believes that additional cost and time burdens should not be placed on businesses unless there is a compelling reason to do so”. Draft legislation dealing with promoters of tax avoidance was also covered. 

While the sub-committee said in its report it was “pleased” to see the government’s commitment to cracking down on tax fraud and aggressive avoidance, Lord Leigh said it was “sceptical” about whether increasing the maximum prison term is the most effective deterrent against tax fraud.

Lord Leigh added: “We were also concerned by how the legislation aimed at dealing with promoters of tax avoidance schemes would be applied to offshore promoters, which we know deliberately place themselves in locations that don’t have tax treaties and extradition agreements with the UK.” 

R&D error and fraud

The Finance Bill will receive its third reading in the House of Commons from 5 February and is expected to receive royal assent, becoming law in the following weeks. The bill contains the government’s plans to overhaul the R&D regime from 1 April 2024 after concerns regarding the high levels of error and fraud from small and medium-sized enterprises (SMEs) claiming relief under the SME R&D scheme. 

Large businesses have tended to use the R&D expenditure credit (RDEC) scheme, but from 1 April, both R&D regimes will be merged. The new regime will then be based on the operation of the RDEC scheme, in a move the government says will simplify the R&D tax credit system.

However, there will also be a new separate scheme under which R&D-intensive SMEs can claim relief. Tax professionals have criticised the move, during Finance Bill Sub-committee hearings, as introducing complexity rather than a simplification. 

The House of Lords report came a day after Menzies tax dispute and disclosure specialist Georgia Gibson-Smith said HMRC’s efforts to tackle R&D error and fraud meant measures introduced “put off” genuine claimants. Gibson-Smith expressed her concerns as the National Audit Office (NAO) released its report on 31 January regarding the government’s tax measures to promote economic growth within the wider tax relief system. 

Menzies noted that, in the report, “managing the risk error and fraud in tax reliefs deemed ‘attractive to fraudsters’ became a focus” for the government, after the report found that an estimated £1.04bn of R&D SME relief was lost to error and fraud in 2020/21. 

The firm also stated that recent changes in the R&D tax relief in 2023 have meant more businesses have engaged professional advisers to support their R&D claims. Menzies expects this to continue when the SME and RDEC schemes are merged in April 2024. 

“The changes in April 2023 where HMRC have invested resource in seeking out R&D fraudulent claims have been widely perceived as overly aggressive among tax professionals,” Gibson-Smith said. “Some of the letters sent by HMRC in response to genuine and legitimate R&D claims come from HMRC’s fraud team, and appear to be accusing claimants of fraud despite claims being legitimate.” 

Given the specialist nature of many R&D claims there is “often a lack of technical understanding by the HMRC officers investigating the claims, which is a barrier to achieving a quick resolution”. 

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