Charlotte Clemence has given herself a year to save her small business, a year in which she is “literally working for nothing” to pay back a tax debt incurred after she fell victim to a research and development scam.
It’s a far cry from last year when she found success on the popular TV programme Dragons’ Den, securing financial backing from entrepreneurs Sara Davies and Steven Bartlett to support her garden art business.
But, since that high point, Clemence has found herself on the receiving end of “threatening letters” from the UK tax authority demanding repayment of a £10,000 tax credit plus interest and penalties.
The adviser who told her to apply for the R&D tax credit has shut up shop and disappeared off into the sunset, with the 30 per cent fee they took for arranging the application. Clemence’s business partner has withdrawn from the venture after the financial stress became too much for her to bear.
Clemence is angry at many parties, including HM Revenue & Customs. The tax authority penalised her, she says, even though she thought she was doing the right thing in claiming money she was entitled to.
The R&D credit “went straight into the business to do more development,” she adds. “It’s not like it went into our pockets. We basically put it back into the economy.”
However, since HMRC demanded the money back, the business has had to make “huge cutbacks” including staff cutbacks. The HMRC bill is not the only thing that has weighed on the company, but Clemence says that as a small business the unexpected cost “threw a massive spanner in the works”.
Clemence had taken advantage of the UK government’s small and medium enterprise R&D scheme, established in 2000. It allowed companies to claim a deduction from corporate tax liability based on their research and development expenditure, or to claim a payable tax credit if the company was loss making.
But, from around 2014-15 the number of R&D claims made by small businesses started to soar, fuelled by a boom in unregulated tax advisers encouraging firms to put in claims, sometimes spuriously.
Several tax experts told the Financial Times that before 2022 HMRC took a light-touch approach to checking R&D claims. There were nearly 83,240 in the 2021-21 tax year.
But the department made an abrupt U-turn after discovering massive levels of fraud and error. HMRC’s latest estimates, published in its 2023-24 annual report, show that of the £7.6bn claimed in 2021-22, £1.3bn of that was down to error and fraud — representing 18 per cent of claims.
“The people who are getting all this money from R&D credits by milking the system and then shutting down their businesses have got off with no consequences,” says Clemence. “It’s us honest, hardworking people that have just found ourselves in this horrible situation.”
Various factors drove the scheme’s abuse, including the fact that tax advice in the UK continues to be unregulated and anyone can call themselves a tax adviser.
Ellen Milner, director of public policy at the Chartered Institute of Taxation (CIOT), was also critical of HMRC’s past practice of paying first and checking later which presented “an opportunity for bad players to exploit”.
Clemence offers a cri de coeur: “How are we ever going to be a country that’s good at industry, if the government treats businesses unfairly?”
It’s a sentiment shared by other owners of small businesses who found themselves in the crosshairs of a crackdown by HMRC on research and development credits.
Andy Formon, is the director of a family-owned business he runs with his wife and two grown-up sons that specialises in the design, manufacture and installation of automation and conveyor systems. He says dealing with HMRC’s chaotic year-long inquiry into an R&D credit of £22,000 that the firm received gave them “considerable” levels of “totally unnecessary stress”.
“It took a toll on both of us. We almost got to the point of deciding it’s not worth the hassle to fight it,” Formon says.
Ultimately, the Formons, with their tax advisers’ backing, decided to continue challenging HMRC’s rejection of the claim and brought a case to the tax tribunal. Before the case had been heard, HMRC this week accepted the R&D claim in full.
Phil Smith, technical lead at ForrestBrown, a specialist R&D adviser representing the Formons says while HMRC’s backdown was “a much welcome outcome” it was unfortunate the family had to go to push for an appeal.
“In our experience, many other taxpayers would not have had the appetite to do so . . . losing out on tax relief to which they are legally entitled as a result,” Smith says. Formon said he believed HMRC was hoping people like him “would just go away”.
Since August 2023, both Conservative and Labour governments have introduced measures to clamp down on abuse in the system, including merging the SME R&D scheme with the scheme for larger companies. In addition, HMRC has rapidly stepped up compliance checking of past claims, hiring 400 staff to assess claims by small businesses. The number of claims has also fallen substantially, down to 65,690 in 2022-2023.
The government also plans to consult on widening the use of advance clearances in R&D, with the aim of providing greater certainty to businesses planning to invest, while reducing error and fraud.
While the need to tackle the problem is undisputed, professional bodies and small business representatives echo small businesses’ concerns that HMRC’s approach is having negative consequences.
“We, and our members, want the bad claims rooted out,” said the CIOT in a strongly worded letter to the tax authority on the issue.
“But as it stands, it seems that HMRC do not have the systems in place to differentiate good (claims) from bad.”
David Hale, government affairs director at the Federation of Small Businesses trade body, said the current HMRC regime is “stifling the government’s drive for growth”.
“Business owners are telling other business owners not to touch the R&D system,” he added. “We now have a tax system that gives the impression that if you do R&D, [HMRC] will investigate and I don’t really see how that leads to growth.”
Part of the problem, critics say, is that HMRC teams are conducting “desk-based” research into businesses’ claims, with little attempt to understand the business or even meet with claimants.
The CIOT’s open letter to HMRC complained that the authority’s compliance teams were taking “aggressive positions” and displaying “a refusal to have conversations (in person or virtual meetings, or phone conversations)” with claimants and their advisers. It also cited examples of “lack of care, getting the technical law wrong, poor communication and grammatical errors” in correspondence with businesses.
This chimes with Clemence’s experience. She mentions that the first letter HMRC sent asked the business to repay a claim of £156,000, which turned out to be a mistake, but took a long time to clarify.
Professional bodies have also raised the alarm about specific compliance tactics that HMRC has used in its crackdown on abuse of R&D tax credits. In the first instance, HMRC used a little-known statutory power to change submitted returns unilaterally to amend or remove the claim to R&D tax relief.
“What that power allows HMRC to do is to correct a taxpayer’s return unilaterally when it believes there are obvious errors or omissions in the return. Traditionally, it’s only been used for things like arithmetical errors, where there’s no question that a mistake has occurred,” said Richard Jones, senior technical manager at the Institute of Chartered Accountants in England and Wales.
“Where you have something that’s a lot more subjective and open to judgment, such as whether there is a valid R&D claim, our view is that it’s not appropriate [to use that power].”
Tax experts have also questioned the lumping together of fraud and error in HMRC’s statistics, arguing they should be thought of separately, as the behaviours have very different motivations. Figures uncovered from HMRC by the Financial Times under freedom of information laws showed that only 1 per cent of R&D claims from small and medium-sized businesses were found to be fraudulent in 2021-22.
The information, taken from a random sample of 400 claims conducted by the tax authority, showed a further 8 per cent had unconfirmed fraud risk indicators, while 10 per cent contained errors. More than a quarter of claims were disallowed for ineligibility.
Professional bodies acknowledge that HMRC has a difficult balancing act to protect the public purse from the R&D credit abuse it has suffered, while also supporting legitimate claims.
“It is a challenging compliance landscape, people are walking away from claims and that’s a failing of the relief but at the same time, there was a lot of fraud and error and they’ve got to do something about that,” says Emma Rawson, director of public policy at the Association of Taxation Technicians a professional body.
Milner of the CIOT adds that any large organisation would have faced difficulties bringing in 400 relatively inexperienced staff at short notice and getting them to deliver to a consistent standard.
Dan Neidle, founder of the Tax Policy Associates think-tank, says that HMRC is faced with managing a system that is “just broken”, with 60,000 claims a year far too many for the department to be expected to handle.
HMRC said: “These reliefs play a vital role in the government’s mission to boost economic growth and we’re committed to ensuring the claims process is straightforward for genuine claimants.
“Given the significant levels of non-compliance in the regime, it’s essential we undertake activity to make sure taxpayers’ money is spent on supporting genuine R&D, spanning criminal investigations of dishonest agents through to greater education of claimants on their eligibility.”
