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Additional corporation tax relief for expenditure on research and development (“R&D”) is a Government initiative designed to incentivise innovation pursuant to the Corporation Tax Act 2009 (“CTA 2009”), Chapter 2 Part 13 (“Part 13”). It operates to either reduce a company’s corporation tax bill or provide the business with a tax credit. R&D tax relief boosts productivity and drives innovation economic growth. However, while Part 13 provides significant financial benefits, claiming the credit requires a precise understanding of the rules with errors resulting in unexpected liabilities arising from the requirement to repay the tax, including interest and in some circumstances, penalties.

HMRC analysis found that in 2020/2021 half of all R&D tax relief claims were incorrect resulting in it introducing various measures and policies to tackle error and fraud.

The most recent measure, announced on 31 December 2024, is HMRC’s new R&D disclosure service for companies to voluntarily disclose that they have overclaimed R&D tax relief and are unable to amend their tax return because they are out of time to do so.

This article explores, in brief, the R&D tax credit, common mistakes in claims, the consequences of misadvised claims by professional advisors, and steps to address potential professionally negligent advice if faced with a tax bill.

What is the R&D tax credit?

R&D tax credits aim to support businesses undertaking ‘innovative’ projects that seek to achieve advancements in science or technology. Qualifying activities must involve overcoming technical uncertainties and developing innovative solutions. Costs may include staff wages, materials, software, and subcontractor expenses. However, determining eligibility requires detailed assessments and adherence to the law and guidelines (as to which, these are summarised below).

The law

The original legislation was introduced in the Finance Act 2000 and then consolidated in the CTA 2009. Section 1041 CTA 2009 states that “research and development” has the meaning given in section 1138 Corporation Tax Act 2010 which defines the term by reference to GAAP but also provides that if something is R&D for the purposes of section 1006 Income Tax Act 2007 then it is such for the purposes of section 1138. Regulations were made under section 1006 prescribing certain activities as research and development, namely The Research and Development (Prescribed Activities) Regulations 2004/712.

Those Regulations state inter alia that R&D will qualify if it accords with the Guidelines on the Meaning of Research and Development for Tax Purposes issued by the Department for Business, Innovation & Skills on 5 March 2004 (as amended in 2010 and 2023, but which are not material for the purposes of this article). Those were known as the BIS Guidelines and latterly, following a merger of Government departments, as the BEIS Guidelines.

To which companies do R&D relief apply?

Part 13 includes provision for R&D relief for Small and Medium Size Enterprises (“SME”s); hence the descriptions the ‘SME Scheme’ and ‘SME relief’. It is distinguished from the R&D Expenditure Credit (“RDEC”) Scheme.

The SME Scheme provides an extra deduction for the purposes of calculating a company’s R&D on all qualifying expenditure, which is taken as an additional deduction in computing corporation tax profit, which can be significant.

The RDEC Scheme, which originally only related to large companies, but which was later extended to SMEs in certain circumstances, is a more limited form of relief and provides entitlement to a payable tax credit which is a percentage of the qualifying expenditure on R&D.

Companies cannot claim both SME relief and RDEC on the same R&D expenditure. Companies that are excluded from the more generous SME scheme because they do not meet the criteria can claim RDEC.

Common reasons for disputes over R&D claims

Errors in R&D claims can arise due to several factors, some of which are:

  1. Lack of Innovation: Science and technology has come along leaps and bounds in the past few years. What may have been groundbreaking a few years ago may quickly become the status quo. HMRC are looking at cases where the grounds cited as the basis for the relief have not been reviewed and HMRC believe that the business activities can no longer be classed as seeking to achieve an advancement in science or technology.
  2. Misinterpretation of Guidelines: Misunderstanding what qualifies as R&D activity. For instance, the expenditure incurred on R&D is “subsidised expenditure” within the meaning of section 1138 CTA 2009 or incurred “in carrying on activities which are contracted out to the company” within the meaning of sections 1052(5) and 1053(4) CTA 2009. There may also be circumstances where the main business activity during the period did not amount to carrying on a trade, as the technology-based entrepreneurial business idea was at a very early stage and not commercially viable.
  3. Overestimation of Eligible Costs: Including non-qualifying costs in the claim.
  4. Relying on Non-Specialist Advice: Working with advisors lacking expertise in R&D tax credits.
  5. Aggressive Claims: Some advisors may encourage taxpayers (knowingly or unknowingly) to push the boundaries of eligibility to secure larger claims, putting clients at risk of HMRC scrutiny. The SME Scheme was described by Mr Justice Henderson (as he then was) at paragraph 12 in Gripple Ltd v HMRC [2010] EWHC 1609 (CH) as follows (emphasis added):

…the provisions form a detailed and meticulously drafted code, with a series of defined terms and composite expressions, and a large number of carefully delineated conditions, all of which have to be satisfied if the relief is to be available… It seems to me… that a detailed and prescriptive code of this nature leaves little room for a purposive construction, and there is no substitute for going through the detailed conditions, one by one, to see if, on a fair reading, they are satisfied. It also needs to be remembered, in this context, that the relief is a generous one, which grants a deduction for notional expenditure which has not actually been incurred.

When HMRC identifies inaccuracies, it may demand repayment of the tax relief plus interest and, in some cases, levy penalties for incorrect submissions.

What to do if HMRC challenges an R&D claim

  1. Understand the HMRC Decision: Request a clear explanation of why the claim was rejected and which aspects were non-compliant.
  2. Engage a Specialist: Seek advice from an R&D tax credit specialist or lawyer (as the authors of this article) with experience in resolving HMRC disputes.
  3. Rectify the Claim: Amend the tax return to correct inaccuracies where you are in time to do so. This may reduce potential penalties.
  4. Appeal if Necessary: Challenge it through the appeals process in the Tax Tribunal (FTT).

The New Voluntary Disclosure Scheme

For companies which have made claims that are excessive but that are yet to be formally challenged by HMRC, the new voluntary disclosure service is available for companies who need to make corrections outside the standard 12-month period for amendments.

The disclosure facility is only suitable where the errors made are not deliberate, i.e. the error was careless or took place despite the taxpayer taking reasonable care.

Where a taxpayer makes a disclosure voluntarily, HMRC will take this into consideration when calculating penalties. Disclosures that are ‘unprompted’ tend to attract lower penalties than disclosures that are ‘prompted’ by HMRC.

The facility also enables the company to make a payment in respect of the tax and credits to be paid, which will stop interest from running.

Addressing Professional Negligence in Misadvised Claims

In circumstances where the company relied on a professional advisor in respect of an R&D claim which is challenged and/or disallowed by HMRC, they may also have a claim against its advisor for negligent advice should it be established that the advisor did not act competently. Such a claim could enable the company to recoup any penalties and interest imposed by HMRC that would not have arisen had proper advice been given. Each case will turn on its facts, however, there are a growing number of instance of corporates bringing proceedings alleging breach of contract and/or professional negligence against advisors. The news is replete with examples.

If a company believes that its R&D claim failed as a result of, or indeed ought to have never been made by, negligent advisors, the steps are broadly to:

  1. Gather Evidence: Collect correspondence, claim documentation, and any other materials that demonstrate the advisor’s guidance and its impact.
  2. File a Complaint: Consider submitting a complaint to the advisor’s professional body, such as the Chartered Institute of Taxation (CIOT) or Institute of Chartered Accountants in England and Wales (ICAEW).
  3. Consider Legal Action: If negligence is evident, a company might seek compensation through legal proceedings. Damages may include repayment of penalties and interest, together with other associated losses.

Conclusion

The R&D tax credit can provide invaluable support for businesses engaged in innovation, but its complexity requires careful handling. If you’ve been misadvised in making a claim, prompt action is essential to address HMRC’s concerns and mitigate financial losses. Holding advisors accountable for professional negligence, when applicable, can help recover losses and mitigate the financial impact of poor advice.

Our Commercial Litigation and Tax teams work together on such matters and have considerable experience in this specialist area of law. For further information, please contact Thomas Johnson or Morag Ofili.

Please note that this blog is provided for general information only. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content of this blog.

Edwin Coe LLP is a Limited Liability Partnership, registered in England & Wales (No.OC326366). The Firm is authorised and regulated by the Solicitors Regulation Authority. A list of members of the LLP is available for inspection at our registered office address: 2 Stone Buildings, Lincoln’s Inn, London, WC2A 3TH. “Partner” denotes a member of the LLP or an employee or consultant with the equivalent standing.

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