What Happens When You’re Audited by HMRC for Tax Credit Claims
The boom in R&D tax credit claims has led to greater policing of submissions by HMRC.
Here Finance Monthly hears from James Dudbridge, Associate Director at tax credit specialists ForrestBrown, who explains how to appropriately navigate a HMRC enquiry.
Research and development (R&D) tax credits are a government incentive designed to reward UK companies for investing in innovation. They’re a valuable source of cash for businesses and support significant growth. HMRC itself found that for every £1 of tax foregone, up to £2.35 of additional R&D is stimulated. In recent years, HMRC has focused its efforts on increasing awareness of the incentives and it has seen success, with the volume of claims being made booming. Around 50,000 claims were made for the 2017-18 tax year alone – a 31% increase on the prior year.
But this success has prompted greater scrutiny of the submissions being made. Firstly, because HMRC has a duty to ensure taxpayers’ money is being used efficiently. Secondly, because HMRC recently uncovered a high-profile instance of fraudulent activity, said to be worth as much as £300m to the public purse.
This greater scrutiny takes the form of enquiries. Put simply, this is when a taxpayer gets a letter from HMRC asking for further information relating to their R&D tax credit claim. It may be worded as a “compliance check”, but in reality, it’s an investigation, and should be treated with the gravity it deserves.
While HMRC doesn’t release data about the volume of enquiries it undertakes, estimates suggest it’s about 5-10% of all claims submitted[i]. That’s potentially as many as 5,000 investigations a year. These can be prompted by any number of factors. It could be that there’s a simple, honest mistake spotted by an HMRC inspector. It could be that HMRC requires more information surrounding specific parts of the claim. Or it could relate to a wider tax position. Sometimes it can be as simple as HMRC deciding it wants to study a specific sector, or technology, in greater detail.
With more enquiries being launched than ever before, it’s important to be prepared. While the vast majority take place before any money is handed over, there are some cases where enquiries are opened after the R&D tax credit has been paid. When that happens, not only may you have to hand back cash that may already have been spent or allocated, but interest may also be charged. In all cases there is also the possibility of penalties applying if any part of the original claim is found to be incorrect.
Not only may you have to hand back cash that may already have been spent or allocated, but interest may also be charged.
But it’s not just the financial impact. If an enquiry isn’t handled effectively, an enquiry can seriously impact your relationship with the tax authority. This can make all subsequent tax issues harder to deal with. Furthermore, an enquiry can take anything from a few months up to several years to resolve. That’s time and resource being spent trying to fix the issue – with multiple people involved from around your business. It can be a massive drain. Not to mention the stress and frustration it might cause.
Avoiding an enquiry
All this begs the question: how can you avoid being the subject of these types of investigation? In some cases, you can’t. You might just be picked at random. But it is possible to reduce the likelihood, and, crucially, increase your chances of a successful resolution if it happens.
Firstly, be prepared. Just because you’ve received a benefit in the past, it doesn’t mean it will be seamless next time – even if you follow the exact same process. The same level of scrutiny should be given each and every year when making a claim – and if it transpires previous documents weren’t quite right, action needs to be taken. Simply updating documentation from your prior year isn’t enough – what HMRC expects in support of claims has changed – and so your paperwork needs to too.
Secondly, it’s vital that those preparing the paperwork are crystal clear on the criteria. Worryingly, some aren’t. Once we outline to them exactly what can go into a submission, they realise they’ve been getting it wrong. In most cases, it’s not intentional. It’s just a lack of understanding about the parameters of the relief. Claims prepared by non-experts quite often don’t properly consider the boundaries of R&D projects – something that HMRC has asked for in recent guidance.
There’s also a need to have a strong understanding of the underlying science or technology, which can be a challenge where a finance team prepares a submission. HMRC will want to see this presented in a particular way. There are then strict categories of costs involved which can be included in the claim.
Top tips for handling an enquiry
If an enquiry happens, you need to act swiftly and judiciously. Once the HMRC letter arrives, be open, be honest, be transparent and be collaborative. It’s important to begin building a positive relationship with your HMRC inspector immediately. Your first response will set the tone for the rest of the process.
At first, there may just be generic questions to answer. Don’t let this fool you. You need to think carefully about the claim you’ve submitted. Try to get ahead of any possible risk areas. Within reason, HMRC will be open to you defending parts of your claim that they may have challenged.
Don’t keep the enquiry away from people within the business. Getting the right information together for HMRC will usually involve a number of different stakeholders in the business, such as the legal team, the finance department and the technical experts. They can all help guide the process and provide insight and expertise to ensure the best possible outcome.
It’s always worth bringing in specialist external support with a strong pedigree in dealing with enquiries. They can help guide you through choppy waters and provide expert advice on all aspects of the enquiry. When engaging with an enquiry support service, the first step is full disclosure. Don’t hold anything back and give them access to your experts for interview.
The next step is to revisit all the costs that made up the R&D tax credit claim and review them again in full. Once this is completed, you will have a strategy in place designed to resolve the enquiry with the best possible outcome for your business. This will often involve formal written responses, as well as preparation of key personnel for any call or meeting required with HMRC.
A silver lining
An enquiry can be a positive learning process. Having been the subject of an enquiry, those involved will be armed with the knowledge they need to ensure subsequent claims are robust and cover all of the areas that HMRC expect to see for that business. This is invaluable – and has a real monetary benefit. It can be the difference between a useful lump sum of capital and a failed claim with significant operational costs.
Although enquiries aren’t necessarily positive experiences, we should welcome their existence. HMRC is enforcing best-practice and it’s reassuring to know that public finances are being protected from potentially fraudulent activity.
If you haven’t made an R&D tax credit claim before and are considering it for the first time, it’s important not to be put off. That said, given HMRC’s focus on quality, it’s worth choosing an adviser with care. Look for a multidisciplinary team who hold professional credentials across accounting, tax and law. Seek evidence of supervision by the Chartered Institute of Taxation. Be assured they adhere to HMRC’s agent strategy.
This will ensure that your claim is not only fully maximised, but also protected from risk. Meaning that when you receive your benefit, you can do with it what the government intended: invest it back into your business to spark your next big push or fund the start of something remarkable.
[i] Estimate made by ForrestBrown