Ayming UK – Written submission (DFG0019)

The following response is prepared on behalf of Ayming, Europe’s largest specialist innovation funding consultancy. We have experience of supporting businesses in claims for R&D reliefs, national and European grants, Patent Box, and other incentives across Europe and North America. Our response is based on the experience of preparing claims for thousands of clients, across a wide range of industry sectors and fields of science and technology. In preparing this document we have sought to represent the views of clients of varying sizes and fields, and in particular those who do not have the time or resource to prepare a detailed individual response.

Summary

Ayming and its clients welcome the reform of R&D reliefs as part of His Majesty’s Government’s economic strategy, creating an environment in which companies can invest in R&D as part of a long-term growth strategy.  Key to this is to ensure that genuine claimants are readily able to access the reliefs to which they are entitled, while restricting the opportunity for error and fraud in the schemes.

Some of the changes made are positive, and bring the schemes closer to a suitable scheme for 2023 and beyond.  Other modifications are a backwards step, which we believe will reduce investment due to factors not necessarily considered.  We also caution against an overreaction to the widely acknowledged problem of error and fraud; if the administrative burden of claiming becomes too onerous, genuine claimants will be deterred from making claims to which they are entitled.

Responses to questions

Our response is structured into sections responding to each question asked in the call for evidence.

1)   Have the changes to the definition of R&D gone far enough in modernising R&D relief, and if not, what more needs to be included?

1. We broadly welcome the proposed changes.  Inclusion of pure mathematics as qualifying R&D activity brings the BEIS Guidelines[1] definition closer into alignment with the definition of R&D given in the Frascati Manual[2], which is that used by many other countries internationally.  Greater synergy of definition with other countries overseas is to be welcomed since it makes it easier for companies to plan effectively, and increases our competitiveness on the world stage.
2. We also welcome the expansion of the scheme to include the costs of data and of cloud computing.  These are costs which are, in many cases, now fundamental to effective R&D, and their omission has been a source of frustration for many claimants, particularly in the IT and financial services sectors.  We are also pleased to see that His Majesty’s Treasury (“HMT”) has listened to feedback provided during consultations regarding the ease of apportioning costs to relevant R&D, and has taken a pragmatic approach that will make claiming simpler and less subjective.
3. Inclusion of costs of Health and Social Care Levy (“HSCL”) is an obvious, but necessary change in the light of the introduction of that tax.  However, given that there is ongoing uncertainty over whether HSCL will be introduced at all (at time of writing, the Government’s policy is to repeal its introduction) this clause may be redundant.
4. The ‘Miscellaneous Amendments’ in Part 6 of the proposed changes are all welcome, albeit they primarily deal with unusual circumstances not anticipated in the original legislation.  We urge a proactive monitoring of any ongoing problems as they occur; in line with the principle that companies legitimately investing in R&D should be entitled to claim, without their eligibility being curtailed due to obscure and unforeseen circumstances.
5. One notable omission is any change to the incentive for capital costs of R&D.  The Research and Development Allowances (“RDA”) regime has not been substantively amended since the 1990s, and is becoming increasingly obsolete in the modern tax landscape; as such, the RDA scheme is of limited appeal and provides little incentives for businesses to invest in capital R&D.  In addition, the treatment of revenue R&D costs accounted for as intangible fixed assets is complex.  Ayming UK has previously recommended the abolition of any capital/revenue requirement for claiming R&D reliefs, that is, that costs otherwise meeting the requirement for R&DEC/R&DTR should be eligible for those schemes regardless of the accounting treatment or capital/revenue status of those costs.  Note that the UK is relatively unusual in making such a distinction; very few schemes internationally have any requirement for costs to be revenue in nature.
6. Finally, there is no proposed change to treatment of plant hire or premises rental.  These are both types of cost which are necessary for a great many R&D projects but which are not currently eligible.  This is a source of frustration to many claimants, and we feel that their costs should be included as a parallel to the inclusion of cloud computing costs.  Observe that many other countries R&D schemes include such costs; those that do not are generally those that exclude everything except for directly incurred payroll costs.

2)   How effective will the changes be in countering error and fraud resulting from spurious R&D claims and is there more that can be done, or different approaches that could be adopted?

1. There are very few changes in the proposed legislation that will have any effect on error and fraud.
2. The only such substantive change is the requirement for claim notifications under Part 3, which we address in Section 6) below.
3. Otherwise, the legislation proposes to empower HMRC to introduce secondary legislation regarding “additional information in regard to R&D claims”, under s27 of the proposed legislation. HMRC and HMT have indicated the likely content of such requirements, most significantly in the following consultations in 2021 in which much of the proposed changes were first outlined.  Ayming questions the effectiveness of many of the measures outlined therein, on the basis that these are largely administrative burdens that will not necessarily deter those seeking to abuse the reliefs.  In addition, some of the requirements suggested (specifically, the requirement for a claim to be endorsed by a senior officer of the claimant company) replicate existing powers already possessed by HMRC but which are apparently not used effectively.
4. We do, however, welcome the suggested introduction of a requirement that a company notify HMRC of the name of an adviser involved in preparing the claim, so long as this is accompanied by effective and targeted compliance activity from HMRC.  There are a number of companies offering poor quality advice, often without the expectations of professional competence from accredited bodies in the tax profession, and targeting compliance at this area is the clear intent of this measure.  Note however that, for the measure to be effective, care must be taken to limit the potential for ‘white labelling’ of claims to circumvent the provision.
5. We are also concerned about the broad nature of the powers granted.  There is a historically problematic relationship between HMRC and taxpayers in relation to R&D reliefs (discussed in section 7), a widely acknowledged limit in the resources available to HMRC, and the Comptroller and Auditor General has criticised HMRC’s performance in his Opinions on HMRC’s financial statements for the last three tax years.  We are concerned that granting HMRC these powers opens the possibility that further legislation might be introduced that is contrary to HM Government’s policy intent, without additional Parliamentary scrutiny.
6. As a final observation, it is fundamental to the nature of a volume-based R&D incentive that claims must be simple and straightforward to make. If the administrative burden becomes too great in the quest to eliminate error and fraud, there is a risk that genuine claimants be put off from claiming; a number of companies have already indicated that this may be the case.  A fine line must be trod to achieve the right policy goal of incentivising innovation.

3)   How successful is the refocusing of the relief in encouraging activity in the UK without adverse consequences?

1. In principle, the proposed changes are in line with the stated policy intent, of refocusing of the relief towards R&D activity taking place in the UK.  However, there are significant unintended and negative consequences that appear not to have been considered.
2. A significant minority of Ayming’ clients (including at least one technology ‘unicorn’) incur expenditure on overseas EPWs or subcontractors that would be excluded by the proposed changes.  However, none of these businesses is planning to onshore any of the activities currently undertaken overseas.  Some companies have merely accepted that their claims will reduce, which in some cases will lead to a reduction in overall R&D investment and hence growth of UK-based revenue.  Other companies are actively considering whether to relocate entirely to a more favourable jurisdiction; such businesses have historically located their headquarters and IP (and, by extension, revenue and profits) in the UK due to the favourable treatments available, but are now questioning whether that is a good long-term strategy.
3. The previous regulations governing overseas expenditure formed a part of the Government economic strategy of making the UK a good place for multinationals to locate global or regional headquarters, and in particular to locate IP in this country.  The proposed legislation acts contrary to that strategy, albeit in line with a new stated policy; however we believe that the overall result of the change will be negative for the UK economy.
4. It is welcome to see that the proposed legislation allows certain qualifying overseas expenditure, broadly in line with recommendations previously made by Ayming, and covering situations where it is necessary to perform R&D overseas due to the nature of the project.

4)   How aware are smaller businesses of R&D relief? Is there more that HMRC could be doing in practice to help smaller businesses access relief to which they are entitled?

1. In our experience, relatively few small businesses are aware of R&D reliefs, unless approached and informed by tax advisors and accountants.  This experience is supported by HMRC’s own report[3], which stated that:

Businesses generally first heard about R&D relief from sources external to HMRC, primarily through accountants or other businesses in the sector.

2. This report identified that many such businesses had missed out on claiming R&D relief in previous financial periods due to lack of awareness.  It noted also that a lack of awareness of Advanced Assurance could be a significant factor in the poor take-up of that service.
3. We are even more concerned that very few small businesses are aware of the proposed changes, and the impact that these might have on their claims.  Not one of Ayming’ SME clients (over 250 businesses) was aware of any proposed changes until informed by us.
4. There is a clear opportunity for HMRC to be proactive, and to communicate about all proposed changes with every existing claimant.  We recommend a letter be sent to all claimants by HMRC, explaining the changes to taxpayers.

5)   How helpful is HMRC and BEIS guidance in interpreting and applying the R&D relief rules?

1. The guidance provided by HMRC in its manual[4] is useful, but is primarily intended for internal use rather than by taxpayers.  The result is that the guidance is often unfriendly for those not already familiar with the basic principles of R&D reliefs.  We also note that the manual takes a very simplistic approach, and is of minimal use in addressing the many complex questions that can arise around interpretation of the underlying legislation.
2. The exception to this is the simple guide for SMEs, published as CIRD99500, which we have seen particularly well received by the smallest businesses.
3. Beyond the published manuals, there is relatively little guidance available.  HMRC’s R&D reliefs helpline is often unresponsive, and the response we have found in all cases has been either reference to the CIRD manual, or advice to submit a claim and allow HMRC to review it (under statutory enquiry if necessary).  This does not assist taxpayers in making accurate claims, nor does it seem an efficient use of HMRC resources.
4. The experience of larger businesses who engage with HMRC’s Large Business Service is mixed, and seems heavily dependent on the inspector dealing with a particular taxpayer.  Some have found very productive engagement, with useful pre-claim discussions generating confidence from both HMRC and taxpayers that the claim is correct, and a clear understanding of what documentation will be provided and in what format.  Other companies have found the experience vague with HMRC being non-committal, and are now in the position that an enquiry is expected into every claim made; the result is frustration and mistrust from all concerned.  This uncertainty compromises the intention of the schemes as an incentive, since taxpayers are unable to effectively plan their R&D in anticipation of benefiting from a claim under these circumstances. 
5. The BEIS Guidelines on the definition of R&D are fundamental to the functioning of the scheme, but they can be difficult to interpret to a specific field of science or technology due to their breadth.  Nevertheless, this is an essential feature, enabling the definition of R&D to apply across the many and varied fields of science and technology for which R&D reliefs are available.

6)   What view do you take of the requirement to give advance notification of R&D claims? What effect would you expect it to have on genuine and spurious R&D claims respectively?

1. The requirement appears to be a purely administrative burden that might restrict legitimate claims, and will have limited effect at preventing error and fraud.
2. The exemption for companies having made a claim in any of the previous three accounting periods are broadly welcome, since they reduce the administrative burdens on companies that routinely make claims.  However, any companies that already make erroneous or fraudulent claims will likewise not be exempted, and therefore this measure will have no effect whatsoever on error and fraud in this circumstance.
3. Contrast with the position of companies that make occasional, or first, claims.  It is entirely possible that such companies will not make a notification, either through omission or because the company is unaware of the requirement (see section 4).  Genuine claimants may potentially therefore lose out on a claim to which they would otherwise be entitled, for a purely administrative reason rather than because they had not invested in R&D.  Meanwhile a company seeking to abuse the scheme seems less likely to omit this step, and therefore the measure seems unlikely to have the desired effect.

7)   What is your experience of HMRC’s approach to dealing with claims to R&D relief which it suspects to be invalid, either through misunderstanding of the rules, or fraud?

1. Ayming has managed HMRC enquiries on behalf of taxpayers across multiple industries, and ranging in size from only a few thousand pounds to multi-million-pound claims.  In addition, we have supported some taxpayers who have recently received letters from HMRC’s Fraud Investigation Service (“FIS”).  Our experience is limited to that of our own clients, and as a result we believe HMRC’s suspicions to be unfounded in the cases in which we are involved.
2. The experience in most enquiries is that HMRC’s approach is adversarial and argumentative.  Taxpayers have often felt that the inspectors are working from the presumption that the claim is incorrect, and selectively interpret facts to support this position.  Facts and evidence that support the taxpayer’s claim can sometimes be ignored or unacknowledged if they do not agree with HMRC’s view.  Furthermore, we have observed that some inspectors will open new lines of questioning when they feel that an existing line is not resulting in a reduction to the claim.  For example, in a recent enquiry HMRC asked 67 questions focussing on the technical nature of the R&D and the costs incurred, which were addressed after significant effort from both Ayming and taxpayer; HMRC has not acknowledged this evidence but has changed its approach and began examining whether the taxpayer is eligible to claim as an SME at all.
3. On other occasions, it has appeared that HMRC’s inspectors are relatively inexperienced.  In some cases, enquiry letters are sent which ask formulaic ‘checklist’ questions, many of which are irrelevant to the claim under enquiry.  For example, we have seen questions regarding the capital costs of R&D for a company which has not made an RDA claim.  We have also a record of an HMRC inspector admitting to having misinterpreted the legislation, and as a result having misled a taxpayer as to the requirements for a claim.  Other taxpayers have found HMRC’s questioning to be directionless; requests for “all project information” are common, without appreciation that this may extend to thousands of pages across hundreds of files.  The result would be a significant administrative effort to provide this evidence, as well as imposing a huge burden on HMRC’s resource in reviewing such information.
4. Finally, we bring attention to a recent change in HMRC’s interpretation of two specific aspects of the legislation governing SME R&DTR, specifically the requirements (under CTA09 s1052 (5) and (6)) that the company not be subcontracted to perform R&D nor be subsidised.  HMRC’s interpretation has changed, in such a way that any R&D conducted by a SME in support of a commercial contract would no longer be eligible for R&DTR; it should be evident that this would severely curtail the majority of SME claims, given that R&D must (in order to be eligible) be undertaken in support of a trade with the implicit expectation that this be a profit-seeking activity.  This interpretation has been tested in the First-Tier Tribunal[5], in which the taxpayers claim was upheld with Judge Harriet Morgan issuing significant criticism of HMRC’s position.  Nevertheless, HMRC continues to ignore this case.
5. The general result of the experiences outlined above is to foster an atmosphere of mistrust between taxpayer and HMRC.  We would prefer an environment in which taxpayer and HMRC could work together collaboratively, to ensure that the right amount of tax is collected, and by extension that the right amount of relief is available. 

8)   Are there lessons the UK could learn from the tax systems of other countries about how to encourage R&D?

1. One of the key trends identified across the Ayming Group is that stability is fundamental to encourage investment in R&D.  Countries (such as France and Canada), where there is consistency of will across the political spectrum to support R&D, have long-running schemes.  The resulting consistency in the process, eligibility, and benefits allows companies to make long-term investment decisions in the certainty of the tax implications of that decision.  Contrasting that with Italy (where the scheme has historically been radically altered with changes in political leadership) or the USA (which, until recently, had no long-running incentive but a rolling incentive requiring annual renewal), the experience is that R&D reliefs are not factored into investment decision-making at all.
2. Some countries (most notably France) operate a scheme of accreditation of advisers.  Such a scheme gives additional confidence to the relevant authority (equivalent to HMRC) that a claim prepared using the advice of such an adviser is unlikely to contain error or fraud.  We note however that this does not give carte blanche to such advisers, who are still subject to enquiry if necessary; rather, it is a mechanism to further improve analysis of risks to the public purse presented by any given claim. 

9)   How successful are the changes in R&D relief likely to be in encouraging innovation and development?

1. Expanding the scope of the schemes is welcomed; taxpayers that are affected are welcoming of the increased benefits arising.  This allows such companies to further reinvest the benefits arising in future R&D activities. 
2. We caution against administrative burdens creating obstacles to genuine claimants.  A number of businesses have stated that, as a result of negative experiences with making claims and in particular from enquiries, they have been deterred from making future claims.
3. Nevertheless, the majority of businesses we represent regard R&D reliefs as a key part of their future planning for innovation.  Many companies treat the reliefs as mitigation of the inherent risks when undertaking a scientific or technologically challenging project; this allows them to take greater risks than might otherwise be commercially prudent.  Clients utilise the benefits arising from their R&D claims by further reinvesting in new innovation.  This aligns closely with the priorities outlined by the then Chancellor (now Prime Minister) in the Budget of “People, Capital, Ideas”.  Obviously, reinvestment in R&D should generate new Ideas; we also note that it leads to job creation and development of new skills (supporting People), and that inherently investment is the creation of Capital.

1 November 2022