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Key points
- Increasing concerns over research and development relief claims.
- Are claims appropriate and properly calculated?
- Are there conflicting interests between clients and advisers?
- Compliance with the Professional Conduct in Relation to Taxation guidance.
- The importance and relevance of the claim fee structure.
- The influence of HMRC on claims.
- Suggestions for a new approach.
Over recent months, I have commented several times on concerns that I and others have on how the market for research and development (R&D) relief claims has developed. I’ve been contacted by advisers as a result of those pieces and several have been generous with their time in talking to me about how they see things. I was able to obtain the views of a range of firms, from large accountancy and tax practices through to smaller firms and specialist boutiques.
I thought that it would be useful to all readers to bring together the various strands that emerged in these conversations and present a view of how I see the current state of the market. This is, I should stress, a personal view: it is based on what people told me, but I take full responsibility for what is written here.
Real concerns
The headline is that there are real concerns about the way that some players in this market are operating. This relates not only to the quality of the claims being made, but also to the business practices that are being adopted. I will explain what I mean by this below, but one thing I do want to stress is that this is not a case of accountancy firms versus boutiques. People on both sides of the aisle were very clear on this and wanted me to emphasise that point. It is about the difference between good and bad work.
In any study of this nature there is a natural inclination to think ‘they would say that, wouldn’t they’. People will always want to present their own work in the best light, and it is easy to be critical of others who do things differently. There is also the risk that some form of informal cartel might exist, so that people already doing this work want to prevent others having a slice of the action. I always had this in the back of my mind when talking to people, but I did not get that sense at all. Those who raised issues seemed to me to have genuine concerns, particularly about the way that some clients were being treated, and wanted to do their part in raising the overall standards in this part of the industry.
Is that really R&D?
The first area of concern is that claims are being put in for expenditure that simply does not fit within the definition of qualifying R&D. This is not a question of disagreements over where the boundaries lie: everybody accepts that the nature of R&D is such that it is perfectly possible for two experts to disagree over whether something qualifies. The concern is about claims for expenditure that could not, on any rational basis, qualify. The classic one is pizza toppings. A large food processing company looking at new technology to improve the production process of pizza dough might qualify, but a small takeaway pizza restaurant trying out different toppings? Claims of this type are certainly going in and do not appear to be challenged – something I discuss later. It’s not just pizza toppings of course, but I don’t think there is anything to be gained by listing other dubious claims. I am sure that many readers will be able to add their own examples.
Who’s doing what?
The second area is quantification. Several people told me that they had seen cases where a small amount of R&D work was probably being carried on, but where the claims were out of all proportion to the expenditure incurred on qualifying activity. Salaries of people not involved at all in R&D seem routinely to be included in claims – I heard of one where a small proportion of every single employee’s salary was included, even though the vast majority of them had nothing to do with R&D. There is real concern that some advisers operating in this area are quite prepared to throw the kitchen sink into claims, seemingly on the basis that there is an assumption that HMRC will not challenge. This does make it very difficult for those advisers who are trying to do a professional job and submit claims on behalf of their clients which include only expenditure which is genuinely incurred on R&D.
Flying blind
So much for the claims themselves, what about the way that some people in the marketplace are operating? In many ways this is of greater concern.
One of the most worrying aspects, which several people referred to, was that there often seemed to be little or no involvement by the company itself in making the claim. I was told by several different advisers that some firms are putting in claims without having any form of approval from the company. Indeed, I am aware of cases where the R&D consultant was not even prepared to share the details of the claim with the company on whose behalf it was submitting it until the firm had agreed that the claim could be sent to HMRC. This is not just about the fine details; it includes information about the nature of the qualifying activity the expenditure included in the calculation. That really is putting the cart before the horse. In the recent AHK Recruitment Ltd case (tinyurl.com/y22mjlgu), HMRC challenged a claim and the company put forward no evidence at all about the nature of the work it was undertaking and had left everything to the adviser. My reading of what happened, and I am happy to be corrected here if anybody in the know wants to put me right, is that the company had little idea about the claim at all. I suppose that the justification for this sort of approach would be that if the company had a copy of the claim it could submit it to HMRC directly, cutting out the firm who had put the claim together. However, I still do not believe that this is an acceptable position to take.
Tension between advisers
These sorts of situation create real problems if the firm dealing with the claim is not the company’s regular tax adviser. Several people told me about cases where they had looked at R&D for the client and had concluded that no relief was available, but were then faced with the client coming back to them to say that they had been advised by somebody else that they could claim. Typically, what then happens is that the client simply instructs the agent to put in a revised return with claim of £X with no explanation, based on the figure provided by the R&D adviser. Not surprisingly, most agents will not be prepared to do this without some evidence about the merits and calculation of the claim. Requests for details are often met with the response from the client that they know nothing about the make-up of the claim and have no information about it. If there is a genuine difference of opinion there could be some discussion between advisers but, in the cases I am concerned about, the firm that has compiled the claim typically refuses to provide the agent with any information, citing commercial confidentiality. The agent is in an impossible position here. The Professional Conduct in Relation to Taxation guidance requires an agent to: ‘Take care not to be associated with the presentation of facts they know or believe to be incorrect or misleading, not to assert tax positions in a tax filing which they consider to have no sustainable basis.’
Indeed, there is now a dedicated part of PRCT dealing specifically with R&D claims, which gives further guidance on the matter (tinyurl.com/y4bg9fpw). Without knowledge of the basis of the claim, how can the agent in all conscience submit a return on behalf of his client? This is particularly the case when they have looked at the facts before and concluded that no claim can be made. Refusal will annoy the client, who has been told by his R&D adviser that they will receive a substantial repayment from HMRC. The client may well see it as ‘sour grapes’ on the part of his agent for ‘missing’ a claim that could be made. Some serious client relationship problems have arisen in these situations, including complete loss of a client. It seems quite common for the R&D adviser to appoint itself agent for the purpose of submitting a revised return which includes the R&D claim. The first that the ‘real’ agent knows about this is often after it is too late to do anything. The R&D adviser then steps down as agent after the return has been processed.
This is all tied up with the question of fees which I will also return to later.
Answering the questions
There are real problems when it comes to enquiries into R&D claims of the type that I have been discussing. I was told of cases where HMRC opened an enquiry and the adviser who put in the claim was not able to offer any assistance to the company’s tax agent. Even when assistance was provided it was of very limited use – often there was simply no evidence at all of the basis on which it had been concluded that R&D was being carried on, let alone how it had been calculated.
Clearly, clients can be left in exposed positions, potentially facing penalties if they themselves do not understand the basis of the claim and have no means of defending their return.
How much does it cost?
Returning to the question of fees, it is common practice for fees for R&D claims to be based on the tax saved. In itself, this is not objectionable or outlawed by PCRT but it does require advisers to think carefully about whether their independence of judgment might be compromised by the potential of earning a big fee. Several people have told me of cases when the claim was designed to give the adviser the biggest fee even though the client’s overall tax profile – taking account of such things as group relief and losses – may well have meant that a better tax result overall could have been obtained by not seeking to surrender R&D-derived losses. There are two schools of thought here. One is that some advisers do not understand how the tax system works and therefore miss these points. The other is that they do, but deliberately make the claims in such a way as to increase their fee at the expense of a better overall position for the client. Neither of these, to say the least, is an attractive proposition.
How long am I paying for?
One of the other concerning areas about fees is the length of the lock-in period on which some advisers are insisting. Several people told me that they have experience of clients having to pay fees for the next five years based on percentages of savings, even where there is next to no work being done for those future years. This seems excessive. Further, it would be unusual for most R&D projects to take five years to complete, so there is an open question about whether, even if there was R&D to begin with, the same type of expenditure would still qualify five years later.
Many of the firms whose activities give rise to these concerns have it as a requirement of their engagement contract that any repayments from HMRC are directly mandated to the adviser, with the fees coming out of the repayment before the balance is passed to the client. That sets alarm bells ringing. One adviser I spoke to was faced with his client being required to mandate the repayments in this way. He did some digging on his client’s behalf only to find that the company which was providing the ‘advice’ had only been in operation for a short time, had no apparent track record of claims, had seemingly limited tax or technical experience, and had little in the way of reserves.
There is an obvious risk here not only that the client will pay an excess fee but also that the client may have limited options if, say, there is a dispute over the level of the charges, particularly if HMRC subsequently looks at the claim.
HMRC’s position
Mention of HMRC brings me to two key points. I lost count of the number of times that the advisers I spoke to said their approach of only putting in realistic claims was compromised by the fact that HMRC appeared to let so many, particularly smaller claims, through without question. There is a perception among many advisers that the department is not as rigorous in examining R&D claims as it should be, with the consequence that some get away with claims that have no foundation. If an adviser has told the client that their activities do not qualify for relief and says there is a real risk that HMRC will reject a claim, they tend not to look good in the client’s eyes when a claim by another adviser results in a repayment without question. Many advisers told me that some refer to good track record of HMRC approval of claims, when all that has happened is that no enquiry has been opened. Taxation readers know that these are two very different things, but can see that the distinction could get blurred when coming from the mouth of an ambitious salesman.
Even more worrying is how some elements (only a minority perhaps but still enough to be a concern) in the market are misrepresenting their involvement with HMRC’s R&D consultative committee to be something more than it actually is. Several people told me that some of the R&D specialists had made a big thing of the fact that they were on the R&D consultative committee. They used this to suggest that this gave them a privileged position and could get better deals because they had inside knowledge, or that membership implied that their claims were pre-approved. That is, of course, not the case but it is easy to see why clients would be impressed. As I understand it, the committee is not a small working group but a large forum mainly to enable HMRC to give presentations to the industry.
A quick count of attendees at a recent meeting showed that there were 86 people present and I believe there is a waiting list for people to join. It is clearly not a forum for private discussions, and I think that HMRC might well consider giving guidance to firms on how their membership of the forum should be used in marketing their services so that nobody is able to obtain an unfair commercial advantage from membership.
Pulling the threads together
I could go on, but I hope that I have painted enough of a picture to show that there are some real problems in this area. I must stress again that most businesses, whether specialist advisers or full-service accountants, are doing a good job for their clients and working in a responsible manner. But I do think that the issues which have been raised here are not confined to a couple of extreme cases – there are systemic problems that do need to be dealt with.
What’s the harm if a company gets R&D relief that it shouldn’t? Well aside from this being a cost to the public purse which ultimately falls on us all as taxpayers, anything that undermines the integrity of the tax system undermines public confidence in the way it operates. But most importantly there is a consumer protection angle here. If people are persuaded to make claims which are not justifiable they may obtain a short-term advantage, but if HMRC does start to investigate they could find themselves having to incur the cost and expense of an enquiry and the prospect of having to pay back the tax plus interest and penalties with little prospect of recovering the fees they have paid. Even if the provider is still in business, the terms of trade are almost certainly not going to allow for refund of fees.
Where to go from here?
What should be done? Some people would say ‘nothing’. We have a free market economy and if there is really a problem here HMRC and/or the professional bodies already have the means to deal with it; I have already mentioned the special advice on R&D claims within PCRT. But there is a feeling among the people I spoke to, and I think that this is symptomatic of a wider concern, that something does need to change.
One response could be to introduce some form of regulation, so that only accredited firms could submit R&D claims. There does not appear to be too much support for this, largely for practical reasons. What would the criteria be and who would make the decision? Would the firm have to show tax expertise only or expertise in research and development processes? If the latter would it have to be specific to particular industries? Personally, I think that the problems of regulation are too big. There is also the fact that companies must always be free to submit their own claims – I can’t ever see a regime being introduced that would require a company to have an external adviser to submit a claim. In any event, this would probably lead to rogue advisers white labelling claims for a company to submit itself, so it would not do anything to improve the quality of claims.
Legal, decent, honest and truthful?
Perhaps a more fruitful area for discussion is whether there should be more restrictions on how firms advertise. We have already seen HMRC use the Advertising Standards Authority to stop promoters from making false claims about avoidance schemes. Could something similar be done here? I have to say I am struck by the number of firms which present themselves as having a 100% success rate. Those who have not yet done so might try a Google search for ‘research and development 100% success’ – the number of hits may be surprising. I have no idea what 100% success rate actually means. Is it that every claim has been reviewed by HMRC and accepted in full with no adjustments? Is it that HMRC has accepted that R&D is being carried on even though the quantum of the claim has been reduced? Is it that returns including claims have been accepted without enquiry? Is it simply just a meaningless phrase designed to impress?
Some rigour in the way firms are permitted to advertise their R&D experience might offer a measure of consumer protection, although I suspect that in practice defining what can and cannot be said would be difficult.
Responsibility and costs
One idea which I think is worth exploring stems from the observation that many claims seem to go in without any active involvement from the company actually carrying out the R&D. Should someone within the company – most probably the competent professional – be required to sign off the R&D claim, perhaps with a level of personal responsibility akin to that in the senior accounting officer regime? Obviously, any return containing a claim has to be signed by the company, but imposing some extra requirement on the company to certify that qualifying R&D is being carried on, might just act as an additional check for those extreme cases where it can seem that the claim comes out of thin air with no discernible substance.
Another suggestion was that a company should be required, presumably by a box on the tax return, to indicate whether the fee for R&D advice was proportionate to the amount of the R&D repayment claimed. This would, it was suggested, alert HMRC to the risk that the claim might be over-inflated and thus be more likely to warrant investigation. Personally, I don’t see this would make much difference to the problem, but others might disagree.
Is it all back to front anyhow?
One more radical suggestion from an adviser with experience of clients being persuaded by others to submit R&D tax refund claims on the flimsiest of evidence, stemmed from concern about the policy framework itself. If the purpose of R&D tax relief is to encourage businesses to carry out R&D work why is it that claims only go in after the work has been done? The incentive effect of such claims is not obvious. Should it not be the other way around: a company should identify an R&D project and obtain funding (or at least an assurance of funding) before it started?
A full system of up-front grants might be too cumbersome, but what about a system under which a company was required to register an R&D project with HMRC before it started? The claim itself could still be made in the return in the normal way, but at least the claimant company would have addressed the issue of R&D at the start. Again, many objections could be made to such a system, but it might dampen some of the speculative claims that undoubtedly the current regime seems to encourage, particularly by firms that concentrate on making retrospective claims to generate refunds.
Back to HMRC
Then there is HMRC’s position in all of this. Almost everybody to whom I spoke said their firm’s efforts to ensure that only properly computed claims were submitted were being made more difficult by the apparent reluctance of HMRC to investigate, particularly at the smaller end of the spectrum. This has led, in these firms’ view, to a culture in which it is very easy for some advisers to chance their arms by submitting speculative (to say the least) claims which they will ‘get away with’ because HMRC is unlikely to challenge them. There is also an assumption in the marketplace that a government policy of encouraging R&D activity encourages HMRC to take a soft line on R&D claims relative to other types of tax relief when selecting cases for enquiry. The department has never, to my knowledge commented on this but, even if it is not true, the perception that it might be is damaging and there would I believe be merit in HMRC making a clear statement about its current approach to R&D enquiries.
Where does that leave us?
I heard too many stories from too many people to enable me to dismiss these concerns as merely sour grapes from firms losing business to rivals. There is, I believe, a deep-rooted and genuine concern that the way that the R&D marketplace is operating needs to be looked at. It is not good for the tax system if businesses are encouraged to make claims that have little or no justification, especially if they are often left completely in the dark about what they are actually claiming for. It undermines the work of firms who are trying to give good advice and ultimately devalues the real incentive effect that a proper system of R&D relief should give. I was pleased to note that concerns about practices in the R&D market feature in the professional bodies’ responses to the call for evidence in HMRC’s consultation on raising professional standards in the tax advice market. The ICAS response (tinyurl.com/y5p5esy2) has some particularly telling examples.
Finally I should say this. It is easier to come across as ‘holier than thou’ here. Being a tax agent is not an academic exercise in determining objective truth – it is about doing the best for the client and making judgments about what is and what is not acceptable. It is perfectly possible for two advisers to disagree about almost anything to do with tax while both are giving proper advice to clients. Also, we must always remember that tax advisers are in business to earn a living and make profits. In a free market there is scope for different people to take differing approaches to what is an acceptable way of doing business. It is also important to appreciate that marketplaces do not stand still.
Many of us, and I include myself, have worked for firms whose approach to the selling of tax advice was once markedly different from how it is today. Indeed, it was suggested to me more than once that some of the old discredited techniques used to sell avoidance schemes are now being transferred to the R&D marketplace. I don’t want to see the heavy hand of state control looking over the shoulder of tax advisers every five minutes, and I suspect that few readers, including those in HMRC, would want this to happen. But equally I believe that doing nothing is not an option. Let’s have a proper debate about how to take things forward.
