HMRC Enquiries and Compliance Checks: A Comprehensive Guide for R&D Tax Credit Claims

As HMRC strengthens its compliance measures for R&D tax credit claims, understanding the process of HMRC enquiries, also known as compliance checks, is crucial for businesses relying on the R&D scheme. 

This blog provides comprehensive information about HMRC enquiries, including what triggers them, best practices for handling them, and tips to avoid getting an enquiry. Additionally, it highlights the importance of working with a trusted partner like Zest R&D for optimised and compliant R&D tax claim.

What is an HMRC R&D tax enquiry?

In most cases, HMRC processes compliant and well documented R&D tax credit claims promptly. A simple desktop review of the claim documents is usually sufficient for HMRC to be satisfied and process your R&D tax credit claim. However, there are instances when HMRC may request additional information to address any questions or concerns they may have. This process is referred to as an enquiry or compliance check.

The main reasons for enquiries are HMRC suspect the work being claimed doesn't meet the definition of R&D OR the costs being claimed aren't consistent with the amount of R&D conducted

It's important to note that an enquiry can lead to delays in receiving your R&D tax credit payment or tax repayment. Even if your claim has already been processed, an enquiry may still occur. Being prepared and having all the necessary information readily available can help you navigate the enquiry process smoothly and ensure a more efficient experience with your R&D tax credit claim.

What Can Trigger an enquiry from HMRC?

HMRC adopts a risk-based system to identify businesses that may not be fully complying with their tax obligations. If your company is selected for a compliance check, it is likely that HMRC has identified a higher level of risk based on one or a combination of the following factors:

Financial Discrepancies

At HMRC, discrepancies in numbers raise immediate red flags. If the figures in your claim report, which contains a breakdown of your R&D costs, do not align with those in your corporation tax return, it is highly probable that HMRC will initiate an enquiry to resolve the discrepancy. For instance, if you list £200,000 worth of subcontractor costs in your claim report but only £100,000 in your profit and loss statement, it can trigger concerns. Accounting errors are commonplace but rectifying them is crucial. In the case of R&D Tax Credits, even a minor mistake can create substantial problems for your business.

Insufficient Proof of Eligible R&D

To claim R&D Tax Credits, you must substantiate that your development work meets the government's definition of 'eligible R&D'. This proof is presented in your technical narrative, which demonstrates your pursuit of genuine technological advancements by addressing scientific or technical uncertainties through systematic experimentation. 

Failure to adequately prove your eligibility, such as discussing business challenges instead of technical ones in your narrative, can prompt HMRC to launch an enquiry to investigate whether your development work genuinely qualifies for R&D Tax Credits. If you fail to provide the necessary proof, the tax authority will significantly reduce the size of your claim. To avoid this outcome, it is crucial to provide a comprehensive technical narrative written in a language that HMRC inspectors can easily understand.

Significant Increase in Claim Size

Although it may seem counterintuitive, HMRC may launch an enquiry if your claim size experiences a substantial jump from one year to the next, without sufficient justification. For example, if your claim increases from £500,000 to over £1,000,000, HMRC may suspect errors or the inclusion of ineligible development work. The best way to address these suspicions is by filing a robust technical narrative that explains the increased claim size and provides evidence that your work qualifies for funding.

Random Sampling

Each year, HMRC conducts random enquiries against a number of claims. This process is aimed at testing the overall compliance of R&D Tax Credits claims. Based on the analysis, HMRC can determine whether any changes are needed in its published guidance or whether additional resources should be allocated to its compliance checking teams.

Best Practices for Handling HMRC Enquiries

Dealing with an HMRC enquiry requires careful attention and thorough documentation. 

Here are some best practices to follow when facing an enquiry:

• Respond promptly and professionally: If you receive a request for additional information or an enquiry letter from HMRC, it is crucial to respond in a timely and professional manner. Ignoring or delaying your response can escalate the situation and lead to further scrutiny.
• Consult with tax experts: Engaging with experienced tax professionals, such as accountants or tax advisors, can provide valuable guidance during the enquiry process. They can help you understand the specific requirements, gather the necessary documentation, and respond effectively to HMRC's queries.
• Maintain organised records: Keeping well-organized records of your R&D activities, expenditures, and supporting documentation is essential. This includes maintaining detailed financial records, technical narratives, project documentation, invoices, timesheets, and any other relevant evidence. Organized records make it easier to address HMRC's enquiries and provide the requested information promptly.
• Seek clarification when needed: If you receive a request from HMRC that is unclear or requires further clarification, do not hesitate to seek clarification from the tax authority. It is better to ensure you understand their requirements fully before providing a response.
• Review and double-check your response: Before submitting your response to HMRC, review it carefully to ensure accuracy and completeness. Mistakes or omissions in your response can lead to further enquiries or potential reductions in your R&D tax credit claim.

How will HMRC penalise errors in R&D Tax Relief claims?

HMRC’s crackdown on errors in R&D tax relief claims does not just cover detection of them. They are also enhancing their ability to enforce the rules, prevent fraud and recover underpaid tax.

HMRC’s Fraud Investigation Service Team have been issuing letters to companies they believe have made fraudulent R&D Tax Relief claims and are setting up a specialist Anti-Abuse team just for R&D claims.

If errors are ultimately found in an R&D claim, HMRC will seek to recover any underpaid tax and consider if a penalty is due. Penalties are based on behaviours and whether “reasonable care” was taken by the company making the claim. Claiming “ignorance” of the rules or using an R&D provider who isn’t suitably competent is unlikely to meet the criteria of “reasonable care.” Where your claim has been submitted with careless errors it is likely that you will be subject to a penalty. Penalties for careless errors can be up to 30% of the tax claim value.

If HMRC suspects the errors identified were deliberate attempts to abuse the scheme, penalties can be up to 100% of the claim value, and they are likely to refer the case to the Criminal Investigation team at HMRC. To avoid getting an enquiry from HMRC regarding your R&D tax credit claim, it's important to follow proper guidelines and provide accurate documentation. Here are some tips we recommend to optimise your claim and minimize the risk of scrutiny or rejection.

Tips to prevent an R&D enquiry

To avoid getting an enquiry from HMRC regarding your R&D tax credit claim, it's important to follow proper guidelines and provide accurate documentation. Here are some tips we recommend to optimise your claim and minimize the risk of scrutiny or rejection.

Understand the Qualifying Projects:

Ensure a comprehensive understanding of which projects qualify as R&D. Familiarize yourself with the qualifying criteria outlined by HMRC, which can be found in the Corporate Intangibles Research and Development (CIRD) manual.

Try to state which project activities do not qualify for R&D tax relief. This can show that you’ve understood the bounds of your project, and you aren’t claiming more than you are eligible to.

Prepare a Detailed R&D Report:

Create a thorough report that outlines the work you've undertaken and clearly identifies the portions that qualify as R&D according to the established guidelines. This report serves as essential documentation for your claim.

Provide Comprehensive Cost Details:

Include all relevant costs in your claim, providing as much detail as possible. Here are some examples:

• Staff Costs: Specify the number of working hours dedicated to R&D for each staff member, and what R&D activities they were undertaking. Utilize any timekeeping systems you have in place to accurately track these hours.
• Subcontractors or Consumables: Submit specific invoices that clearly indicate the costs incurred and why they were required for your R&D project. Additionally, include the percentage of each invoice that is directly related to R&D activities.

Follow Cost Inclusion Rules:

Adhere to the cost inclusion rules set by HMRC. For instance, if you're claiming costs for unconnected subcontractors, remember to reduce those costs by 65% before including them in your claim.

Include Eligible Costs Only:

Ensure that the costs you include in your claim are eligible for relief. It's important to note that certain expenses, such as rent or capital costs, are not eligible for R&D tax credits.

Collaborate with an Accountant:

To enhance the accuracy and completeness of your claim, work closely with an experienced accountant. They can help ensure your corporation tax return is submitted accurately and attach the R&D report, reducing the risk of errors or omissions.

Seeking a trusted partner to help you build your R&D tax claim?

HMRC compliance checks are a critical but poorly understood element of the R&D Tax Credit scheme.

If you have any questions about enquiries or want some help with your company’s compliance check, our dedicated team of R&D Tax Credit professionals is here to help.