R&D Tax Credits a “honeypot” for rogue agents says HMRC chief

Jim Harra, the Chief Executive of HMRC, was questioned by the House of Commons Treasury Committee last week and asked to explain how the estimated cost of R&D Tax Credit fraud and error has suddenly jumped from £336 million to £1.13 billion.

The Treasury Committee also wanted to know what lessons have been learned by HMRC and how they will be fed into policy.

Mr Harra admitted that HMRC had clearly underestimated the level of fraud and error in the past because HMRC “did not have the best method of measuring it”.

He explained that:

“In the past we took a measure from the compliance cases that we worked but because they'd been selected on a risk basis, we made some assumption about the level of non-compliance in the remainder of the population, which is a reasonable approach. But when we did a random enquiry program, we found that assumption was clearly wrong and the level of error and fraud across the population was much higher than we had thought - unacceptably high - and that 50% of claims contain errors”.

Instead of explaining why HMRC had been asleep at the wheel in terms of its oversight of the scheme, Mr Harra took the opportunity to castigate a certain type of R&D Tax Credit advisor:

"[R&D] is a very generous tax relief. It’s intended to be generous and has become more generous over the years because it's intended to incentivise R&D. That then makes it a honeypot I'm afraid for people for whom it is not intended and an industry has grown up around tax advisors helping people to make claims that are not compliant so it is part of the attractiveness of the scheme that attracts those people.

“We have got to balance two things. We've absolutely got to make it as easy as possible for people who are entitled to that relief to get it because it's a very, very important economic incentive, whilst protecting the public purse from those who want to abuse it.

On the whole, Mr Harra seemed pleased with HMRC’s action and signalled that there would be no relaxation on its compliance efforts:

“I feel we've taken good action in recent years. For example, the year that we have measured (2020-2021) when we've come up with an illustrative figure for 2022-2023, we believe that we've reduced the small business error and fraud in R&D by about five percentage points through the additional operational effort that we have taken. But we knew that the government has also introduced a series of policy measures which we believe will also take that error and fraud down but it remains unacceptably high and we've got to really stay on top of it”.

We've also got to work with tax agents about how they can add more value to this process.

[On] about 90% of R&D claims there's a tax agent behind them and despite that half of them are wrong so we're also working with the tax agent professional bodies about how their members can add more value to ensuring that their clients’ claims are correct”.

Can HMRC fraud and error estimates be relied on?

Serious questions undoubtedly remain regarding the reliability of the HMRC figures for R&D Tax Credit fraud and error.

Jim Harra confirmed that the first estimate of £336m was based on extrapolating data from compliance cases that were selected on a risk-based approach. These would have been claims that were selected for enquiry because there appeared to be a strong indication that they were incorrect.

Once it was suspected that the £311m figure was a serious underestimate, HMRC introduced a mandatory random enquiry programme (MREP) for SMEs which involved taking a random sample of claims to better estimate the true levels of non-compliance.

HMRC Deputy Director, James Armitage, told the recent RDCF call for R&D advisors that the methodology was to take 500 cases randomly selected using no risk criteria at all, and a “specialist” R&D team worked those cases in an enquiry process.

It was this work that led directly to the figures of non-compliance rising from an estimated 3.6% (£336m) to 16.7% (£1.13b). This is highest in the SME scheme where non-compliance is estimated at 24.4% (£1.04b).

It appears that HMRC’s conclusions about error and fraud, which have led to the adoption of the bulk compliance approach, and which were used by HMRC in its response to the CIOT’s open letter as justification for that approach, come entirely from that very specific piece of work in which a “specialist team” looked at just 500 random R&D Tax Credit claims.

HMRC believes “half of all claims are non-compliant” solely on the basis of that work. That’s a very strong conclusion, especially as it is being used as an excuse for HMRC to accept that “the reforms and operational action required to tackle the problem will have an impact on compliant claimants”.

I spoke with a senior ex-HMRC inspector who told me of their concerns that HMRC appears to be happy for there to be casualties and for compliant companies to be adversely affected, which is obviously contrary to HMRC’s charter and the values of getting it right and treating customers fairly.

These are the questions that HMRC should answer:

• Who were these investigators in the “specialist team” and what was their background, grade and training?
• Presumably the findings of that project were published internally by HMRC and it was actually written up and fully recorded so will that work be released so that everyone can see it is valid? 
• How many claims out of the 500 were rejected?  For the rejected claims, can HMRC provide an analysis of the reasons for rejection?

HMRC has previously claimed that the “main driver” of non-compliance is related to interpretation of the advance in science or technology.

If HMRC is arguing that the main reason for rejection amongst the randomly selected cases – ie cases not picked up because they exhibited particular risks – was because HMRC believed the claimant had incorrectly interpreted the rules surrounding what constitutes an advance then this would be rather concerning.

There is now considerable evidence that HMRC caseworkers are failing to understand the rules they have been tasked to administer, and in particular misinterpreting the BEIS Guidelines which have statutory force.

What Mr Harra didn’t explain was how we arrived at a position where over £1b of R&D Tax Credits is being paid in error or due to fraud.

Perhaps the biggest question of all is why did it take over 20 years of operation for HMRC to realise that R&D Tax Credits were like a “honeypot” that attracted people who wished to abuse the schemes for their own financial gain?

Article written by Rufus Meakin

Rufus Meakin helps companies prepare complex R&D Tax Credit claims where robust HMRC compliance is essential.

If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to call me on 0794 110 3285.