In the recent HMRC consultation regarding the R&D tax credit cap for SMEs, they talked about a need to identify and rely on ‘Hallmarks’ of R&D to ensure that claims that are being made are bona fide and not an attempt to play the system.
The first HMRC consultation
The consultation has been borne out of a rising concern that as R&D tax can be paid as a cash credit, some businesses are either abusing the scheme or in the most severe cases, settling up fraudulent structures to access ‘free cash’. Our industry has not helped the situation by some marketing themselves as PPI type ambulance chasers instead of realising the role we play is as custodian of the public purse.
In an attempt to target the fraudsters and the chancers, HMRC consulted businesses to help understand if a cap would work to stop these behaviours. The overall feedback was that, whilst in part, it would, it may also hurt the very businesses that the scheme is supposed to support and drive.
The second HMRC consultation
The second consultation has been far more focused and tried to get into the bones of what a fraudulent structure looks like and how can it be targeted. This consultation introduced the term “hallmarks of R&D”, a concept that I fully advocate.
What are the hallmarks of R&D?
Failures – The most obvious indicator of R&D is that things didn’t go quite according to plan and that some aspects of the project just didn’t work. It is very difficult to argue that the outcome was uncertain when everything works all of the time. We also need to be realistic about what constitutes failure. For example, the render of a colour on a website might take a few attempts to get right, but the answer can be found pretty easily and may be a matter of a google search. This would be a red flag. But if something it comes down to the need of advice from competent professional and you can’t google the answer pretty quickly, then it could be the hallmark of R&D.
Specialism – The term competent professional shows that the company has relied on expertise instead of trying to claim for whoever was around at the time. This doesn’t mean you need degrees, titles and the like- just the ability to point to people and be comfortable that they bring a level of depth that is unique. The most common type of competent professional we meet is based on practical experience of the business.
People – A challenge for HMRC is how businesses use people at the early stage. It is fair and understandable that businesses, particularly when the capital is limited, rely on subcontractors to avoid fixed costs. These costs are perfectly legitimate and feature in most R&D claims. Sadly, however, some have chosen to set up relatively complex structures to layer the fraud and create a web that is then used to play the system. Having solid records and having an independent view of the purpose of the structure is the best position a company can take.
Intellectual Property (IP) – The subject that is almost always forgotten but, for me, is the trump card of an R&D hallmark is that it creates IP. The nature of R&D and the resultant innovation that is created often leads to the intangible benefit of IP. I find this often comes along as an afterthought (if a thought at all). HMRC, by introducing the Patent Box scheme which provides another generous tax benefit to the company, want to see a link between patents and the R&D activity that potentially created that patented product or process. It is therefore wholly reasonable to want to see in a company’s business model that the R&D cycle is linked to the company’s future IP. It goes to the very purpose of R&D – what advancement are you trying to achieve, and if you achieve it how does that value play into economic benefit for the company and also the UK economy.