R&D tax credit consultancy ForrestBrown, has identified that software companies are starting to receive letters from HMRC regarding recently filed R&D claims that ask recipients to “help confirm you are eligible”. Here Tom Heslin, associate director and senior software sector specialist at ForrestBrown, offers practical advice for companies who have received a “nudge” letter from HMRC having filed a claim.
Over the years, we’ve reported extensively on HMRC’s shifting approach to R&D tax claims as it clamps down on companies potentially abusing the system or making errors. Yet recent YouGov research highlighted that just one in five businesses (20 percent) claiming R&D tax relief were worried about the risk of an HMRC inquiry – despite the very real threat of one.
This research also showed that 50 percent of respondents had a high degree of confidence that their claim could withstand the scrutiny of an HMRC inquiry. Unfortunately, this suggests a serious misplaced sense of security - something that’s further evidenced by letters recently being sent to software companies.
Historically, most applicants receiving a payment for R&D tax relief would have little or no direct communication from HMRC. However, times are changing. This is because HMRC’s latest annual report estimated that there could be up to £311m of mistakes or scams included in its figures.
With over 70,000 R&D tax credit claims being filed each year, HMRC cannot hope to review all claims in detail. However, concerted efforts are being made; the tax authority has recently added 100 new R&D staff meaning it has the resource to review a far larger proportion of claims than before.
And it appears that HMRC has found a number of errors in claims when carrying out compliance checks in the IT sector. Under pressure from the National Audit Office to address this, HMRC has started to send software companies a swathe of correspondence about R&D claims, and these “nudge” letters shouldn’t go ignored.
Having worked this sector for many years, we’ve often heard the sentiment; “because it’s a novel piece of software it must be R&D”. However, there is more nuance than that in determining eligibility for R&D tax relief. Whilst novel piece of software that fulfills a need is a potential indicator of R&D, it’s not an explanation of why the project meets the specific definition that HMRC are ensuring compliance against. It’s likely that the reason for the “nudge” is that HMRC have also encountered this sentiment to varying degrees.
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Don’t celebrate too soon
When money from an R&D tax credit claim hits a company’s bank account, it’s natural to assume it has been accepted by HMRC. However, an unchallenged claim is not the same as an accepted claim.
In fact, receiving payment doesn’t mean HMRC has “accepted” anything. The claim might have been processed, but in the UK, tax is based on the concept of self-assessment. This means HMRC could still check that a company has got its claim right. It typically has 12 months to ask any questions, regardless of whether the money remains in a bank account (or has been spent).
Sadly, less reputable advisers prey on this misconception– resulting in companies often paying the price for being misled or not understanding some critical HMRC terminology from the off. Furthermore, if a claim is submitted year after year, and goes unchallenged, this gives spurious advisers – and by extension, their clients – misplaced confidence to make similar future claims. However, it may only be a matter of time before HMRC asks questions.
Deciphering correspondence from HMRC isn’t always straightforward. HMRC typically uses “compliance checks” (more traditionally called an inquiry) and “eligibility letters” - or “nudge” letters, as they’re known in the tax world.
If a company is subject to a “compliance check”, in the best-case scenario it has to pay back any money it received erroneously, with interest. The worst case scenario includes potential penalties (up to 100 percent of the tax due), plus sometimes amendments to earlier claims. Harm to a company’s reputation with HMRC is a further cost, as is the possibility of wider checks that could be subsequently made.
Meanwhile, for the many software companies that may have recently received “nudge” letters, these shouldn’t be filed and ignored. While it does not necessarily mean anything is wrong with your claim, it should be taken as an opportunity to check that you are confident and comfortable it would withstand a compliance check.
HMRC use advisory letters as a proactive way to inform the behaviors of taxpayers, which act as a mechanism to encourage companies to look at HMRC’s own guidance on R&D claims and check they are comfortable. In doing this, HMRC hopes that companies will review their own claims without the need for an inquiry.
Putting things right
Much depends on whether a company has prepared its own claim or if they’ve used an adviser. We’ve helped numerous businesses who have found themselves subjected to a compliance check into their R&D tax relief claim and needed support to resolve the inquiry.
In these cases, we’ve usually found that the business itself was well-intentioned; most companies set out to pay the right amount of tax and maintain a good working relationship with HMRC. However, they’ve also often fallen victim to spurious marketing claims and poor tax advice, which has led them into a potentially difficult situation.
These businesses only became aware of problems with their claims once they were in a formal compliance check, and unpicking these issues therefore takes time for both HMRC and the company.
For companies that have received a “nudge” letter and prepared their R&D claim in-house, there are links included to HMRC’s guidance on R&D claims. Ideally these resources will have been used to prepare the claim, but if not, there’s some reading to do and perhaps some rethinking of the submission as well.
If short of time or still uncertain, companies can still reach out to an R&D tax adviser. A reputable adviser will happily review the R&D claim and provide clear written advice explaining any risks and making practical recommendations for next steps. If the claim needs to be amended to address errors, an R&D tax adviser will know how to efficiently do this. An accountant can also provide guidance, although they may recommend bringing in a specialist - especially on the interpretation of the eligibility of a software project.
For those that worked with an R&D tax adviser to prepare the R&D claim, share the letter with them immediately. Don’t settle for a general reassurance that all is well; they should provide advice, answer any queries and run through with you why the projects you submitted qualify (if they have not already done this as part of their normal service). This is usually done in the form of a report, but ask further questions if it doesn’t reflect your projects well, show a good understanding or doesn’t obviously relate to the key tests in the guidelines.
Importantly, remember that your business that carries the risk associated with the R&D claim, not the adviser. An adviser’s role is to ensure a company understands its claim and any risks within it. If that’s not the case and the handling of questions is unsatisfactory, seek a second opinion. Don’t wait until you receive a compliance check letter or you’ll have missed the opportunity to address any errors with minimal fuss.
It is crucial that companies understand this whether or not they’ve received a “nudge” letter. Now’s the time to look closely at your adviser and R&D tax relief claim because the risk sits firmly with you.
Tom Heslin, associate director and senior software sector specialist, ForrestBrown