The reforms designed to clean up Britain’s £8 billion research and development tax credit scheme have worked very well.
More than six out of ten businesses conducting R&D have reduced their investment as a direct result, according to new data from consulting firm RCK Partners, with hiring projects frozen and technology projects canceled altogether.
R&D tax credits fund science and technology projects and cost the Exchequer around £8 billion a year. After continued abuse of the scheme, HMRC seriously scrutinized claims and brought forward a number of changes, including reduced relief rates, which come into effect in April 2023.
The results for small firms now look sharper than intended.
An RCK survey of more than 250 chief financial officers at R&D-active SMEs found that a third have hired fewer technical staff than planned, and one in five have canceled innovation projects altogether. 30 percent were forced to take out loans to cover delayed aid payments, and almost as many returned to directors’ fees.
Lord Hammond of Runnymede, former chancellor and chairman of RCK Partners, called the findings “disturbing” and urged policymakers to look “carefully” at whether the scheme still works.
“It is a national priority to ensure that our SME sector, which is an important part of the economy, does R&D,” he said. “The values of small and medium-sized companies are being reduced at the same time that the state is being strengthened. Risks and difficulties are increasing while rewards are decreasing.”
That combination, a tight fit over a little looseness, is what business owners are going to see. The burden of compliance decreases at the same time that the payment decreases.
On its own terms, the demolition was successful. The government says the cost of fraud and error fell from £1.34 billion in 2021-22 to £497 million in 2023-24, with an estimated 43,615 R&D claims made by small businesses. HMRC’s most recent annual accounts also revised total aid spending for 2023-24 by £920 million, from the original £3.26 billion to £2.34 billion.
“It confirms that the impact on SME claims has been greater than policy makers may have expected or intended,” Hammond said. “Policy making is not an exact art. You develop a policy, you make a model, you apply it. But if you have a mind, go back and monitor what happened … and adjust the model.”
Peter Roscoe, founder of RCK Partners, was clear that enforcement itself is not the problem. “HMRC has done an excellent job in reducing fraud and error,” he said. The difficulty, he added, lies in the “conflict” of the investigation process, an issue familiar to any company that has looked at the general question of metastasise.
“Some examiners ask targeted questions that are easy for them to answer, and then sometimes [a business] he can find someone who can continue for two years.”
The second problem is the advisory market itself. Roscoe pointed to online advertising, where claimants are “contacted without reason” by companies promising to bring an R&D claim but are often not qualified to do so. An investigation by The Times in 2022 revealed how these incentives were directed by corrupt tax advisers who promoted dubious claims, several of which were audited by HMRC. Those same advisors, Roscoe said, intimidated the most innovative companies from trying to access the program at all.
The cooling effect is measurable. About a quarter of respondents said they decided not to file a claim at all, a figure that rose to nearly half among firms with 250 to 499 employees. HMRC defines an SME as a business with up to 500 employees, meaning that the largest firms in that bracket, often those with the most advanced R&D programmes, are the most likely to leave.
The government is not moving. “This report is based on a small proportion of UK SMEs,” it said. “The reality is that the UK’s R&D tax relief programs continue to provide significant support to business productivity and growth, with £8 billion of relief claimed by 2025-26.
“Our reforms mean that taxpayers’ money is now going towards real innovation, effectively tackling the high levels of error and fraud that have plagued the programs over the years.”
Ministers have already floated mandatory pre-approval of R&D claims as a way to restore certainty, and an HMRC review found that non-compliance was higher where professional agents were involved. No one talks about the basic arithmetic described by Hammond. With business investment appetite already at a post-Covid low, the question for the Treasury is whether a scheme that no one wants to apply for can still be called a stimulus.
