Billions of pounds of taxpayer money have been lost to error and fraud in tax schemes intended to promote research and development (R&D) in businesses.
Critics argue that some companies are exploiting these tax breaks without conducting any actual research or development.
HMRC's latest accounts reveal that £4.1 billion has been wasted since the introduction of these schemes in 2020, deeming the levels of error and fraud as "unacceptable." This disclosure comes amid political disputes between the current and previous governments over a "hole" in public finances.
The Labour Party insists that cuts and tax increases are necessary due to concealed spending by the former administration, whereas the Conservatives maintain that they were transparent about the state of the public finances.
The Corporation Tax Research and Development tax relief scheme for small to medium businesses and the Research and Development Expenditure Credit for larger businesses were designed to incentivize innovation. These schemes, which have now been merged, allowed companies to offset their R&D expenses against their corporation tax to reduce their overall tax liability. An "enhanced" scheme, introduced in April 2023, further benefits small businesses making a loss by allowing them to pay even less tax.
However, critics claim these schemes are being exploited by businesses fraudulently claiming the relief. Tax expert Colin Haley informed a House of Lords committee in November 2022 that unscrupulous business owners were exploiting the system, with computers automatically approving claims. He described a "Wild West" environment where tax advisors profit by encouraging companies to claim the relief.
"Outside advisers cold-call companies all the time saying, 'We have a special relationship with HMRC. Some 99% of our claims are accepted by HMRC. It’s free money from HMRC,'" Haley explained.
An HMRC spokesperson acknowledged the "unacceptable" levels of non-compliance and assured the public that decisive action is being taken against those abusing the schemes. The number of civil servants working on compliance for the R&D tax schemes has increased from 100 to 500 over the past four years. Consequently, the incidence of error and fraud has decreased over time. In 2020-21 and 2021-22, more than a sixth of the money spent on the schemes was lost to error and fraud, much higher than initially estimated. However, this rate fell to 13.3% in 2022-23 and to 7.8% in 2023-24.
HMRC clarified that errors were more prevalent than fraud and described the term "error and fraud" as encompassing a range of behaviors, from simple mistakes to deliberate non-compliance.
Some argue that HMRC has been excessively stringent in regulating the tax relief schemes. In March, several businesses reported being asked to repay money despite having legitimately claimed the tax breaks. Speaking to the Lords committee in 2022, Mr. Haley supported tax relief for R&D but advocated for more scrutiny of businesses claiming the tax break.
The release of HMRC's figures coincides with a political debate between Labour and the Conservatives over a £22 billion "hole" in public finances. Chancellor Rachel Reeves attributed her decision to cut the winter fuel allowance for those not on benefits to undisclosed previous spending by the Conservatives and promised further cuts. Former Chancellor Jeremy Hunt criticized Labour's spending decisions, highlighting their commitments to a national wealth fund, GB Energy, and public sector pay raises.
The Institute for Fiscal Studies (IFS) indicated that some of Labour's claims of hidden spending by the previous government "appear" to be accurate but noted that half of the spending "hole" relates to public pay, where government choices and known pressures played a role.