Unprecedented Challenges: Understanding HMRC’s Scrutiny of R&D Tax Credit Claims and the Role of SIC Codes

As Tax Fee Protection Providers, our claims department have seen the volume of R&D tax credit investigations reach previously unprecedented levels. Most of our accountancy clients are perplexed about why these claims have been challenged by HMRC whereas in previous years claims from even the most unlikely candidate companies for R&D have been processed without challenge.

Now, they are seeing claimants whose business are either firmly grounded in qualifying R&D activities or companies who have a history of innovation and development have bafflingly led to HMRC questioning the validity of their projects.

Any practice that has previously been subjected to an R&D enquiry will attest (and it is also well documented for those that have not yet had this pleasure) that once HMRC initiates an investigation into an R&D claim, the process is highly challenging and time-consuming to satisfactorily resolve.

Consequently, many R&D claimants are choosing to concede, despite having legitimate claims.

An compliance check is therefore something that should be avoided at all costs, as it typically involves the R&D claimant persuading HMRC staff lacking technical expertise but displaying unwavering determination that a genuine technological advancement was sought and the work involved was technically uncertain for a competent professional in the field to resolve.

So, how does HMRC decide when to issue a compliance check?

Unfortunately, there is no “check list” of criteria which are required to be met so it is almost impossible to determine HMRCs reasoning behind the request letters being issued. However, there is a historic pattern that certain types of claims are more likely to trigger an enquiry than others. For example:

  • Claims were submitted without any supporting documentation or descriptions of R&D.
  • Claims where the costs do not align with the figures in the accounts.
  • First-time claims with substantial values.
  • Significant increases in R&D expenses compared to previous claims, without any explanation.
  • Claims from companies falling under specific SIC codes.

The requirement for all R&D claims to be accompanied by a mandatory Additional Information Form (“AIF”) since 8 August 2023, has provided HMRC with more detailed data, particularly regarding why projects are considered qualifying R&D for tax purposes.

The AIF also mandates that claimants declare their SIC code, making it crucial for all R&D claimant companies to scrutinise this aspect closely.

Why does the SIC code determine a compliance check?

It has been apparent for some time that HMRC is scrutinising SIC (Standard Industrial Classification) codes to swiftly identify claimants in sectors unlikely to engage in R&D,

HMRC confirmed this approach in a recent response to the Chartered Institute of Tax (CIOT), where it stated:

“We undertake targeted activity when large volume risk is identified; for example, in trade sectors where we do not generally see successful claims for R&D, and among first-time claimants within those sectors.”

Provide a list of some of the sectors it would not usually expect to see an R&D claim originate from on its website.

https://www.gov.uk/government/collections/research-and-development-rd-tax-relief

The types of claims which are rarely eligible for R&D tax reliefs include those made by:

  • Care homes.
  • Childcare providers.
  • Personal trainers.
  • Wholesalers and retailers.
  • Pubs.
  • Restaurants.

However, anecdotally we have become aware of an expanded list that identifies additional sectors HMRC believes are unlikely to engage in qualifying R&D which includes:

  • Real estate agents.
  • Textile industries.
  • The construction industry.
  • Educational institutions.
  • Consultancy firms.

This additional list is believed to be part of a formal HMRC investigation and was sent to a taxpayer. However, we cannot confirm whether it was issued in error or if HMRC is actively targeting companies in these additional sectors.

Obviously, if this list is part of an internal mandate to review R&D claims in these sectors, then there are likely hundreds of other R&D claims that will come under HMRCs microscope.

If HMRC now regards construction firms and consultancy businesses as “unlikely to be undertaking qualifying R&D,” it represents a significant shift in their previous approach.

It is possible that HMRC is combining its approaches to look at these sectors in combination with claims lacking evidence and/or first time claimants as an area of potential challenge in sectors where dubious claims for innovation could be made, for example:

  • Environmentally friendly conversions/extensions using materials not commonly used together or
  • the development of larger scale items not available on the market (such as tiles, cladding etc.)

However, targeting a whole sector as one where R&D is unlikely to occur seems odd, even for HMRC!

The problem of inaccurate SIC codes

As SIC code sifting seems to be HMRCs approach to enquiries, it raises the question of whether your client’s SIC code is accurate and actually reflects the type and nature of the industry and business your client is undertaking in the current year.

Many companies select an SIC code at the point of incorporation and choose one that closely relates to their intended activity at the outset of their business journey. The chosen code is then often forgotten about as the business grows and evolves. As there is no day-to-day impact of the code so the original code is usually rolled forward and included in the company’s annual accounts and Confirmation Statement.

However, we are seeing evidence that HMRC are now using the SIC code declared to Companies House and comparing this to the detail of the R&D claim submissions as a reason to deny claims.

A recent letter received from R&D in an active enquiry stated:

The R&D Activity is not relevant to the company’s trade.

Companies House shows the business SIC code as XXXX. In order to be eligible for the R&D tax relief CIRD81400 R&D Tax Relief: conditions to be satisfied CTA09/s1042 states:

Relevant research and development for a company is research and development:

  • related to a trade that the company carries on, or
  • from which it is intended that a trade to be carried on by the company will be derived

As the company SIC code listed on Companies House and the businesses general practices do not relate to the R&D project claimed for then the business would not be eligible for the R&D tax relief.

It looks, therefore, that the often neglected SIC, is now becoming more crucial and should be regularly reviewed to ensure all potential R&D claimants are eligible for the credit.

Ultimately, this is approach from HMRC is likely to be challenged at First Tier Tribunal and is potentially on shaky ground as a reason to deny R&D relief, but it may scare off some legitimate R&D claims, which appears to be the intention behind the approach.

It is therefore critical at this stage to ensure your clients are correctly categorising themselves and that the SIC codes reflect the current nature and activity of the trade.

If you have any questions on the above, please contact the Tax Advice line quoting your reference number.

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