UK: ‘Free money’: £4bn lost to fraud and error on flagship HMRC ‘innovation’ scheme

A government scheme to champion new research and boost the economy has cost more than £4bn in fraud and error since 2020 after widespread abuse.

The research and development tax credits scheme was designed to help drive world-leading innovation, but turned into what has been described by experts as a “wild west” with huge volumes of dubious claims.

Alleged claims of groundbreaking research included a safer method developed by a window-cleaning firm to hold a water bucket at height; adding vegan and gluten-free options to a pub menu; and redesigning corporate websites. The scheme was described as “free money” by some agents.

New figures published in HM Revenue and Customs’ annual report last week reveal that the estimated cost of fraud and error in the scheme was more than £4.1bn from 2020-21 to 2023-24. HMRC says expenditure on the reliefs in 2023-24 was £7.7bn.

The scale of the abuse of tax credits has emerged as Rachel Reeves, the chancellor, pledges to crack down on tax fraud and non-compliance. Labour hopes to raise £5bn by the end of this parliament by recovering more tax revenues. Tax officials said that the error and fraud in R&D tax relief revealed in the report was “clearly unacceptable” and the public would expect action.

Colin Hailey, a technology tax expert who has given evidence to parliament on the tax reliefs, said he and other advisers were warning about the abuses in the scheme more than six years ago. He said claims were not being properly vetted by HMRC and the increase was driven by agents claiming hefty commissions.

“There was an industrialisation of the claims process with all these advisers saying they were experts and could sort the claims for between 20% and 30% of the value,” Hailey said. “It was the wild west. These advisers were cold-calling firms and saying, ‘you don’t think you’re doing R&D, but we can help you’.

“I remember talking to tax inspectors in Manchester saying, ‘we had a claim from a window-cleaning company who were claiming for the R&D of hanging a bucket on the other side of the ladder.’ It was quite rightly thrown out, but they knew these claims were out there.”

Firms complained of being in­undated with calls by agents, urging them to sign up for the tax credits. Operators of care homes, pubs, fitness centres and dental clinics were told to apply for the tax credits, based upon their best ideas for improving business. One tax consultancy claimed on its website it had saved a hotel and pub in Chester £28,000 with a claim for “innovative menus, catering for vegan and gluten-free diets”. The firm and the pub considered the claim was permissible, because of “all the hard work that goes into crafting our menus”.

HMRC did not respond to a request for a comment about whether the tax reliefs said to have been claimed by the hotel and pub business were legitimate.

A House of Lords finance bill subcommittee hearing was told in November 2022 that some advisers were claiming “some 99% of our claims are accepted by HMRC. It’s free money.” It was alleged that agents were encouraging firms to claim for activity that would not normally be classed as research, such as redesigning a website.

The tax relief was first introduced in 2000 in response to evidence that Britain’s R&D spending was falling behind that of its competitors. The scheme works by reducing a firm’s corporation tax bill or by making a direct payment to the business. A valid claim must represent a significant advance that overcomes scientific or technological uncertainty and which “could not easily be worked out by a professional in the field”.

The HMRC annual accounts published last week reveal that the projected and final estimates of the value of error and fraud in the scheme was £1.127bn in 2020-21; £1.337bn in 2021-22; £1.051bn in 2022-23; and £601m in 2023-24.

According to the report, one analy­sis of claims for small and medium-sized firms in 2021-22 estimated that about one in four contained error or fraud, which was described as “among the highest reported across all government spending programmes, including those administered in response to the pandemic”.

Officials are now checking claims more rigorously while hoping to recoup some of the billions of pounds lost through error or fraud. They will also increase the number of compliance inquiries.

An HMRC spokesperson said: “We generated a record £843.4bn in tax revenues last year, up 3.6% on the previous 12 months.

“With R&D claims, public money is at stake and taxpayers rightly expect us to scrutinise them. We do that thoroughly and fairly, and the overwhelming majority of valid claims are paid on time.

“But the levels of non-compliance that we are seeing within these schemes are clearly unacceptable and the public rightly expect us to take action. This includes better help, guidance and processes, as well as decisive action against the minority who deliberately set out to abuse the schemes.”