An HMRC compliance check or ‘enquiry’ can spell bad news for your business. Here’s what you need to know about how compliance checks work, why you might face one, and how you can avoid them in the future.
While HMRC processes the majority of R&D Tax Credit claims without issue, a small but growing number of submissions face what’s called a compliance check.
Compliance checks, which are also known as ‘enquiries’, occur when HMRC needs more information about your development work in order to judge the legitimacy and accuracy of your tax credit claim.
This may sound simple, but dealing with an enquiry can create major challenges for your business.
Not only will it delay your funding by several months, but it could also damage your relationship with HMRC, reduce your funding windfall, and embroil your technical and financial teams in lengthy back and forths with tax inspectors.
Despite these risks, many businesses are largely unaware of what compliance checks are or why they happen.
Now that the number of enquiries is increasing, we wanted to help you understand these time-consuming investigations by explaining what they are, how they work, and what you can do to avoid them.
If you still have questions about HMRC enquiries after reading this article, just drop us a line.
Our R&D Tax Credits experts are always happy to lend a hand.
What is an HMRC compliance check?
A compliance check or ‘enquiry’ is essentially an investigation into your R&D Tax Credit claim.
They generally happen when the tax inspector reviewing your tax credit submission finds a discrepancy in your financial data or is unsure whether some aspect of your development work is eligible for funding.
Some enquiries are also launched for random sampling purposes.
To clear up their concerns, your inspector will write to you with a list of questions designed to collect more financial and technical data about your R&D.
Enquiries generally involve multiple rounds of questioning and can take weeks, months, and sometimes even years to resolve.
But while facing an enquiry can be extremely inconvenient, they are a vital mechanism for protecting the R&D Tax Relief scheme from abusive claims and ensuring that UK taxpayers receive value-for-money.
Why does HMRC launch enquiries?
HMRC will usually launch an enquiry for one of four reasons:
At HMRC, nothing raises a red flag quicker than numbers that don’t add up.
If the figures in your claim report - the document containing a breakdown of your R&D costs - don’t match those in your corporate accounts, there’s a good chance your tax agent will initiate an enquiry to clear up the discrepancy.
One example of a discrepancy would be listing £200,000 worth of subcontractor costs in your claim report but only £100,000 in your P&L.
Accounting errors are easy to make and fix. But when it comes to R&D Tax Credits, a small mistake can create big problems for your business.
Insufficient Proof of Eligible R&D
To claim R&D Tax Credits, you must prove that your development work meets the government’s definition of ‘eligible R&D’.
You deliver this proof in your technical narrative, demonstrating that you pursued a genuine technological advance by tackling scientific or technical uncertainties through systematic experimentation.
If you fail to prove your eligibility - for example, by talking about business challenges in your narrative rather than technical ones - HMRC will launch an enquiry to investigate whether your development work truly qualifies for R&D Tax Credits.
If you can’t prove that it does, the tax authority will significantly reduce your claim size.
Again, the best way to avoid this outcome is by providing a watertight technical narrative written in a language HMRC’s inspectors will understand.
A Jump in Claim size
On the surface, ‘a jump in claim size’ might seem like a strange reason for HMRC to launch an enquiry.
The point of R&D Tax Credits is to encourage companies to invest more money in development work. So why should HMRC penalise businesses for doing just that?
Unfortunately, if your claim size dramatically increases from one year to the next - from £500,000 to over £1,000,000, for example - without sufficient justification, it can make HMRC think that you’ve made a mistake. That you’ve started claiming for ineligible development work, for instance.
The best way to allay these suspicions is by filing a robust technical narrative that explains the increased claim size and proves that your work qualifies for funding.
Every year, HMRC launches enquiries against a number of claims at random.
It does this to test the overall compliance of R&D Tax Credits claims.
Based on this analysis, HMRC can determine whether it needs to change its published guidance or allocate more resources to its compliance checking teams.
Defend Your Claim, Protect Your Funding
What happens during an HMRC enquiry?
A compliance check is essentially a back and forth with HMRC in which you will provide a range of financial and technical data to answer your tax inspector’s questions.
Where and in what form these questions take place varies. You might receive everything in writing. Or you might be asked to join a series of conference calls and in-person meetings.
The structure of your enquiry – and how quickly it’s resolved – depends on how effectively you can answer your inspector’s queries at each stage of the investigation.
Handle their questions accurately and succinctly, and your enquiry could be relatively straightforward.
But muddy the waters with unclear answers and irrelevant data, your compliance check could drag on for many months or even years.
This is why, if you’re facing an HMRC enquiry, it’s a good idea to bring in expert help.
GrantTree’s experienced Enquiry Defence team knows exactly what tax inspectors are looking for, enabling them to resolve HMRC’s queries quickly, expediting your enquiry and minimising the disruption to your business.
Now, let’s look at what can happen during an HMRC compliance check.
All enquiries start with a compliance check letter from HMRC.
This letter will contain a list of questions covering a mixture of financial and technical information and a deadline for your response.
The deadline will be 30 days after the letter was generated. So something like 25-28 days after you receive it.
You will need to collate the required information, including evidence like bank statements and invoices, and send everything back to HMRC.
If your R&D Tax Credits claim has changed since you filed it, you will also need to include an updated filing.
Unfortunately, very few compliance checks end after you respond to the first letter.
HMRC almost always has additional questions based on your reply. They will either pose these questions in an interview, held in person or virtually, or a follow-up letter.
A follow-up letter will include a list of questions that will unpick or challenge the information you provided after the first.
It will likely explore your team’s job roles relating to R&D. In other words, who did what on your different projects.
Like the initial letter, follow-up correspondence will contain a strict deadline for your response.
After the first or second letter, HMRC could ask to interview your finance and technical teams to discuss your development work.
This meeting is hosted by an HMRC tax inspector. Though they are free to use internal resources at HMRC to assist them with the more technical aspects of the enquiry.
For example, many software and Dev Ops claims that are enquired see HMRC's DevOps team ('CDIO') brought in to assist the inspector.
Enquiry interviews are not antagonistic, per se. But they can be gruelling.
Over the course of a two-to-three-hour session, HMRC’s inspectors will look to interrogate various aspects of your project, stress-testing their eligibility for the R&D scheme.
During these high-pressure exchanges, it’s easy to create misunderstandings that result in mistrust and cause both sides to double down on their positions.
But while an enquiry interview is a potential banana skin, it’s also your chance to put your enquiry to bed, once and for all.
Prepare thoroughly, and work with an Enquiry Defence specialist like GrantTree, and your compliance check could be over soon.
After the interview, HMRC will write to you with their conclusions.
If you’ve successfully defended your claim, the inspector will confirm that your application for R&D Tax Credits can proceed without any reduction in claim size.
But if things have gone awry, your inspector will explain which of your technical work they have disqualified from your claim.
If HMRC is threatening to disqualify some of your development work, you have two choices.
You can challenge HMRC’s decision and request another interview to restate your case. This may result in a larger claim size but will cause further delays.
Or you can accept the decision, accept the smaller claim size, but get your money sooner.
When will I know if my claim is being enquired?
You won’t know for sure that HMRC is launching an enquiry into your R&D Tax Credits claim until you receive the letter mentioned above.
You may receive what’s called a ‘nudge letter’, asking whether your company’s tax affairs are up to date. Nudge letters often precede an enquiry, so if you’re sent one, start making preparations.
Also, if your R&D Tax Credits claim hasn’t been processed after three or four months, and you haven’t heard anything from HMRC, an enquiry letter might be on the way.
If your claim hasn’t been processed after six months, it’s all but certain that you’ll be stuck with a compliance check.
Minimize Your Risk of an Enquiry
The best way to avoid an HMRC compliance check is to claim with an R&D Tax Credits specialist like GrantTree.
Our tax and technical experts will prepare a fully-maximised, fully-compliant claim, minimizing your chances of an enquiry.Find Out More
What are the potential outcomes of an HMRC Enquiry?
The consequences of an enquiry range from lengthy delays to hefty fines.
The outcome for your business depends on how well you fielded HMRC’s questions, the speed of your responses, and of course, the strength of your original R&D Tax Credit claim.
Here is the complete list of possible consequences, alongside what you can do to influence their likelihood.
No matter what you do, an HMRC compliance check will always delay your R&D Tax Credit claim.
Delays can last anywhere from a few months to more than six years, depending on tax inspector capacity and how long it takes to resolve your enquiry.
This is one of the reasons it’s important to answer HMRC’s questions as quickly and thoroughly as possible.
Fielding HMRC’s questions typically takes around 60 hours.
Though, it can take much, much longer.
In fact, some companies are forced to respond to many enquiry rounds spanning several years.
If you’re handling your enquiry internally, your senior finance and technical people will almost certainly need to dedicate considerable time to the process.
As experts in their field, the opportunity cost of their time is huge.
The hours they’ll spend preparing for and participating in high-pressure technical interviews could be better spent on other, more valuable projects.
If you don’t defend your enquiry effectively, HMRC could disqualify legitimate R&D from your claim, reducing your relief or cash credit.
To make matters worse, HMRC has the right to launch enquiries into claims filed up to seven years ago.
If the tax authority decides that any of your previous development work was ineligible for funding, it could ask you to repay funding that you received–and in all probability spent–long ago.
If your R&D Tax Credits claim is enquired, or worse, found to be inaccurate, it could weaken HMRC’s trust in your company.
Poor trust increases your chances of facing compliance checks in the future and could compel the tax authority to re-examine your previous R&D Tax Credit claims.
This might mean you have to repay large amounts of funding your company received and invested several years ago.
How can I avoid an HMRC enquiry?
Defending an HMRC compliance check can be difficult, stressful and resource-consuming.
Thankfully, there is a range of steps you can take to reduce your chances of facing an HMRC enquiry and keep your relationship with the tax authority intact.
Go through your claim with a fine-tooth comb and triple-check that all your calculations tally with your P&L, tax computations and CT600.
It’s also a good idea to tie the length of your technical narrative to the monetary size of the claim.
For example, if one of your projects was particularly expensive, you should dedicate more space to explaining the technical work involved.
When writing your technical narrative, make sure you remember your end-user: the HMRC tax inspector. This means writing your report so that a non-technical person can comprehend it.
Remember, HMRC needs to understand the problems you encountered and how you solved them. Industry jargon and poorly displayed data will stop them from doing that.
Make sure your technical narrative explains the uncertainties you faced during your R&D and how you overcame them.
Discussing legitimate uncertainties and your approach to solving them is vital to proving that your development work qualifies for R&D Tax Credits.
If someone non-technical is writing your narrative (which we wouldn’t recommend), you must equip them with the correct data.
My advice is to make a single member of your technical team - someone directly involved in the R&D - responsible for collecting all the necessary information.
A technical person will be much better placed to identify the industry analyses, development reports and experimental results that will reinforce your company’s claim to R&D Tax Credits.
By far, the simplest and least stressful way to avoid an HMRC compliance check is to work with an R&D Tax Credits specialist like GrantTree.
Our experienced tax and technical experts know the R&D Tax Relief scheme inside and out, meaning we can ensure your claim is fully compliant with all the latest legislation.
We’ll also prepare a watertight technical narrative that justifies your development work’s eligibility in a language that HMRC’s tax inspectors will understand.
HMRC compliance checks are a critical but poorly understood element of the R&D Tax Credit scheme.
So I hope this article has given you a better understanding of how they work, why you might encounter one, and how to avoid them.
If you have any questions about enquiries or want some help with your company’s compliance check, our dedicated team of R&D Tax Credit professionals is here to help.
Just drop us a line, and one of our team will be right with you