Summary of conclusions and recommendations
Government Review of Research and Development Tax Relief
1.While it is right for the Government to keep the R&D relief scheme under review to ensure that it meets the needs of a modern economy and provides value for money for the taxpayer, too much change over too short a period can create uncertainty. We are concerned that the number of significant R&D changes made in the last 5 years has led to a perception of instability in the UK’s R&D tax relief regime and undermined the intended incentive effect of the relief. (Paragraph 32)
2.The Government’s postponement of a final decision on creating a single merged scheme of R&D relief added to the uncertainty around R&D relief. Businesses can only start to prepare in earnest once a change is confirmed. The Government’s announcement of a prospective commencement date of an unconfirmed measure did not give businesses sufficient certainty to be able to plan effectively. (Paragraph 33)
3.We welcome the announcement at Autumn Statement 2023 that the R&D review is now complete. Businesses need time to adjust to all the recent changes to R&D relief. We recommend that, over the medium term, the Government does not make further changes to R&D tax relief, other than to simplify the relief as set out in this report. (Paragraph 34)
The Research & Development Intensive Scheme for Small and Medium Enterprises
4.We acknowledge that the Government responded promptly to concerns about the impact of the reduction in the rate of R&D relief for SMEs following its announcement in November 2022. However, the development of the R&D intensive scheme over only a few months, and without the benefit of formal consultation, was not an example of good policy-making. (Paragraph 47)
5.It is disappointing that the Government did not carry out a public consultation on the R&D intensive scheme, but instead appears to have chosen to consult on a confidential basis with selected stakeholders. We acknowledge that a formal consultation would have taken more time, but this might have avoided the need to make significant changes to the scheme in November 2023, only a few months after first announcing it. (Paragraph 48)
6.We welcome the Government’s continued commitment to work with businesses on possible further improvements to the scheme. It is important that the Government is as transparent as possible about its further engagement with stakeholders on this measure. (Paragraph 49)
7.A scheme based on R&D intensity is agnostic as to the type of R&D that a company is undertaking. We note that a number of our witnesses did not understand why this approach had been taken, rather than targeting specific policy objectives, such as providing tax credits for activities that support the Government’s net zero commitments. (Paragraph 59)
8.The Government should explain why it considers this approach to be the best way of incentivising the types of innovation that will support economic growth. (Paragraph 60)
9.We acknowledge that the threshold test for R&D intensity creates a cliff-edge, but we recognise that many alternative approaches, such as tapering relief as R&D intensity decreases, could create more complexity. However, we welcome the announcement at Autumn Statement 2023 of a grace period to help mitigate this. (Paragraph 61)
10.It is important that modelling of the threshold for R&D intensity is based on accurate data, is properly tested, and can be justified objectively by reference to the policy aim. We are concerned that this appears not to have been the case with the original proposed 40 per cent threshold—and this may also be true of the new 30 per cent threshold. (Paragraph 62)
11.We recommend that the Government monitors the operation of the R&D intensive scheme and, in particular, keeps the threshold for R&D intensity under review to ensure that the scheme is appropriately targeted and effective in achieving its policy objectives. (Paragraph 63)
12.It is disappointing that, although the R&D intensive scheme has applied since April 2023, HMRC has not yet published any guidance—including draft guidance—on how the scheme will work in practice. Businesses need to know whether they are R&D intensive in advance of April 2024, when they will be able to make their first claims under the new scheme, so they can plan accordingly. (Paragraph 69)
13.We are concerned that the incentive effect of R&D intensive relief will be weakened because SMEs have no certainty about whether they are R&D intensive, and so eligible for additional relief, until after they have invested in R&D. (Paragraph 70)
14.We acknowledge that the lower R&D intensity threshold should mean that more companies will have confidence that they qualify as R&D intensive in a given period. However, a lower threshold is no substitute for clear rules that businesses can readily understand. (Paragraph 71)
15.We recommend that HMRC publishes draft guidance on applying the R&D intensity test as a matter of urgency. (Paragraph 72)
16.We are concerned about the abuse of R&D relief, which has increased due to exploitation of the tax repayment available under the SME scheme. We note the Government’s commitment to tackling this abuse but we agree with our witnesses that there is a risk that, with the creation of the R&D intensive scheme, new opportunities for spurious claims could be created. (Paragraph 77)
17.We welcome the Government’s announcement that HMRC will be funded to deploy additional officers to manage the compliance risks relating to the new scheme. (Paragraph 78)
A new merged Research & Development tax relief scheme
18.We recognise that the Government has sought to engage with stakeholders on merging the two existing R&D tax relief schemes since January 2023. However, given the significance of this change, the consultation in January 2023 should not have been limited to the design and implementation of the scheme; it should also have considered the fundamental question of whether a single scheme was desirable. (Paragraph 84)
19.We welcome the Government’s acknowledgement that having one scheme, instead of the proposed two, would be simpler and its apparent willingness to consider further simplification in the future. (Paragraph 94)
20.We agree that providing relief under the merged scheme by way of an above the line credit to all companies, whatever their size, is the right decision. (Paragraph 95)
21.We acknowledge that, for those companies that are not R&D intensive, having just one scheme for R&D tax relief will be a simplification. However, we agree with many of our witnesses that retaining the existing SME scheme for R&D intensive businesses is a missed opportunity in terms of the Government’s tax simplification agenda. (Paragraph 96)
22.We recommend that the Government consult in the near term on bringing the R&D intensive scheme within the new merged scheme to create a fully merged and simplified scheme. (Paragraph 97)
23.We acknowledge that the change to the start date announced at Autumn Statement 2023 will mean that the merged scheme may not apply to some businesses until 1 January 2025. For some companies, however, it will be much earlier. (Paragraph 104)
24.We remain concerned that, even with the latest possible start date under the revised timetable, businesses will not have enough time to prepare for the new scheme. (Paragraph 105)
25.We recommend that the start date for the new scheme be delayed until a company’s first accounting period to start on or after 1 April 2025. (Paragraph 106)
26.Given the significance of these changes, it is critical that businesses that could be affected know that they are happening sooner rather than later. We welcome the work of representative bodies and advisers in raising awareness of the changes among the business community. However, the primary responsibility for informing taxpayers of changes to tax regimes lies with the Government. We welcome the Minister’s confirmation that there is a communication plan and a specific budget allocated to HMRC for this purpose. (Paragraph 110)
27.We recommend that, as a priority, HMRC should implement an education campaign about what the merged scheme will mean for businesses investing in R&D. (Paragraph 111)
28.We are doubtful that final guidance of the quality needed to support businesses as they adjust to the merged scheme can be put in place by 1 April 2024. Without final detailed guidance, well in advance of the start date, it is not sensible or appropriate to bring the merged scheme into effect. (Paragraph 121)
29.We are concerned that the introduction of the merged scheme will impact investment in R&D by SMEs, and subsequently impact UK productivity and growth. We note the concerns raised by witnesses that the reduction in the rate of the relief may deter SMEs from submitting future claims. If it is the Government’s intention to reduce the number of claims from SMEs and focus the relief on larger companies, then it should make this clear. (Paragraph 122)
30.We recommend that the Government commits now to evaluating the effectiveness of the merged scheme in incentivising investment in R&D by large and small businesses in three years’ time. (Paragraph 123)
31.We ask the Government to provide evidence of the economic impact of the merged scheme and the R&D intensive scheme and, in particular of the additional monies they have injected into the UK’s R&D systems. (Paragraph 124)
32.The cost to taxpayers of implementing new tax rules is an important consideration when developing new policies. While not confirming whether the merged scheme would go ahead, the Government has been clear since January 2023 that, if it did, it would take effect from April 2024. Changing the way in which R&D relief is given is a major change and we see no reason why indicative cost estimates could not have been provided in July 2023. By only publishing its costings in late November 2023, the Government left it too late for stakeholders to engage on whether its estimates accurately capture those costs. (Paragraph 129)
33.Where the Government is proposing a major change to how businesses are taxed, we recommend that costs are modelled at an earlier stage in the consultation process to allow for stakeholder engagement, even where some details have not yet been finalised. (Paragraph 130)
Subcontracting Arrangements
34.We recommend that in 2024 HMRC work closely with members of its Research and Development Communication Forum in order to clarify the treatment of both ‘contracted out R&D’ and subsidised expenditure. (Paragraph 139)
35.It is clear that changing the rules on subcontracted R&D would always result in winners and losers. The Government should have been more transparent in July about its reasons for its chosen approach so that those businesses at risk of losing out could at least understand the policy rationale for this. (Paragraph 158)
36.We consider that there should have been a wider, and more formal, consultation on the treatment of subcontracting arrangements at an earlier stage. It is particularly disappointing that the new Finance Bill provisions on subcontracting were not themselves subject to formal consultation before being laid before Parliament. (Paragraph 159)
37.Given the range of commercial arrangements relating to R&D activity, we consider that defining ‘subcontracted R&D’ to exclude what the Government calls a ‘normal’ contract may be very challenging, if not impossible. We therefore agree that it is vital that detailed guidance on the meaning of ‘subcontracted R&D’ is made available as soon as possible. We are concerned, however, that there is insufficient time for such guidance to be developed prior to the legislation coming into force from April 2024. (Paragraph 160)
38.We welcome the Government’s decision to remove the restriction on relief for subsidised expenditure under each of the merged and R&D intensive schemes. (Paragraph 161)
39.Detailed guidance on subcontracted R&D, including realistic examples, must be available to businesses in advance of 1 April 2024 when some businesses will have to apply the new rules. HMRC needs to assure businesses that final guidance will be available before the start date of the merged scheme. (Paragraph 162)
40.We acknowledge that changes to the subcontracting rules announced at Autumn Statement 2023 should go some way to assuaging the concerns of larger companies concerning the adoption of the SME model for subcontracting arrangements. Nonetheless, such businesses will have a heavy compliance burden given the need for them to review each subcontracting arrangement in order to confirm eligibility for R&D relief in advance of the merged scheme coming into effect. (Paragraph 166)
41.Transitional rules within the merged scheme would be undesirable: they add to the overall complexity of the transition and could mean that affected businesses are subject to two different regimes (both the RDEC and the merged scheme) in relation to R&D spend until the end of the transitional period. The need for such transitional arrangements would be best avoided by deferring the start date for the merged scheme to allow companies to prepare for the changes. (Paragraph 167)
42.If the Government persists with its current timetable for the merged scheme, we recommend, notwithstanding the reservations set out in our conclusion above, that transitional provisions be included in the legislation so that providers can continue to claim relief for R&D done under an existing subcontracting arrangement for a specified period. This would enable them to review their existing arrangements and negotiate any changes needed for their contracts to remain financially viable. Any such transitional arrangements should be as simple as possible to implement and should last no longer than is necessary to enable those affected to adjust to the new sub-contracting regime. (Paragraph 168)
Changes to HMRC Data Collection
43.From the evidence received, it seems very likely that the costs to employers of providing this data, both one-off and on-going, have been significantly underestimated. (Paragraph 197)
44.We recommend that HMRC publishes the assumptions on which the costs to businesses of the employee hours requirement were based. HMRC should then work with interested parties to review these costings and produce revised estimates that are more realistic and re-evaluate the extent to which the proposed benefits outweigh these costs. (Paragraph 198)
45.We consider that the case for requiring employers to provide employee hours data to HMRC has not been made out. Additional burdens should not be imposed on businesses unless there is a compelling reason for doing so. It is not clear how understanding economic activity, enforcing the National Minimum Wage and the National Living Wage, planning for contingencies, or assessing NICs reliefs can be considered to be “for the collection and management” of the listed taxes, as specified in the draft legislation. (Paragraph 199)
46.At the time they gave evidence, witnesses remained unclear about exactly what information on employee hours was required and for what purpose, despite the fact that consultation on this measure has been on-going for more than a year. This level of uncertainty at this stage in the development of the measure is unacceptable. The Government should have been much more transparent from the beginning about what information is required and how it will be used. We do, however, welcome the Government’s clarification that the requirement is for data relating to hours paid rather than hours worked. (Paragraph 200)
47.The Government should clarify its intentions concerning sharing data about employee hours with other Government departments and agencies. It should consult with relevant stakeholders before any such sharing takes place, even if it is permitted under existing powers. (Paragraph 206)
48.HMRC must publish guidance to help employers and businesses understand exactly what data they need to provide as early as possible in 2024. (Paragraph 207)
49.HMRC must set out how the collection of employee hours data falls within the stated purposes of being for “the collection and management of the listed taxes”, as specified in the draft legislation for Finance Bill 2023–24. If the Government wishes HMRC to collect data that is not directly necessary for these purposes, this should be specifically legislated for, following a full consultation to consider the implications of such an extension of HMRC’s powers. (Paragraph 208)
50. HMRC said that additional information about dividends for owner-managers would make it easier to operate relief schemes in any future emergency. This is not, in our view, relevant to the collection and management of tax. (Paragraph 217)
51.While we accept that a lack of common identifiers in the data held by HMRC and Companies House respectively means that it is not possible for HMRC to cross reference the information held by Companies House regarding dividends paid to owner-managers, the Government should consider how to make its systems compatible with each other so that they are able to exchange data where appropriate. (Paragraph 221)
52.It is disappointing that the Government did not publish draft regulations with detail about the nature and extent of the additional data to be required by HMRC for consultation at the same time as it published the draft legislation or even the Finance Bill. This delay reduces the amount of time businesses have to prepare for the introduction of these new requirements. (Paragraph 224)
53.Early publication of draft regulations and full consultation on the detail of the additional data to be required by HMRC is crucial if the Government is to go ahead with a 2025/26 start and the Government must, in any event, allow all stakeholders sufficient time to make the changes necessary for these additional requirements before they are implemented. (Paragraph 225)
Dealing with Promoters of Tax Avoidance
54.Given the difficulties inherent in extradition, in particular in the case of territories with which the UK does not have extradition agreements, we remain concerned about how the legislation aimed at dealing with the promotors of tax avoidance schemes can be applied to offshore promoters. (Paragraph 246)
55.We recommend that, during the passage of the Finance Bill, the Government provides greater clarity about how the legislation will be effective against promoters of tax avoidance schemes that are based offshore. (Paragraph 247)
56.We agree with witnesses that the creation of a criminal offence for the promotors of tax avoidance schemes requires greater safeguards, including effective, independent oversight of the stop notice and subsequent criminal prosecution processes, to be built into the legislation. (Paragraph 252)
57.Greater clarity is needed about the position where a stop notice is under appeal, and that appeal may be successful. It cannot be right for someone to be at risk of criminal prosecution as a result of a stop notice that the tribunal then strikes down. (Paragraph 257)
58.We recommend that there be independent oversight, external to HMRC, of the issuing of stop notices leading to criminal prosecution. While there are different ways of approaching this, our preference would be for these to be authorised by the tax tribunal. (Paragraph 258)
59.Criminal proceedings should not be taken in circumstances where a stop notice is under appeal and so may be overturned by the tax tribunal. We therefore recommend that the legislation be amended to put this beyond doubt. (Paragraph 259)
60.We recommend that HMRC do more to publicise the risks of involvement in avoidance schemes to potential and actual users, employing more direct communication channels than just GOV.UK, including social media, as well as traditional media outlets such as advertising, the press, and the broadcast media. (Paragraph 267)
61.We recommend that the legislation on disqualification of directors is amended to afford protection to ‘stooge directors’ by targeting it more narrowly at the ‘controlling minds’ behind the promotion activities. Although there are different ways of doing this, one possibility would be to take into account the extent of a director’s knowledge or involvement in the company’s activities in deciding whether they had a ‘reasonable excuse’ as provided in the legislation. (Paragraph 268)
62.When deciding whether to apply for a disqualification order in the ‘public interest’, HMRC must assess the extent of the director’s culpability and knowledge of the tax avoidance scheme in question, and whether there is a history of persistent involvement in such schemes, or of a failure to comply with stop notices. (Paragraph 271)
63.We recommend that HMRC publish the criteria it intends to apply when deciding whether disqualification is in the public interest. (Paragraph 272)
64.We are concerned that, in the context of its present difficulties, HMRC lacks the capacity to undertake the extra work entailed by these measures to deal with promoters of tax avoidance schemes (Paragraph 276)
65.We recommend that resourcing within HMRC for these measures be kept under review so that any lack of capacity can be remedied as quickly as possible. (Paragraph 277)
Doubling the Maximum Sentence for Tax Fraud
66.We consider the fact that HMRC does not hold data about the sentences handed down in cases of prosecution for tax fraud to be a serious oversight, as it makes it difficult to assess the deterrent effect of custodial sentences. (Paragraph 287)
67.Given that it is four years since the commitment to double the maximum prison term for tax fraud was made, and the importance of a robust evidence base for policy development, we feel that the work to understand the deterrent effect of HMRC’s criminal investigations resulting in prosecution should have been undertaken sooner—and in any event before the draft legislation was published in July 2023. In the absence of any such analysis, we do not see what justification there can be for the change in policy and are sceptical about the deterrent effect of doubling the maximum sentence for tax fraud. (Paragraph 288)
68.We recommend that HMRC collects data about the sentences handed down for tax fraud, including the number of times the new maximum sentence is imposed by the courts, and provides annual reports of its analysis of this data, including an analysis of the deterrent effect of these sentences. (Paragraph 289)
69.While we recognise the impact of wider delays in the criminal justice system and of resource constraints within HMRC, we are concerned by the sharp decline in the number of prosecutions for tax fraud in recent years, and the impact this is likely to have on deterrence. (Paragraph 295)
70.We ask that HMRC review its strategy for the prosecution of tax fraud to ensure that the deterrent effect is maximised and ensure that it has sufficient resources to make prosecution an effective deterrent. (Paragraph 296)
71.We are concerned about the apparent lack of awareness of the whistleblower scheme to report tax fraud. If the scheme was publicised more widely more whistleblowers might be encouraged to come forward, to the general public benefit. (Paragraph 300)
72.We recommend that HMRC do more to publicise its whistleblower scheme, using channels other than GOV.UK, including social media, as well as traditional media outlets such as advertising, the press, and the broadcast media. (Paragraph 301)
73.We recommend that HMRC consider what further incentives it could deploy to encourage greater participation in the whistleblower scheme. (Paragraph 302)
Cross Cutting Issues
74.We note that the Tax Policy Framework recognises the useful role that informal consultation can play in developing policy. That does not mean, however, that it should be used in place of public consultation when designing policy—particularly as, by limiting engagement to a pre-selected group of stakeholders, the Government risks missing out on useful input. (Paragraph 309)
75.The Government should follow its Tax Consultation Framework and start consultations on significant changes at Stage 1. (Paragraph 310)
76.In setting a timetable for the implementation of a measure, the Government must take full account of the steps taxpayers need to take to prepare for the change and the support HMRC needs to provide for this. Regulations and guidance relevant to changes should be published as early as possible, and with a timetable that ensures sufficient time for proper consultation on regulations before the measure takes effect. (Paragraph 317)
77.The Government needs to revisit its standard model for costing and ensure that HM Treasury and HMRC conduct a meaningful dialogue with stakeholders about what businesses need to do to prepare for any change, including being transparent about any assumptions made. (Paragraph 321)
78.The Financial Secretary assured us that HMRC’s resources have been increased and are monitored. Nonetheless, we note that successive Finance Bill Sub-Committees have raised the question of HMRC resourcing in recent reports, yet the situation seems to be getting worse. It is counter-productive to keep introducing new legislation placing additional burdens on HMRC if the department is already unable to provide a satisfactory level of service to taxpayers. (Paragraph 325)
79.The Government should review resourcing for HMRC not only in relation to individual measures but also to ensure that taxpayers receive the level of service they have a right to expect. (Paragraph 326)
80.We consider that proper safeguards in these cases are essential both for the protection of taxpayers and because safeguards are necessary to secure buy-in from stakeholders and voluntary compliance by taxpayers. (Paragraph 328)
81.Against a backdrop of increased distrust of HMRC and the Government’s tax policy in recent years, the Government must ensure that additional powers for HMRC are tempered by appropriate safeguards for the taxpayer. (Paragraph 329)