UK startups are being told they need to pay back hundreds of thousands of pounds in R&D tax credits to the UK’s tax agency HMRC, after it decided claims were mistakenly handed out and implemented a number of measures to tackle what it calls high levels of “error and fraud”.
Sifted spoke to five companies that say they’ve been asked to repay tax rebates. One CEO tells Sifted that repayment and subsequent rejected tax credit claims will leave their startup with a £500k black hole in their finances; another says they’re worried their business won’t survive if HMRC’s repayment case is upheld. One says they’d had to sell off their business’s assets after delays to R&D tax credits caused by an investigation into a previous claim.
R&D tax credits give tax rebates on the money companies spend on innovation. Small businesses (SMEs) can typically get back between a quarter and a third of their R&D spending. All of the startups Sifted spoke to say they believe their businesses satisfy the “innovative project” criteria needed to receive tax credits.
It comes two years after startups told Sifted they were struggling with delays in R&D rebates. “There were delays two years ago but not the level of scrutiny we’ve seen in the last 18 months,” says Adam McCann, cofounder of Claimer, a startup that helps companies apply for R&D tax relief.
Sifted submitted a request under the Freedom of Information Act to HMRC, asking how many companies had returned tax credit financing to it, and for the total sum the agency had recouped. HMRC said it could not say because it is not required to collate data in that way.
‘Sledgehammer to crack a nut’
New figures published by HMRC last week estimated that abuse of the R&D tax credit scheme had cost it £4.1bn between the 2020-21 and 2023-24 tax years. The tax agency spent £7.7bn on the scheme in 2023-24.
In 2021, the government started asking for more information from claimants and set up an “anti-abuse unit” within HMRC to tackle error and fraud. In 2024, HMRC said it was now checking “20% of claims compared with 1% previously”.
But startups tell Sifted the new measures have led to the department wrongly asking them to repay claims.
The CEO who told Sifted an HMRC investigation could lead to a £500k deficit in their company’s finances said that the agency opened a review into their company’s application for credits in 2022, which then involved reviewing the money it had received in 2021. Sifted has seen correspondence between the company and HMRC.
The company — which won awards for tech innovation — has not received 2022 credits because of the investigation, and may have to hand back the money it secured in 2021.
“I’m not doubting there might be some bad actors, but the response by HMRC seems to be inconsistent and disproportionate, with wide-reaching implications for the startup sector,” the CEO — who asked to remain anonymous for fear of compromising the claim — says. “It feels like they have used a sledgehammer to crack a nut.”
HMRC told Sifted that taxpayers rightly expect it to scrutinise R&D claims because public money is at stake. A spokesperson said: “We do that thoroughly and fairly, and the overwhelming majority of valid claims are paid on time.”
‘Free money’
R&D tax credits were seen by some startups as “free money”, says McCann. In his view, abuse of the system was in part due to tax advisors working on a no-win-no-fee model that could have contributed to companies submitting non-compliant claims.
“The levels of non-compliance that we are seeing within these schemes are clearly unacceptable and the public rightly expect us to take action”, an HMRC spokesperson told Sifted. “This includes better help, guidance and processes for legitimate claimants, as well as decisive action against the minority who deliberately set out to abuse the schemes.”
One R&D tax credit consultant — who is hired by startups to help claim credits and tackle repayment requests — says that of the around 800 cases they’ve been involved in, around 70 startups have been asked to repay cash.
Slow moving
Many startups say that part of the problem is how slow HMRC has been in processing claims and appeals.
“Compliance checks can take 9-12 months on average to resolve,” says Tom Adcock, partner at accountancy firm Gravita. Adcock says he has one client whose compliance check has been pending for a year and a half.
HMRC has said that it “consistently met its published aim” to process over 80% of claims within 40 days during 2023 to 2024. It has 500 people working on R&D compliance, compared to 100 in 2020-2021.
But one climate tech founder tells Sifted that their case has dragged on for over a year and a half and their company “won’t be able to survive” if HMRC upholds its case for repayment.
The startup received a tax rebate for the 2022 financial year but, a few months later, received a letter from HMRC saying the money had been sent in error and that it no longer qualified for the five-figure sum.
The startup shared more information on its work with HMRC, but the agency stuck with its decision. The case has now progressed to HMRC’s ‘alternative dispute resolution’ service (ADR), and, if HMRC stands by its decision again, the founder says they will take the case to tribunal. Sifted has seen correspondence between the company and HMRC.
“HMRC said we’re not qualified to call ourselves innovative, but we won an Innovate UK grant for our innovation during the same period,” they say. Innovate UK is a government body that issues grants to “game-changing and commercially viable R&D”.
The climate tech’s tax credit issue has meant the company hasn’t applied for tax rebates for 2023 or this year, the founder tells Sifted. Companies are able to submit new claims while previous ones are under investigation, though the founder believes it’s very unlikely they’ll be successful.
“It’s massively affected cash flow,” the founder adds. “It’s unwarranted and unacceptable. It’s a problem with how funds have been managed at Treasury level, it’s got nothing to do with me and my business.”
Another founder tells Sifted their startup has battled an HMRC investigation for 14 months, and that in that time they had to sell the business’s assets due to cash flow issues partly caused by delays to their R&D claim.
After receiving a £70k tax rebate at the start of 2022 for the previous financial year, they tell Sifted that at the start of 2023 HMRC opened an investigation into their claim. The company submitted another claim for £90k in March 2023, then in July that year HMRC informed them that they didn’t qualify for tax credits in either year, and would have to pay back the £70k. Sifted has seen correspondence between the company and HMRC.
All three of the startup’s non-founder employees were laid off and the two founders stopped paying themselves salaries to reduce costs and keep the business afloat. “The business was put on standby, barely able to continue operations,” says the founder.
While the startup won its appeal eventually, by this point it had sold its assets to settle debts it had accrued by not having access to the £90k in tax credits, says the founder.
“Our experience highlights the challenges faced by many tech startups with the UK R&D tax credit system,” says the founder. “The inconsistent approach, lengthy process and severe financial impact demonstrate the need for improvements in how HMRC handles R&D claims, especially for innovative small businesses.”
Fundraising early
Another founder tells Sifted that HMRC R&D tax credit investigations were “one of the main reasons” their startup had to fundraise early.
They say they have been asked to repay a £55k tax rebate for the financial year ending in 2022 and have been appealing against the HMRC case since October 2023. Sifted has seen correspondence from HMRC asking for repayment. Their R&D tax credit advisor has advised them not to apply for new claims until this one is processed — due to new claims unlikely to be granted if a previous one is being investigated.
“We’d probably have an extra £150k-200k right now if not for [the HMRC case] — this could be months if not a year of runway,” they tell Sifted.
“If investors ask why the runway is short, I can explain,” they say. “But most investors don’t actually ask — and we’re suddenly in a situation where the company looks unfavourable to outsiders.”
The case is still not settled and HMRC have asked for an extension to September. Sifted has seen correspondence between the company and HMRC.
Others have turned to alternative financing options to extend their runway in the absence of R&D tax credits, says Adcock.
“To bridge the financial gap caused by delayed R&D tax credits, we’ve seen an uptick in startups turning to debt funding or seeking alternative funding sources,” he says. Several of his clients have recently taken out R&D advance funding — a loan against an R&D claim that they have submitted.
“This has become more common as many companies saw delays in receiving their repayments from HMRC,” Adcock tells Sifted. “These alternatives are often more expensive and come with higher interest rates or less favourable terms.”
Not worth it?
While “people were taking liberties in the past,” says Oli Kicks, investor at Concept Ventures, “no one knows what’s going on or what the process looks like” these days, he tells Sifted.
“Our general view is do not factor [R&D tax credits] into the budget in its current format, as it’s a completely unreliable means to extend runway or de-risk cash flow,” Kicks says. “Previously, during 2021, it was more of a reliable timeline and process you could go through.”
Some startups have abandoned tax credits altogether, says Adock. “Some have decided that the current regime is simply too complex and costly to go through the process of making a claim.”
Read the orginal article: https://sifted.eu/articles/startups-tax-credits-hmrc/
