R&D Tax Claims: A warning for SMEs looking to exit or acquire

The UK government’s R&D tax credit scheme was designed to support innovation, particularly among SMEs. However, with HMRC now cracking down on fraudulent or erroneous claims amounting to £1.3bn in 2021-22 alone, businesses must ensure compliance to avoid serious financial consequences.

As Russell Payne and Allister Manson, both Partners at Opus Restructuring & Insolvency, discuss, for those looking to sell or close their company, and for buyers considering acquisitions, understanding the risks associated with past R&D claims is essential.

With recent scrutiny from HMRC on claims—both past and present—business owners must now look to take a proactive approach. For those aiming to exit a business, whether through sale or liquidation, ensuring compliance is crucial. Likewise, buyers need to conduct rigorous due diligence to avoid inheriting financial liabilities tied to past R&D claims.

The scale of the issue
HMRC estimates that in 2021-22 alone, 18% of all R&D claims, amounting to £1.3bn, were fraudulent or erroneous. This spike in incorrect claims has been largely driven by unregulated tax advisers who encouraged businesses to submit claims with little regard for eligibility. Some businesses were even advised to claim for routine activities under the guise of R&D, despite the stringent criteria set by HMRC.

Historically, HMRC took a relatively relaxed approach to verifying claims, but that stance has changed dramatically. The government has reallocated resources to scrutinise R&D tax claims, meaning businesses that have made claims in recent years could soon find themselves under investigation.

Advice for business owners looking to exit
For directors considering selling their business, closing it through a Members’ Voluntary Liquidation (MVL), or striking it off the Companies House register, it is essential to conduct a thorough review of any past R&D claims.

A key fiduciary duty of directors is to ensure that their company can meet its liabilities. If a past R&D claim is found to be non-compliant, it could result in significant tax liabilities, penalties, and interest. Directors signing a Declaration of Solvency in an MVL must be confident that all financial matters, including potential HMRC claims, have been appropriately addressed.

Where there is any uncertainty, seeking a second opinion from a tax specialist or voluntarily disclosing concerns to HMRC could help mitigate risks. HMRC tends to take a more lenient approach towards businesses that self-report errors rather than waiting to be audited.

Awareness for buyers
For those looking to acquire a business, due diligence is more critical than ever. Tax compliance should be a key focus, with particular scrutiny of any R&D claims made by the target company in the past six years, or even further back in cases where fraud is suspected.

Buyers should ensure that their advisors assess whether past R&D claims were legitimate and whether there is a risk of HMRC intervention. In cases of doubt, buyers may wish to negotiate tax indemnities or warranties from the seller, request that money be held in escrow, or reduce the purchase price accordingly. Meanwhile, for sellers, failure to address potential compliance risks could lead to delays in the sale process while specialist, highly technical advice is obtained on the merits of an R&D claim.

Impact on the M&A market
The increased scrutiny of R&D tax claims is already influencing the M&A landscape. Buyers are becoming more cautious, factoring in potential tax liabilities before proceeding with acquisitions. This could lead to price reductions or deals falling through altogether if compliance concerns are not addressed early in the process.

For sellers, failure to review past claims and address potential risks could mean not only financial penalties but also diminished exit values or even complete deal breakdowns. As such, taking proactive steps to verify past claims is no longer optional; it is a necessity.

Act now before HMRC does
HMRC’s intensified focus on R&D tax compliance is not a temporary measure; it is a long-term shift. Businesses that have historically relied on R&D tax credits must ensure that they have met the eligibility criteria and be prepared for increased scrutiny.

For directors planning an exit strategy, now is the time to review past claims, seek expert advice, and address any potential compliance risks before they become costly problems. For buyers, heightened due diligence is essential to avoid inheriting tax liabilities that could significantly impact the value of an acquisition.

HMRC is moving slowly but decisively. Businesses cannot afford to wait until they are investigated. By then, it may be too late to mitigate the damage.

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