UK startups are being unfairly targeted by government efforts to recover research and development (R&D) tax credits handed out in error, industry leaders say, with some facing massive financial losses as a result of the clawbacks.
Launched in 2000, R&D tax credits were designed to incentivise businesses to invest in innovation, allowing them to reduce their tax bills or claim cash credits. But UK tax agency HMRC has ramped up efforts to recover awarded funds from some claimants, citing high levels of “error and fraud”.
Now, nearly a year on from Sifted last reporting on the issue, founders and startup advisors tell the publication they’re still bearing the brunt of HMRC’s crackdown despite making what they believe to be legitimate claims.
Some startups say that they’ve been forced to reduce headcount and shut down operations as a result, while others say the uncertainty caused by lengthy HMRC investigations can have major knock-on effects, regardless of the outcome.
“The R&D tax credit clawback situation has been devastating for many startups,” says Sarah Malter, founder of Kapitalise, an agency which helps startups make R&D tax credit claims.
“We have observed companies drastically reducing their operations due to unexpected HMRC clawback demands, and a few have been affected enough that they have had to close shop.”
The UK tax agency told Sifted R&D tax credits played a “vital role in the government’s mission to boost economic growth” and it was committed to ensuring a straightforward process for genuine claimants.
“Given the significant levels of non-compliance in the regime, it’s essential we undertake activity to make sure taxpayers’ money is spent on supporting genuine R&D,” a spokesperson said.
“This activity ranges from criminal investigation of dishonest agents through to greater education of claimants on their eligibility.”
Startups suffering
The R&D tax credit scheme was set up to encourage British companies to increase spending on developing innovative technology, and small businesses can typically get back between a quarter and a third of their R&D spending for approved claims.
HMRC spent £7.7bn on the scheme in 2023-24, according to figures published by the tax agency in 2024. The government department also estimated that abuse in claims had cost it £4.1bn between the 2020-21 and 2023-24 tax years.
As a result, HMRC has massively increased scrutiny on claims, saying in early 2024 it had increased the number of compliance checks to 20% of claims compared with 1% previously.
“The uncertainty of the R&D tax credit scheme is one of the top three things that we hear complaints about from startup founders,” says Jordan Sullivan, head of economic policy at lobby group Startup Coalition.
One founder — who spoke to Sifted on the condition of anonymity to avoid further jeopardising their business interests — tells Sifted their startup was told it needed to pay back £50k in tax credits granted over the previous two years in 2024.
The startup was also told any other claims it planned to submit would not be eligible — including one it was preparing for £150k.
The founder says that they were claiming for a “new type of database system”, which fitted HMRC’s criteria. They were told because this involved building on existing systems rather than being totally new, it would not qualify as “innovative”.
“Timing wise was terrible, we were raising round,” they tell Sifted. “If an investor is doing due diligence on you, having an investigation with HMRC is killer.”
The startup is now in liquidation, which the founder says was in part due to a cash flow crisis caused by R&D tax credit clawbacks and being told it wouldn’t be able to claim in the future.
“The fact that we could no longer make assumptions that receipts of R&D tax credits were part of our financial model, meant we had to start cutting jobs,” they say.
“Part of that's on us because we shouldn’t have assumed tax credits would be granted, which was a mistake, but there's a wider point about having some reliability built into the system.”
Time intensive
Even for startups that successfully argued against an order to repay tax rebates, fighting investigations can be a hugely time consuming process that can detract for other areas of business.
Another founder, who also preferred to remain anonymous to protect future business interests, tells Sifted it took more than 700 hours of work by their team and expert R&D consultants to settle an HMRC investigation into £1m in tax rebates previously granted.
The founder says HMRC’s case officer argued that their startup’s software didn’t qualify for R&D tax credits because it wasn’t “new science”, which they tell Sifted they don’t believe should have impacted their claim.
“Startups don't have 700 hours of resources on hand to deal with bureaucracy, nor do we have the ability to absorb a £1m hit on cash flow easily,” says the founder.
“We moved a significant amount of our R&D out of the UK as a direct result,” he tells Sifted. “We would have moved the whole business had it not been for the tax implications of such a restructure.”
Part of the problem is being unable to have a direct conversation with HMRC about investigations, says the founder.
“Despite raising several complaints, we were denied the opportunity for a meeting on the matter,” they tell Sifted. “We never got to speak with HMRC in the two year period the investigation was ongoing for.”
Startup Coalition’s Sullivan tells Sifted complaints from UK startups about HMRC were “mainly to do with customer service.”
The solution?
Many in the startup sector accept HMRC needed to reduce abuse of the R&D tax credit scheme.
“This tightening of oversight, along with a broader market calibration, has helped eliminate any bad actors and invalid claims which has been a much needed and positive development,” says Rob Whiteside, CEO at EmpowerRD, an advisory company which helps startups claim for R&D tax credits.
But it's now “essential to enter a new phase built on stability and predictability,” he adds.
There are signs HMRC is attempting to fix the problem.
The tax agency launched a consultation on an advanced clearance process — which would provide businesses with upfront assurance that their R&D projects qualify for tax relief — in March this year. HMRC will be consulting with industry until late May, and will announce how the process will be taken forward later this year.
Those plans have been met with cautious optimism by startup leaders and advisors.
In the meantime though, the uncertainty caused by HMRC’s clawbacks is causing startups to think twice before claiming for R&D tax credits.
“We have clients who, despite being successful in their compliance checks, have been so burdened by the significant time and resources required to respond to numerous rounds of questions that they have decided not to submit future claims, despite being eligible,” says Malter.
“If the UK is to remain a global leader in innovation, the businesses building tomorrow’s solutions must feel supported, not second-guessed,” Whiteside tells Sifted.
