UK tax credit recall could kill startups

Good morning there,

This morning we've got the story that UK startups are being asked by the country's tax agency to return money they received as part of an R&D tax credit scheme; some companies have been left with five- and six-figure holes in their finances. Scroll on for that.

Elsewhere today:

• 20 wealthtech startups to watch
• Does a GenAI surge in the legal sector signal the end of the billable hour?

— Kai Nicol-Schwarz, reporter

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UK tax credit recall could kill startups

Startups in the UK are being asked by HMRC — the country’s tax agency — to return hundreds of thousands of pounds in R&D tax credits 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”.

Zoom out: R&D tax credits give tax rebates on the money companies spend on innovation, and small businesses (SMEs) can typically get back between a quarter and a third of their R&D spending. But HMRC says “error and fraud” in the R&D tax credit scheme cost it £4.1bn between the 2020-21 and 2023-24 tax years. So it’s trying to fix that. 

An HMRC spokesperson told Sifted: “The levels of non-compliance that we are seeing within these schemes are clearly unacceptable and the public rightly expect us to take action [...] 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.”

But four startups — all of which say they believe their businesses satisfy the “innovative project” criteria needed to receive tax credits — tell Sifted that HMRC’s approach is leaving them financially hamstrung. 

One CEO says that repayment and subsequently 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 against their company 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.

“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,” one of the CEOs tells Sifted. “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.” 

Another complaint is that it is taking too long to process claims and appeals. One climate tech founder says 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. Their startup received a tax rebate for the 2022 financial year, which HMRC later said had been sent in error. 

HMRC has said it “consistently met its published aim” to process over 80% of claims within 40 days from 2023 to 2024. It has 500 people working on R&D compliance, compared to 100 in 2020-2021.

We dig into the stories of startups that have been impacted by HMRC stepping up its investigations into abuse of the R&D tax credit system. You can read the full piece here.

— Kai Nicol-Schwarz, reporter & Freya Pratty, senior reporter

💰 20 wealthtech startups to watch. (Sifted Pro subscribers)

🇺🇸 How to build your first team in the US. (Sponsored by J.P. Morgan)

🧑‍⚖️ Does billing by the hour in the legal sector need a rethink? It’s a question the FT’s Lex column is pondering, after a GenAI surge in the sector. 

• Legaltech has been one of the VC flavours of the year so far in 2024, with a flock of startups raising one after the other. In the UK, in the past seven months alone, Luminance raised $40m, Robin AI picked up $26m, Definely $7m and Wordsmith AI $5m. Sweden’s Leya Law also raised $10.5m.

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