Since the introduction of an R&D scheme for small and medium enterprises (“SME”) in the UK in 2000, over 300,000 claims, totalling £33.3bn have been made, the majority of which are by SMEs.
HMRC’s latest statistics from September 2020 show that SMEs have made over 52,000 claims for £3bn in the 2018/19 tax year. The generosity of the SME scheme has led some companies to push the limits to maximise their claims, often without genuine justification. Some SMEs have claimed R&D Tax credit for work that has no relevance to R&D. Others have tried to get the benefit for R&D activities undertaken outside the UK by using set up structures in the UK solely for this purpose.
As a result, in the 2018 Budget it was announced that to mitigate this abuse of the SME scheme, the PAYE cap will be introduced to the payable tax credit. All the claims made for the accounting periods beginning on or after 1 April 2021 are now affected.
The idea behind the new rule is to start limiting the amount of SME R&D tax credit to three times the amount of Pay-As-You-Earn (“PAYE”) and National Insurance Contributions (“NICs”) liability for the period plus a £20,000 grace amount. The cap was originally removed from the SME scheme in 2012.
What does the PAYE cap mean?
To give you an example of how the cap works, if a company has £20,000 in PAYE/NICs in the claim year, the maximum tax credit it can claim will be £20,000*3+£20,000=£80,000. In addition, for the purpose of cap calculation, the company can include related party PAYE and NIC liabilities that can be attributed to the R&D project. It is worth noting that this new cap will mostly affect small, loss-making companies with large expenditures on subcontracting activities or the companies that fall into a loss-making position due to the R&D enhancement (Valley of Death) and choose to surrender the loss for a cash lump sum. A lot of family-run companies and start-ups are therefore going to be impacted by the new rules, as well as companies with large expenditures on consumables, or software.
As with any rule, the cap has its own exceptions:
- If the amount of company’s payable claim doesn’t exceed £20,000, the cap would not apply to its claim.
- The company will not be subject to the cap if it can satisfy two tests: it must be actively managing its intellectual property (IP) that arises from the R&D project. In other words, the company’s employees should be preparing to create/create or actively manage IP and spend no more than 15% of its overall R&D expenditure on related party subcontracting or EPW provision.
What if the exceptions don’t apply to me?
If the company doesn’t fall into any of the two categories, then it is good to know the implications of the new PAYE cap on the benefit calculation process.
Firstly, the total cap amount is always time apportioned to reflect the length of the accounting period (“AP”). If the AP lasted less than 12 months, the cap will be proportionally reduced.
Secondly, when calculating the cap, double counting of PAYE and NIC liabilities must be avoided. This applies to the scenarios when there are two connected companies.
For example, Company A subcontracts R&D activities to Company B, which also has its own R&D activities that it claims the benefit for, or Company B supplies Company A with EPWs. Both companies A and B will therefore be calculating the PAYE and NIC to arrive to the final PAYE cap figure, however Company A will be also including Company B’s NICs and PAYE number in its cap calculations as it is a connected company.
The blanket approach simply penalises SMEs in general, discouraging investing in innovation and claiming R&D Tax credits, which has an adverse effect on the economy. It will not however prevent ‘creative’ companies from finding new ways of abusing the scheme.
We therefore believe that the more prudent approach would be to improve HMRC compliance of the SME scheme. One way to do this is to increase the resources to enable more efficient identification of potential issues within the claims to prevent SMEs from claiming irrelevant R&D expenditures. At the same time, still encourage genuine R&D activities to be undertaken. This correlates with the original aim of the SME scheme since its introduction back in 2000.
Ayming UK will continue to closely monitor any changes to the legislation and is here for its clients to advise on any aspects of the new regulations and their impact on the scheme.