HMRC is introducing new legislation to limit the payable tax credit received by certain companies who claim R&D relief under the SME scheme.
The new rules, which come into effect on 1 April 2021, will principally impact companies with limited UK staff costs and high sub-contracted R&D costs.
Although the new legislation is designed to target specific abuses of the R&D system, it is possible for genuine claimants to be adversely affected, particularly start-ups, or companies which engage significant sub-contractors to carry out R&D, which we typically see in the software/tech sector.
What is the SME R&D Scheme?
The SME R&D scheme provides relief of up to 24.7% of a profitable company’s R&D costs through a reduction in the company’s corporation tax liability.
The SME scheme also provides relief to loss-making SMEs, or those who have a tax loss after accounting for the additional R&D deduction, by enabling companies to surrender the resulting losses to HMRC in exchange for a payable credit of 14.5% of the loss.
A loss making company can effectively receive relief of up to 33% of their R&D costs as a payable credit. It is these companies which may be affected by the new rules.
Why are the R&D tax credit rules changing?
R&D Tax Credits are very valuable for innovative companies and have been supported by successive governments for more than 20 years.
However, the scheme has been subject to abuse from certain claimants with little genuine UK R&D activity, leading to the introduction of new rules which will place a restriction in the payable credit for loss making companies.
What are the new rules?
The new rules, known as the PAYE cap, will limit the amount of the payable R&D tax credit an SME can claim to £20k + (300% x relevant expenditure on workers).
Relevant expenditure on workers is defined as the company’s total PAYE and national insurance liabilities for the period, plus some PAYE and NI liabilities of any connected companies undertaking sub-contracted R&D for, or providing workers to, the company.
In addition to the ‘buffer’ of £20k, there is a complete exemption for companies which can satisfy two conditions:
- Its employees are creating, or preparing to create IP, or managing IP
- Less than 15% of the R&D spend is spent with connected persons
How will this affect genuine R&D Tax Credit claimants?
Despite the £20k buffer and the exemption mentioned above, it is still possible that genuine claimants will be adversely affected.
This is particularly the case for start-up companies, or those with low salaried directors who may rely on sub-contract or externally provided support for R&D work.
For example, a company with a taxable loss pre-R&D of £100k and R&D spend of £100k will be entitled to a payable credit prior to the introduction of the PAYE cap of £33,350.
From 1 April 2021 companies in this position will need to consider their ‘relevant expenditure on workers’ to ensure this is sufficient to cover the excess of the payable credit over the £20k buffer.
What should R&D Tax Credit claimants do?
Firstly, claimants should not be put off by these changes, as the R&D tax credits scheme is still extremely valuable for qualifying companies.
We encourage all companies to check their entitlement to relief.
The Radius team have a deep specialisation in R&D tax credits and are ideally placed to advise on these new rules. If you have any concerns about your claims, in relation to this new legislation or generally, please do not hesitate to speak to your usual Radius contact.