PAYE and NIC cap: a comprehensive guide

This article explores the purpose of the PAYE cap, its calculation both before and after 1 April 2024, its interaction with SME R&D tax credits and RDEC claims, and special cases and exceptions. 

It affects a number of potential claimants, including businesses recharging personnel costs between group entities and those actively managing IP outside the UK. Whatever your scenario, given that the new rules have increased complexity, it’s vitally important that you understand whether it affects your business before claiming.

Purpose of the PAYE/NIC cap

It has been well documented that the government has grown increasingly anxious about the misuse and abuse of R&D tax relief. It’s a shift in policy outlook ForrestBrown has covered extensively. 

The PAYE/NIC cap is part of the government’s response to the abuse, designed to make it harder for fraudsters to exploit the relief. The cap is particularly focused on companies with minimal UK-based employment costs. By linking the amount of payable credit to PAYE and NIC liabilities, the cap ensures that relief is targeted at companies that contribute to the UK economy through employment.  

However, despite efforts to minimise the impact on genuine businesses, some will still be caught. For example, where a business relies on external resources to carry out R&D or recharges personnel costs between group entities, the cap could affect the R&D funding available to the business. 

The cap is a rather blunt instrument. It is not safe to assume that just because you don’t have any intention of abusing the relief, that you won’t be affected. 

These efforts to minimise unintended consequences have added several layers of complexity to the measure, so any company planning to prepare a tax credit claim needs to be aware of the rules, especially with the introduction on of the merged scheme to consider alongside this. 

Rules prior to 1 April 2024

For accounting periods beginning before 1 April 2024, the PAYE cap was calculated differently for the SME R&D tax credit and the Research and Development Expenditure Credit (RDEC) scheme: 

• SME: For accounting periods beginning on or after 1 April 2021, in most cases, SME businesses could only claim a payable tax credit of up to 300% of their combined PAYE and NIC liabilities, plus a £20,000 buffer. 
   
• RDEC: This cap was more restrictive than the SME incentive. It was only based on the PAYE and NIC liabilities of staff and connected EPWs engaged in qualifying R&D activities. Any RDEC amount that exceeded the PAYE/NIC cap was carried forward and treated as an amount of RDEC to which the company was entitled for the next accounting period. 

In all instances, NIC liabilities mean both employer and employee contributions.  

Rules post 1 April 2024

For accounting periods beginning on or after 1 April 2024, the PAYE cap calculation has been harmonised for both the SME R&D tax credit and the RDEC scheme. The introduction of the merged scheme has resulted in the SME cap being taken forward for all claimants. The cap for all claims is now calculated as: 

 £20,000 plus three times the company’s “relevant expenditure on workers”. 

Relevant expenditure on workers means:  

• Total liabilities for PAYE and NIC for the company’s employees and directors (regardless of R&D involvement), plus  
• PAYE and NIC of any connected EPWs or connected-party subcontracted R&D (restricted to the appropriate R&D apportionment). 

A company’s claim, of any size, will be uncapped if it meets two tests. These tests require that: 

• Its employees are creating, preparing to create or actively managing intellectual property (IP). 
  AND 
• Its expenditure on work subcontracted to, or externally provided workers provided by, a related party is less than 15% of its overall R&D expenditure. 

For these purposes, IP includes know-how, trade secrets, any patent, trademark, registered design, copyright, design right, performer’s right or plant breeder’s right. These exceptions align to the SME cap that has been in place since 1 April 2021. 

Who is affected by the PAYE/NIC cap?

Read this blog closely if any of the following are relevant to you: 

• Actively managing IP outside the UK. 
• Businesses with low or no payroll expenditure. 
• Planning to claim a payable R&D tax credit over £20,000. 
• Recharging personnel costs between group entities. 
• Subcontracting R&D work between related parties. 

The impact of the PAYE/NIC cap

If your R&D tax credit is capped, you’ll receive a lower amount of cash. If the cap relates to an SME’s accounting period that started prior to 1 April 2024, or a claim made under ERIS, the SME may carry forward the balance of losses which cannot be surrendered for a credit, to be offset against future taxable profits. For RDEC and the merged scheme, the amount which exceeds the cap is carried forward as an RDEC credit for use in its next accounting period. 

Many companies that carry out R&D projects each year will factor the tax credit funding into their cash flow for the year. That’s really the philosophical underpinning of the relief: the credit is reinvested into the business, creating more projects that qualify. Innovation begets more innovation. Failing to be aware of the cap and its potential implications could negatively impact cash flow to the business.  

What to do if you are affected?

The presence of the cap is no longer new, however, many companies face changes to their business and may find themselves impacted by the cap when they previously had not been.  

If you are a genuine UK-based R&D company, you may still be affected by the cap. This is not the government’s intention, but the R&D tax legislation is a prescriptive code, so you cannot rely on HMRC taking a sympathetic view. They will apply the law as it is written. 

A company that relies on employees of a different group company to work on R&D projects, especially if those workers are based outside the UK, or one with low or no salaried staff, are most likely to be impacted. 

R&D is a high cost, high-risk endeavour, so it is not unusual for younger, R&D intensive businesses to make tax losses and/or rely on external resources before the business is ready to start taking on employees. The cash credit element of R&D tax relief is designed precisely to offer a crucial cash injection in these circumstances. However, the cap could delay that cash by potentially years.  

The right approach will depend on your business’s circumstances and will take into account several factors. Good advice is worth it. The worst-case scenario is not spotting the impact until HMRC does. That means an enquiry, potentially a repayment and possibly even penalties. 

Now is not the time to think you can carry on doing what’s worked before when it comes to your R&D claims. Things are changing, so use this as an opportunity to review your R&D claim and ensure that you are managing its risks. 

Article update history:

19 November 2025: this article was updated to include calculation information post- and pre-April 2024, as well as bringing the details up to date.