PAYE and NIC cap: What it is and how it affects SME R&D tax claims

From 1 April 2021, SME R&D tax credit claims will be subject to a cap. This cap could limit the amount of cash value available to businesses and will primarily affect those without substantial payroll costs in the UK.

If your business relies on external resources to carry out R&D or recharges personnel costs between group entities, you need to check whether the new cap will affect your R&D funding.

Why is the PAYE / NIC cap being introduced?

In recent years, 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.

A recent £29.5m R&D tax relief fraud offered a powerful example of how the relief is being abused. But misuse of the incentive goes deeper than the headlines. HMRC seems increasingly convinced that some bad apples are actively seeking to exploit the relief using artificial structures to try to gain substantial cash payments.

The PAYE/NIC cap is part of the government’s response to the abuse, designed to make it harder for the fraudsters to exploit the relief. However, despite efforts to minimise the impact on genuine businesses, some will still be caught. As we explained in our consultation response, the cap is a rather blunt instrument. It is not safe to assume just because you don’t have any intention to abuse 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 SME planning to prepare a tax credit claim after the cap comes in needs to be aware of the rules.

Feeling unsure about the cap and its impact on you? Contact ForrestBrown >

Who is affected by the PAYE/NIC cap?

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

• SME business 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.
• Actively managing IP outside of the UK.

Key features of the PAYE/NIC cap:

The amount of payable credit that a qualifying loss-making SME can receive in any one year will be capped at:

 £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).

After considering the responses to the previous consultations, the cap now includes the following features to minimise the impact on genuine businesses:

• A company making a small claim for payable credit below £20,000 will not be affected by the cap.
•  A company will be able to include related party PAYE and NIC liabilities attributable to the R&D projects when calculating the cap, also multiplied by 300%.
• 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: any patent, trademark, registered design, copyright, design right, performer’s right or plant breeder’s right. (Update: As announced in Budget 2021, the definition of IP has been widened to include ‘know-how’ and ‘trade secrets’.)

 The impact of the PAYE/NIC cap

If your R&D tax credit is capped, you’ll receive a lower amount of cash. The balance will be carried forward as trading losses and may be offset against future taxable profits.

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. The cap risks disrupting that cash flow in a year fraught with uncertainty and challenges.

When is the PAYE/NIC cap being introduced?

In his 2021 Budget speech, Chancellor Rishi Sunak clarified that the commencement date for the cap is the first accounting period beginning on or after 1 April 2021.

This means if your company prepares accounts for 31 December, the first accounting period for which the cap is applied will be the year ended 31 December 2022.

What to do if you are affected?

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.

So first, review your previous claims and determine whether the cap would apply. This is most likely if you rely on employees of a different group company to work on your R&D projects, especially if those workers are based outside of the UK, or if you have low or no salaried staff, perhaps because your business is young and your directors are drawing nominal salaries.

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 SME 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. 

Although it was mooted during the consultation on this measure, it is unlikely that these businesses will be in a position to materially change their plans simply to protect the R&D tax relief funding. Effective planning may, however, mitigate the impact of the cap.

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 you are managing its risks.