On the 1st April 2021, HM Revenue & Customs (HMRC) reintroduced the PAYE cap to the SME R&D tax relief scheme. This is a measure to prevent the rise of fraudulent claims. The scheme provides SME businesses with tax reliefs and/or a tax credit on expenditure made on qualifying R&D activities.
Most loss-making SME businesses receive a cash credit as an incentive for the qualifying R&D work carried out each year. HMRC identified several structures where expenditures outside the UK were re-routed through a UK entity with little or no employment. The HMRC then enabled the entities to access the payable tax credit.
HMRC estimated the damage of over £300m in 2018. This raised a call to carry out a consultation in Spring 2019, with the responses published in Spring 2020. However, the government delayed the implementation of measurements to allow for further consultation on the changes.
What is the PAYE/NIC cap?
The PAYE/NIC cap aims to deter the abuse of the SME scheme limiting the payable tax credits. The cap only applies to loss-making companies or companies that become unprofitable because of the deductions achieved through the R&D enhancement.
The two main criteria for this cap defined by HMRC are:
● This cap does not apply to payable R&D tax credits claims under £20,000.
● Any claim above £20,000 has the amount payable through R&D tax credits limited to three times the total expenditure on workers, including pay as you earn (PAYE), National insurance contributions (NICs) during the claimed period, plus a grace amount of £20,000.
● Its employees are creating, preparing to create, or actively managing intellectual property (“IP”), which may include ‘know-how’ and ‘trade secrets’.
● The qualifying R&D expenditure on subcontracted R&D, or the provision of externally provided workers (EPWs) by connected persons, is below 15% of the overall R&D expenditure.
Businesses affected by this limitation could carry forward additional losses to offset the profits in the following fiscal year. If the accounting period is under 12 months, HMRC proportionately reduces the amount.
As per the legislation draft, the main organisation can add the staff costs incurred by the connected company undertaking the R&D. It can also add any generated qualifying expenditure on workers’ overall expenditure.
Many SMEs rely on the payable tax credits to fund their research, especially after COVID-19. As a result, the R&D tax relief scheme has enabled them to continue innovating. This cap could affect thousands of SMEs.
If you would like to talk about whether PAYE/NIC cap has affected your company, then feel free to contact our friendly team of R&D tax experts today.