Developing cutting edge new technology can be an expensive business that drains cashflow, especially for seedling businesses who are likely to exhaust initial seed investment capital. A repayable tax credit is therefore a great way of preserving cashflow from surrendering losses.
For some years, small and medium-sized enterprises (SMEs) can obtain an uplift on their qualifying R&D expenditure – currently at 230% of spend. If they surrender losses arising as a result of that spend, they can surrender those and now reclaim 14.5% of that amount as a payable credit.
However, there have also unfortunately been a large number of fraudulent claims which have increased noticeably since HMRC last lifted the previous version of a PAYE cap back in 2012. Inevitably the concept of a PAYE cap has been brought back. Finance Bill 2021 is reintroducing this concept, subject to the Bill receiving Royal Assent.
The cap is only applicable for losses that are being surrendered for cash ie. as a payable tax credit and not to restrict the total quantum of R&D allowances. The remainder is still available for carry forward against future profits of the company.
How the cap works
The cap restricts the amount of payable R&D tax credit to a flat rate allowance of £20,000 + three times the "relevant expenditure on workers" (REW).
The REW comprises the total PAYE and NI deductions made by the company on all employees and not just those involved in R&D. The PAYE and NICs liability includes any connected persons to the claimant company which have either undertaken subcontracted R&D or where externally provided workers to the claimant company were used. Any amounts which are included where the company has subcontracted for any other connected company or provided externally provide workers must be excluded from this total in order to avoid potential double counting.
Company X has a total surrenderable loss arising from its R&D claim of £300,000, which will lead to a tax refund of £43,500 (14.5%).
The PAYE and NIC liability for all employees during the year amounted to £50,000. The PAYE cap does not kick in until £170,000 of claimed refund is made i.e. £20,000 plus (3×50,000). So the refund is not restricted.
Company Y has a similar set up to company X except that its key employees are also shareholders and they primarily take their remuneration by way of dividends. Total PAYE and NICs now amount to only £5000.
In this case, the refund cap will be much lower at £35,000 (£20,000 +3 times £5000). The R&D tax refund will now be limited to this lower amount. The remaining attributable losses of £58,620 (100/14.5 x £8500 not repaid) are then available to carry forward as losses against future profits.
The IP exemption
Where a company creates and / or manages its own intellectual property (IP) then it may obtain exemption from this PAYE cap.
There are two key conditions for this exemption:
1. The company creates or manages “relevant intellectual property” - defined as patents, trademarks, registered designs, copyright, design rights, performance rights or plant breeders rights. Also included are any rights that are similar in a non-UK jurisdiction. The third category is “any information or technique not protected by a right” but having industrial, commercial or other economic value. The claimant must have a right to exploit either singly or jointly to exploit the IP.
2. The company outsources to connected companies no more than 15% of its total R&D qualifying expenditure whether through subcontracting arrangements or by use of externally provided workers.
What is clear is that strong evidence will need to be kept to help reinforce any claim. However, given how wide the definition has become, it is hard to envisage any situations where the company’s own employees are used or there is use of third party contractors or workers, where the exemption won’t apply.
Managing the cap
These new rules will undoubtedly provide an additional layer of complication to the R&D calculations that will take place each year for innovative companies.
If the IP exemption is to be relied on then careful review will be required as to whether the project work undertaken by the claimant does indeed fit with the definitions of intellectual property for tax purposes. It seems that know-how and secret processes which are not made public are also eligible and so there should be numerous situations where the PAYE cap should not apply.
Claimants will need to give thought as to whether they can alter their payroll costs to fit more closely with the definition including whether owner managers should be paid through the payroll rather than by dividends and whether subcontractors of connected companies should be put on the payroll (which may be under review anyway given the new off payroll rules which have also been brought into effect at the same time).
The rules above are for SMEs only and do not affect large companies which claim research and development expenditure credit (RDEC). Large companies have their own PAYE cap which is based on the PAYE costs relating to R&D. No change has taken place recently on this.
Corporation tax rate
You may be aware that corporation tax is scheduled to increase to 25% for accounting periods beginning on or after 1 April 2023. If losses are being incurred now but profitability is expected in the near future, then a re-think may be required over the viability of an early surrender. For example, £100,000 loss surrendered now will give a tax refund of £14,500. If however those losses are instead carried forward to 2023/24, then the cash value for the same losses some three to four years later could be £25,000.
The next step
With more complication being added, taking advice becomes more critical than ever. UHY have great experience in dealing with R&D claims for both SMEs and large companies. Please contact Andrew Snowdon on firstname.lastname@example.org or check with your local adviser as to any steps you need to take to improve your claim.
For more detailed information, please grab a copy of our R&D Tax Guide here.