Companies will see the return of a PAYE/NIC cap for SME R&D payable credit claims from April 2020, as announced in the Autumn 2018 Budget.
Research & Development Tax reliefs have been designed to encourage innovation in UK Businesses. £1.8 billion of support has been claimed for 2016-17 so far compared to the £350 million claimed in 2010, which shows that more businesses are making the most of this helpful tax relief.
Unfortunately, HMRC has seen the attempted abuse of this support, with SME companies being set up to claim cash when they have no legitimate R&D activity. £300 million of fraud has been identified and prevented by the HMRC and these new rules being set in place from April 2020 will help address similar abuses in the future.
What are the changes and what do they mean?
A qualifying, loss-making SME business will be limited to the amount of R&D they can claim in any one year. This will be capped at three times the amount of the Company’s PAYE and NICs liability for that year. It will affect mostly the 'one-man-band' or smaller businesses who are still innovating with legitimate R&D - but have low PAYE and NICs liability.
They will be able to claim a payable credit up to the cap and carry forward any unused losses to be set against future profits. HMRC state that 'close to 95% of companies claiming the payable credit will be unaffected'.
What our experts think
Ben Phillips, a director at Aspen Waite says:
"While I agree that something should be done to stop fraudulent claims, I think this is a bit of a rushed policy and could actually harm some companies that the R&D legislation was brought in to help, now favouring large business and penalising small start-ups."
The potential pitfalls of the revised R&D legislation could catch out a few clients in some situations. This is only going to affect loss-making companies, so technology start-ups will be particularly at risk. I’ve made a couple of highlights below:
Example One: The prototype heavy engineering company
For companies where the expenditure on prototype machine builds heavily outweighs the payroll in a claim, there could be reductions in the amounts reclaimed by the company. An example I have is using data from a claim recently approved by HMRC:
The expenditure profile of the claim is as follows:
|Total Allowable Expenditure||566,903|
|Enhanced @ 130%||736,974|
|£1,303,877 (230%) @ 14.5%||£189,062.16|
The maximum repayment amount that could be claimed by this company would be £189,062.16
How does the 3x PAYE Restriction affect this claim?
PAYE liability of the company was £27,000*. It is not clear yet if the employers' allowance also needs to be deducted from this total liability, so potentially this could be lowered to £24K depending on how the legislation is written.
£27,000 x 3 = £81,000 maximum cash repayment. Therefore only £558,620.68 of losses are able to be sacrificed. The remaining losses would have to be carried forward, as per normal tax losses rules.
Example Two: The new technology start-up
This is my biggest concern for the new legislation, as it could hit hardest those that really need the cash most.
For example, a University Masters graduate turns his dissertation into a business to develop his research into a commercial product. He incurs £50,000 on prototyping during his first year as a limited company. He did not take a salary as we often find for start-up companies of this type that doesn’t take any professional advice before incorporation.
Under current legislation, they could claim enhanced expenditure of £65,000, giving a total tax loss of £115,000. This could be sacrificed at 14.5% for a cash repayment of £16,675.
Under the new rules, there would be no repayment allowed, as there is no PAYE in this company.
Under current best advice circumstances, where we advise clients to take their tax threshold allowance as a salary in the accounts, the Director may have paid himself £12,000. The total PAYE paid by this company would be just the Employers NIC at (£12K – 8424) x 13.8% = £493.49. (The employers' relief of £3K does not apply to directors the salary.)
The R&D repayment on this example is limited to £1,480.47 - this is a huge reduction in cash repayments for these start-up companies that arguably need the cash most.
Where R&D is subcontracted and the employees are paid in a separate company to the one claiming, as there is no PAYE expenditure, an R&D claim will only enhance losses - and not be eligible for any repayment.
This is something that we see reasonably often where the R&D is carried out in a separate vehicle to the main trading business. Perhaps a charity has formed a limited company subsidiary to carry out the R&D but the staff have remained on the payroll in the parent company/charity. Again, there would be no PAYE liability in the subsidiary - and therefore no repayments allowed by the R&D scheme.
How can Aspen Waite help?
While these changes won't come in to effect until April 2020, and companies will be able to claim retrospectively under the current legislation, we would advise you seek proper advice going forwards if you use R&D Tax Credits as a means of tax planning.
If you think you may qualify for R&D, or would like advice on what these new rules could mean for your business, give one of our trusted Aspen Waite advisors a call. We would be happy to help.