On the 12 November 2020, the government published draft legislation to implement a Research & Development (R&D) tax credit PAYE cap for small and medium enterprises (SMEs). Companies receiving repayable R&D tax credits under the SME scheme might be affected by these new rules. The legislation will take effect from 1 April 2021 and accounting periods straddling 1 April must be treated as two separate periods with the cap applying to second period (ie from 1 April 2021 onwards).
Background to the changes
The original consultation on this issue “Preventing abuse of the R&D tax relief for SMEs” was published in 2018 and the government’s proposed solution, capping the repayable R&D credit at a multiple of the PAYE paid by the SME claimant had been scheduled to come into effect on 1 April 2020. However, this was delayed due to concerns over the impact it would have on genuine R&D claims by small companies: many respondents (including BDO) pointed out that genuine start up R&D businesses, particularly in the technology and sciences sectors would be disproportionately affected. The uncertainty caused by the COVID-19 pandemic was also a clear reason to delay.
The detailed legislation that has now been unveiled shows that the government has taken steps to address the concerns that a number of small businesses that undertake valuable and genuine R&D activities could have been inadvertently penalised by the new legislation. The published legislation now includes a number of tests and exemptions for companies where, if satisfied, they will not be caught by the new rules.
New exemptions to the PAYE cap
The new rules will include a £20,000 claim threshold, below this amount the cap will not apply – so smaller claimants will be unaffected by the new rules. While this will come as a blow for some larger claimants, it means that the new rules are now only targeting companies that subcontract large amounts of their R&D to third parties.
Even where a large amount of R&D work is subcontracted out, the government have now also included new features to minimise the impact on companies undertaking genuine R&D. An R&D claim, of any size, will not be capped if the claimant company meets two tests:
- That the company’s employees are creating, preparing to create or actively managing intellectual property
- That expenditure on work subcontracted to a related party, or externally provided workers provided by a related party, is less than 15% of the claimants overall R&D expenditure.
These new conditions are similar to requirements already present in the legislation for the UK patent box regime. However, in this instance the test is focussed on the management activities around the exploitation and development of intellectual property rather than its ownership. These rules have been designed to exempt companies with low PAYE and NIC, but which are nevertheless themselves engaged in genuine, substantial R&D.
Another helpful addition to the new rules is that a company will be able to include related party PAYE and NIC liabilities attributable to the R&D project when calculating the cap and these will be subject to the 300% multiplier.
We welcome these sensible additions to the draft legislation to ensure that genuine R&D activities in small companies is still rewarded via the SME scheme. However, we recommend all SME companies that benefit from a payable credit from their R&D claims examine the impact that these new rules may have on their future claims. Where the new rules are anticipated to affect projected cashflows, it may be appropriate to adapt the manner in which R&D activities are conducted to ensure your business model remains viable.
For help and advice on structuring your R&D projects and managing your R&D claims, please get in touch with your usual BDO contact or Ross Northall.
BDO have developed a proprietary R&D AI Toolkit that provides a benchmarking number along with a “Priority” rating for claim risks and opportunities as well as allowing you to estimate your potential R&D claim value.
The R&D AI Toolkit can be used to:
- Benchmark R&D claims against companies of a similar size and the industry sector average
- Receive suggested Priority Ratings for risks and opportunities
- Reduce the risk of errors and penalties for incorrect R&D claims
- Gain clarity and assurance when you calculate your R&D claim
BDO’s R&D AI toolkit is available for purchase on BDO Store. Download now for a hassle-free R&D claims experience