A raid on R&D tax credits
There may be a significant tax storm on the horizon for those entrepreneurial businesses which research, develop and innovate.
Small and Medium Sized businesses (SMEs) which engage in research and development (R&D) can currently benefit from very generous tax relief, which has the potential to reduce a company’s corporation tax liability, or even entitle a company to receive a payable tax credit worth up to £33.35 for every £100 spent on qualifying R&D.
In his 2018 budget, the then Chancellor Philip Hammond announced that to help prevent abuse of R&D relief for SMEs, he would cap the amount of payable R&D tax credit that a company can receive from 1 April 2020
There has since been a consultation as to how this cap will be implemented, and we await the final legislation.
This cap has the potential to significantly damage investment in research and development in the UK, and to create serious cash-flow issues for affected companies. Our profession has provided clear consultation responses, many of which are available online, and we can only hope that those who draft the final legislation listen!
Here, we explore how this cap may work, and which companies are likely to be impacted.
What is the proposed cap?
For accounting periods beginning on or after 1 April 2020, a company’s payable R&D tax credit will be limited to their PAYE and NIC liability payable during that accounting period. Any PAYE or NIC due in that accounting period will count towards the cap – not just that relating to the company’s R&D employees.
It is possible that the PAYE and NIC liability of all companies under common control would be included in this cap – which has the potential to both mitigate the impact of the cap, and to create an administrative headache!
It is also proposed that the smallest claims will not be affected – HMRC have suggested a threshold payable tax credit of £10,000 – i.e. if a company will be claiming a payable tax credit of less than this amount, their claim will not be restricted, regardless of their PAYE and NIC liability.
It is likely that only one claim below the threshold will be permitted for companies under common control.
What sort of claims are being targeted?
The consultation documents provided by HMRC set out that there are two intended targets:
- Fraudulent claims, where no R&D has taken place.
- Expenditure outside the UK re-routed through a UK entity wholly or mainly for the purposes of accessing the payable tax credit.
Unfortunately, the proposed cap is a very blunt instrument, with the potential to have a real impact on companies investing in genuine R&D.
Which companies are likely to be affected?
Loss-making companies, with high levels of R&D expenditure, but with few employees, are most likely to be affected. In particular, we are concerned about the following types of companies:
Early-stage start-up companies
Salary costs may be minimal, as founders and early employees may not draw market rate salaries. Employees may instead receive share options, which may, for example in the case of an EMI scheme, not attract any PAYE or NIC on issue.
Companies which sub-contract much of their R&D
There are various reasons a company may subcontract much of its R&D, whether to make use of external expertise or facilities, or simply because a company is at an early stage in its life cycle. In these cases, the company’s genuine R&D spend may be high, but they may incur very little PAYE and NIC.
Companies which manufacture, where their R&D costs are substantially those of materials
When a company is developing physical products or engineering processes which require substantial materials, its genuine R&D spend may be high, but their PAYE and NIC cost may be low.
Companies “controlled” by Venture Capital Companies
These companies, operationally, do not form part of a group, but it is likely they will have to share information and co-operate, as they will be effectively considered a group for the purposes of the cap. As mentioned above, it is likely that only one threshold payable credit will be available per group, therefore companies controlled by Venture Capital Companies will not be able to count on receiving even a small claim.
Example of how the cap might work
We have set out an example below of how this cap might work: – from our experience, this situation is common.
Example – Company X
The company is an early stage biotechnology company, currently engaged in pre-clinical development. The company has three employees, its founders, who are paid below market-rate salaries of £25,000 per year. The company is loss making, even before R&D expenditure, having made no commercial sales. The company has no laboratories of its own, and therefore sub-contracts much of its R&D. Its qualifying expenditure on R&D is summarised below:
|Total qualiying expenditure||£602,000|
Under the current regime, the company can claim a payable tax credit on this expenditure of £200,767.
The company’s total expenditure on PAYE and NIC is £20,163. Under the new cap, the company’s R&D tax credit would therefore be capped at three times this value, £60,490.
As compared to the current regime, the company’s payable tax credit would therefore be £140,277 lower, as is summarised below – potentially creating significant cash flow problems.
|R&D tax credit under current regime||£200,767|
|Capped R&D tax credit||£60,490|
|Loss of payable tax credit for company||£140,277|
How we can help
Kreston Reeves has a leading team of tax advisers, including R&D specialists. If you think this cap may affect your company, please get in touch, and we can model the potential impact for you, and start work to mitigate this impact.
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