The PAYE Cap regarding R&D Tax Credits: Everything you need to know!

From 1st April 2021, HMRC has reintroduced the PAYE Cap to the SME R&D Tax Credits incentive, which will potentially impact many start-ups and scaleups. In this blog we will discuss how the cap could affect your R&D tax claims and who is most at risk of being affected.

HM Revenue & Customs has reintroduced a limit on the payable tax credit that companies can receive from the SME R&D Tax Relief incentive, with businesses only being able to claim payable tax credits worth up to 300% of their combined PAYE and NIC liability, plus a £20,000 buffer.

Known as the PAYE Cap, this regulation has been designed to protect the R&D Tax Credits incentive from fraudulent claims. However, this could have the knock-on effect of reducing the relief available to many legitimate start-ups and scaleups.

Below, we will answer the major questions surrounding the cap, including: Which businesses are liable to have their claims capped? Which are exempt? And why has HMRC brought this mechanism back after being removed from the incentive in 2012.

What is the PAYE Cap?

The PAYE/NIC Cap limits the size of payable tax credit companies can receive through the SME R&D Tax Relief incentive.

The cap applies to loss-making businesses, as well as firms that are taken into a loss by the R&D enhancement (130%) and then surrender this loss for a cash lump sum.

The cap is set at three times a business’s combined PAYE and National Insurance Contribution liability plus £20,000.

Unconnected subcontractor fees and salaries from most overseas workers cannot be included when calculating your liability. However, you are permitted to include a portion of the PAYE & NIC liability of a connected company that is performing R&D activities on your behalf.

An example of the PAYE Cap

Company X, a loss-making business (£300,000 losses in the period), has a qualifying spend of £250,000 and a PAYE/NIC liability of £15,000.

As Company X is loss-making, it would traditionally be able to claim up to 33.35% of its expenditure back as a payable tax credit. In this example, that credit would be worth £83,375.

However, now that the PAYE Cap has been introduced, Company X would only be able to claim 300% of its combined PAYE/NIC liability, plus the £20,000 buffer.

This means Company X’s payable tax credit would be capped at £65,000.

Potentially missing out on nearly £20,000 worth of funding could be devastating many small businesses.

Exceptions to the cap

Following the initial consultations, HMRC announced on the 12th of November 2020 that the cap will have three ‘features’ that were designed to protect legitimate businesses from losing out on this valuable funding. This means that not all small businesses will be affected by the reintroduced PAYE Cap. 

Here is a brief explanation of these features:

Feature 1: £20,000 buffer amount.

The first £20,000 of payable tax credit claims will be exempt from the PAYE cap.

Claims under £20,000 will remain uncapped, with only payable credit claims worth over £20,000 being capped according to the following calculation:

PAYE Cap = £20,000 + 300% of a company’s PAYE & NIC liability

This buffer amount will help in protecting legitimate start-ups where directors will be taking little to no remuneration, and with few employees from missing out on valuable funding.

Feature 2: Related company costs can be included.

Companies can include relevant staff costs from connected entities in their PAYE and NIC liability calculation if the costs are attributable to the development work being undertaken.

This feature will benefit small, loss-making groups of connected businesses. Where one companies employ the majority of the group’s staff.

Feature 3: The two tests

The final feature is based on two tests.

The first test looks at whether a company’s employees are “creating, preparing to create or actively managing intellectual property”.

This mirrors criteria within the Patent Box scheme, another branch of government incentive for companies undertaking R&D. 

The second test requires that costs relating to its expenditure on work subcontracted to, or externally provided workers provided by, a related party is less than 15% of its overall R&D expenditure.

If your company passes both tests, your claim will not be capped.

When does the PAYE cap come into effect?

The PAYE Cap came into effect on 1 April 2021. However, it will only impact claims for financial years that start after this date. For example, if you have a December year end, you do not need to pro-rata your upcoming claim. You would only need to apply the cap from 1 January, if your company is affected.

Why is HMRC reintroducing the PAYE Cap?

The reintroduction of the PAYE Cap is to combat the rise of abusive and/or fraudulent claims being submitted to the R&D Tax Credit incentive. Specifically, shell companies that are designed to extract government funding while contributing nothing to the UK economy. These artificial corporate structures usually do not have many employees, leaving them highly vulnerable to a payroll-based cap.

We applaud HMRC’s efforts to protect the R&D Tax Credits incentive and identifying and preventing fraudulent attempts totalling more than £300 million already.

However, the potential downside to the reintroduction of the PAYE cap is that many legitimate eligible businesses, especially those who subcontract a large amount of the development work, will miss out on a vital source of funding.

Never applied for R&D Tax Credits? You are definitely missing out.

The pandemic has affected everyone in one way or another but we feel business owners have been hit particularly hard. The government has issued several incentives which have often been confusing or pulled without much notice and there are very few people who can help business owners navigate this field. If you have survived the pandemic, amazing, keep it up!

If you would like a helping hand to replenish cash reserves or pay for some of the PPE requirements you have had to fork out four then stay tuned, you are hopefully in the right place.

This article is aimed at business owners who have never applied for R&D Tax Credits before, and want to get a little more clued up before making any decisions. This article will help you understand the qualifying criteria but if there is anything you are unsure of you can always give us a call on 0161 667 5069 or email the team at info@countingking.co.uk

Make sure you meet the basic eligibility criteria and then consider how the regulations apply to your business.

  • The downside: the rules can be tricky to understand and knowing how they apply to your industry.
  • The upsides: it’s a very generous tax relief, it’s not just for science and technology companies, and if you are lucky enough HMRC will even issue a payable credit!

So, does your company qualify for R&D Tax Credits?

Here are the basics, you must meet these minimum criteria:

  • Limited company registered in the UK that has been trading for 12 months
  • A going concern, not in liquidation or administration (or planning to close in the near future)
  • Have incurred costs related to R&D projects such as product development etc

If you are happy you can satisfy the above then we are all good to start the process!

Some helpful background tips.

We get asked a few questions pretty regularly so lets see if we can answer some of the more popular ones:

  • You can backdate an R&D Tax Credit claim up to two accounting years, claims are submitted within your 12 month financial periods.
  • The incentive primarily aims to reduce your Corporation Tax bill but in many cases you can receive a tax rebate from previous years and even receive payable credits in the form of a cheque or bank deposit from HMRC.
  • Its project dependent, not industry specific. As long as your R&D project makes a ‘scientific or technological advance’, it’ll be eligible.
  • R&D Tax Credits are worth as much as 33p for every £1.00 you spend on R&D related projects.

Great to know:

  • You can still claim tax relief even if your R&D project fails
  • You can still claim R&D Tax Credits if your company is making a loss
  • If we work on your R&D Tax Credit claim, you don’t pay us unless your claim is successful and once we have confirmed you have received the benefit from HMRC

Not all businesses claim the same R&D Tax Credits. It is important to know which part of the incentive is right for you.

SMEs apply for the R&D Tax Credit Scheme.

To claim under the SME scheme you must have fewer than 500 staff members and either less than £100m turnover or less than £86m in gross assets.

Large companies use the Research and Development Expenditure Credit Scheme (RDEC Scheme).

If your company has more than 500 staff and exceeds the cap on turnover or assets then you are designated as a large company and must use the RDEC scheme.

There are a few exceptions to the above, but these are best discussed with relevant examples.

How do I know if my R&D project eligible?

HMRC define eligible projects that “…seek an advance in science or technology through the resolution of a scientific or technological uncertainty….” The reason this is quite vague is to try and include as many industries as possible. This is great news for many companies as they can take advantage of the generous incentive on offer.

A couple of key things to note: the regulation is quite specific in ensuring companies are working towards innovation that is industry-wide. It cant simply be an improvement within your business that is readily available off the shelf or your competitors already do. Yours has to be better, different or custom!

Secondly, the project is actively trying to innovate and create / improve upon a product, process or service that’s new or makes improvements to something that already exists.

More details regarding eligibility can be found in our Knowledgebase here.

Most clients have a pre-conviebed idea of what will be eligible and forget to look at the rest of their business. This usually results in businesses under-claiming the true value and losing thousands. By using a professional and qualified R&D tax credit advisor, you can relax knowing they will look at all the angles and maximise your claim in a safe and compliant manner.

But what costs can I claim for?

The reality is quite pleasing. Many companies thing they can only claim for materials but in actual fact, the list is much bigger meaning you can claim for much more!

Labour is always a great place to start. You can claim a % of employees time spent on projects via their Salary, Employers Pension Contributions and Employers NI Contributions.

Any sub-contractors that have been involved in projects throughout the year can also be included.

Materials & Wastage can be claimed for prototypes and materials used in the construction process (if applicable).

Software Licences – Sometimes, companies require specific software they otherwise wouldn’t purchase.

Utilities, a realistic % of this can be attributed to your claim.

There are several other costs but you get the idea, it is much broader and generous than people usually anticipate.

Some costs cannot be included for the purposes of R&D tax relief, such as: marketing, advertising, market research, legal costs such as patents etc as these costs are incurred once the project has been successful which in turn means they happen after the R&D process finishes.

Why it makes sense to work with Counting King

You get qualified, experienced tax professionals with qualifications and credentials to back it up. To be clear, we’re not trying to take over all your accountancy work. We’re R&D specialists and work with your existing accountant to put together your R&D tax relief application only.

When you hire experts like ourselves it means the process is much quicker and safer than going alone or using an accountant who isn’t as familiar with the legislation.

We don’t charge any upfront fees. We are confident that every application we submit will qualify and be processed successfully that we only invoice once we have received confirmation that you have received your benefit. In short, if you don’t receive an R&D Tax Credit, you don’t pay us penny.

We have a 100% success rate.

If your business would like to receive a large tax benefit then please get in touch by calling 0161 667 5069 or emailing us on info@countingking.co.uk

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