Under the UK R&D Tax Credit programme, R&D costs incurred for work done around the world can qualify for R&D tax relief. This is a very generous aspect of the programme but one that was subject to abuse.

Companies outside the UK, with no real business purpose in the UK, were setting up UK companies and running foreign R&D costs through the company only to obtain the refundable/payable R&D tax credit. HMRC identified roughly £300M in fraudulent attempts.

To prevent this abuse, a draft legislation has been introduced whereby any payable R&D tax credit would be limited to 3 times the PAYE.

The problem with this cap is an unintended result to deny or substantially reduce the payable R&D tax credit for certain SMEs, particularly start-ups. In many cases, start-ups engage staff on a contract basis as opposed to employee/PAYE basis for various reasons.

Thus, you can have the situation where a start-up has one employee on a reduced salary (because the company is bootstrapping) and hiring R&D staff on a contract basis. For example, if the PAYE were £5,000, the payroll cap would be £15,000 and therefore any payable tax credit over this amount would be denied. With the average SME receiving roughly £55K in tax credits, this could result in a substantial reduction of R&D tax credit relief.
Under new draft legislation, there are now 2 exceptions allowed. First, any payable credit below £20K is not affected by the cap. However, more importantly, any SME will not be subject to the cap whose employees created the IP behind the R&D work and its expenditures on externally provided workers and work subcontracted to a related party is less than 15% of its overall R&D spend. If passed, the new legislation will apply to accounting periods on or after April 1/2021. This is great news to SMEs in the UK.

If you have any questions on the R&D tax credit programme, or how this particular legislation may affect you, please contact your usual Partner or Manager who will be happy to help.