Changes for R&D tax credits

Businesses considering making an R&D claim need to understand the ‘capping’ changes made by the Chancellor

When first introduced, the small and medium enterprise (SME) R&D scheme had a cap on the amount of credits that could be claimed. This was linked to the levels of PAYE/NIC paid. However, back in 2012 this cap was removed.

What is changing?

HMRC is concerned that fraudulent R&D claims were being made in situations where the SME had low levels of employment or other activity. This includes a substantial rise in ‘abusive’ claims since the PAYE cap was removed. In particular:

  • HMRC has identified and prevented a number of fraudulent claims, worth over £300m in total, involving companies that were set up to claim payable tax credit even though they undertook no R&D
  • It has also identified a number of structures where expenditure outside the UK has been re-routed through a UK entity. These entities have little or no employment or activity and are set up wholly or mainly for the purpose of accessing the payable tax credit.

To counter this, the Chancellor announced the re-introduction of the PAYE/NIC linked cap.

How does the cap work?

The government has stated its intention that genuine companies undertaking R&D should not be adversely impacted by the cap. So although the original cap was one times the PAYE/NIC paid in the period, the proposed new cap is set at three times the payments. The main points contained in the consultation:

  • to mitigate the administrative burden on smaller companies, the government is considering applying the cap only to payable tax credit claims above a certain ‘threshold’, so that the smallest claims would be unaffected
  • groups of companies will be limited to one ‘below threshold’ claim
  • there are specific rules for groups making larger claims
  • if a company’s payable tax credit is limited by the cap, it will still be able to claim a payable tax credit up to the level of the cap and carry forward any unused losses against future profits in the normal way
  • there are detailed proposals for surrendering carried forward losses
  • HMRC states that genuine companies are not the intended targets of the cap and so it will work with stakeholders to refine its application so that legitimate companies and business models will be protected as far as possible – whilst preventing the abuse that has been identified.

Examples from HMRC of how the cap will work in practice

  1. Company A is loss-making. It spends £100,000 on R&D in 2025. The R&D relief increases its loss by £130,000 (=130% x 100,000). The company surrenders losses of £230,000 for a payable tax credit of £33,350 (=14.5% x 230,000). In the same year, Company A is liable for total PAYE and NICs of £40,000.
  2. The company could therefore receive a maximum payable tax credit of £120,000 (=300% x 40,000). If there were a 'threshold' set at £10,000 (for the purpose of this example), the company would not be affected by the cap since it has enough PAYE and NIC liability to go beyond the threshold level. The company would receive its entire R&D payable tax credit claim.
  3. Company B has the same R&D spend as Company A but a lower PAYE and NICs liability of £3,000, so it doesn’t have enough PAYE and NICs liability to go above the threshold level and can receive a maximum of £10,000 payable credit. The company would need to have just under £11,117 (33,351 =300% x 11,117) of PAYE/ NIC liability to claim all its potential payable tax credit, but it can make a claim at the threshold level instead. Therefore, it would receive a payable tax credit of £10,000.
  4. This is equivalent to surrendering losses of £68,965 (14.5% x 68,965 = 10,000). The company would be able to carry the remaining £161,035 (=230,000 – 68,965) losses forward to 2026 to use against future profits.
  5. If Company B conducts less R&D in 2026, or employs more staff, it may be able to surrender some of that £161,035 in that later year to claim a payable credit of £23,350. This would be in addition to any other eligible losses in that year.

Further information

Full details of the proposals are contained within the consultation document released on 28 March 2019 entitled ‘Preventing abuse of the R&D tax relief for SMEs’. This includes details of how to respond.