With the introduction of the PAYE Cap only a few weeks away, R&D Tax Credits expert Zoi Georgakopoulou unpacks which companies are most likely to be affected by this impending legislation.
In just six weeks, HM Revenue & Customers will implement the PAYE Cap; a new policy that will reduce R&D Tax Credit payments for thousands of UK businesses.
Designed to protect the SME R&D Tax Relief scheme from abusive claims, the PAYE Cap will limit the size of payable tax credit a company can receive based largely on the cost of its payroll. The Cap will go live on 1 April, and will be set at 300% of a business’s combined PAYE and NIC liability, plus a £20,000 buffer.
To safeguard the claims of genuinely innovative businesses, HMRC has also incorporated some protections into the cap, based on the management of IP and use of outsourcing.
While these protections will undoubtedly prove useful, they also have muddied the waters a little, leaving many businesses wondering whether their R&D Tax Credit claim will be affected.
To clear things up, I’m going to run through what kinds of business are most susceptible to the PAYE Cap.
This is only guidance, of course. As with all tax legislation, there’s bound to be both middle ground and marginal calls. But hopefully, this breakdown should shed some light on this complex but important issue.
The first thing to consider is your financial position. If your company is loss-making, breaking-even, or is only just profitable, your tax credit claim may be affected by the PAYE Cap.
This is because the cap exclusively affects claims for R&D Tax Credits, which are only available to companies that surrender a financial loss.
R&D Tax Relief, which reduces the amount of corporation tax owed by profitable companies, is not subject to the cap.
When I say ‘only just profitable’, I mean that your profits are less than, or roughly equal, to your qualifying R&D spend.
If you tick this box, the R&D Tax Relief enhancement mechanism will take your company into an artificial loss, meaning you’ll qualify for a tax credit, and could be susceptible to the cap.
Let’s say your company is pre-profit, loss-making or around break even. The next thing you need to look at is outsourcing.
If you outsource most of your research and development work you have a higher chance of being affected by the PAYE Cap.
This is because the costs associated with outsourcing work – to an external agency or developer, for example – cannot be included in your PAYE Cap calculation. So while outsourcing adds to your eligible development expenditure, it could jeopardize the size of your payable R&D Tax Credit.
There are some caveats to this. If the businesses you are outsourcing to are ‘connected’ to your company – they’re subsidiaries, for example – then you are allowed to include their outsourcing fees in your PAYE Cap calculation, with a 300% multiplier.
Likewise, if a connected business furnishes you with externally provided workers (EPWs), you can apportion the workers’ fees to your PAYE/NIC liability, based on how much of their time was spent on eligible R&D.
In both cases, connected businesses must be based in the UK. If these costs are incurred in another country, even if it’s by a direct subsidiary, they cannot be included when calculating your PAYE Cap.
Managing Intellectual Property
The final factor is whether your staff were “creating, preparing to create or actively managing intellectual property”. Though this is predicated on your subcontractor and EPW expenditure to connected business being less than 15% of your spend. More on that below.
Really, the question is whether your staff were directly involved in creating IP. Were they writing code, building computer models, exploring patent management, and so on.
If your staff were actively involved, and the company keeps the rights of exploiting the generated IP, you might be able to pass one of two HMRC tests regarding intellectual property.
You can read more about the two tests in our comprehensive blog on the PAYE Cap. But essentially, if you can prove that a) your spending on subcontractors and EPWs from related businesses was less than 15% of your qualifying spend, and b) that your staff were actively involved in managing IP, then your claim will not be capped.
Proving that you meet the IP requirements is a complicated process, and I would strongly advise anyone new to this to contact an R&D Tax Credits specialist for help.
But the heart of it is this: the less work your staff performed related to your IP, the more likely your claim will be cut down by the cap.
I hope you now have a much better idea of whether your business will be subject to the PAYE Cap, and can act with confidence knowing what your government funding position will look like going forward.
If you are looking for professional help navigating the PAYE Cap, or on other matters related to R&D Tax Credits, then please get in touch! My colleagues and I would be happy to assist you.
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