R&D Tax Credits: PAYE Limits and offsets

Innovative

Back in 2011 (that feels like a long time ago), we wrote:

… but there will be one very important development in April 2012 – the removal of the PAYE/NIC cap. This is great news from the extremely numerous tech startups who spend money but do not employ people directly (for example, if they employ contractors or pay their directors in such a way as to not incur any PAYE/NIC). From April 2012, they will be able to claim money back even without having paid any tax.

Of course, April 2012 feels a long, long way away if you’re running such a startup right now, but we can only applaud the fact that the government is putting in real changes that will make a difference to startups in the near future.

Well, April 2012 sure doesn’t feel far away now. Or rather, it feels far away in the other direction. How time passes… In fact, by the time you read this, it might be the distant future already, like 2014 or something. Say hello to the robots from me.

Anyway, I thought it was worth clarifying the topic of PAYE limits, before they become obsolete. First of all, what are they and when do they apply?

The 2012 budget change

Since April 2012, the PAYE limit doesn’t apply. What does that mean, though? It means that for accounting years ending on or after 1st April 2012, the PAYE cap is irrelevant.

So, for any subsequent financial year, you won’t need to worry about PAYE caps at all. This doesn’t, however, mean that you don’t need to worry about PAYE at all. More on this later.

Before 2012, for unprofitable companies, the PAYE cap means that you can only receive, as cash, a tax credit up to the amount of PAYE, Employee’s NI and Employer’s NI that the company contributed. This measure was originally designed to make the scheme budget-neutral, so the government could correctly claim that the scheme was not a grant, but a tax break.

For example, you might have made a tax loss of £200k back in 2010. With a qualifying expense of £100k, you would get an enhancement of £75k, bringing your loss after the claim to £275k. As per my earlier article on the topic of surrendering loss, this would mean that, at the 2010 rate, you would be able to surrender £175k of “enhanced expenditure”, at a rate of 14%, in exchange for a tax credit of £24.5k.

However, if in that year you only paid £1,000 of PAYE and NI, you would only be able to get £1,000 of tax credit back. So £1,000 / 14% = £7,142.85 would be surrendered, and £167,857.15 will be carried over to the next year. That’s how the cap applies.

But what is the cap?

There are two components to the cap, and they are often confused.

One, the more important one, is how much PAYE/NIC your company actually owed to HMRC. This should be calculated by your accountant, or whoever is in charge of your payroll. Ideally, your claim, if subject to the cap, should state this. This is the figure that you should use to calculate the cap.

The second component is what you actually paid to HMRC. In theory this should be exactly the same as what you owed, but we all know that theory and practice are only the same in theory.

The key question there is whether you are up to date on your PAYE/NI payments, and HMRC is aware of this. If that is the case, then you can ignore small discrepancies and use the “theoretical” cap.

Offsets

If, however, you “forgot” to pay your PAYE/NIC for half the year (it happens more often than we’d like), then the theoretical cap will still apply, but HMRC will deduct the owed money from the amount you claim.

So, taking the same example as before, if you were supposed to pay £50k of PAYE/NIC, and you did, you would get your £24.5k of tax credit. If you only paid £40k, and due to various issues didn’t get round to paying the last £10k, you would only get £14.5k of tax credit (and no longer owe £10k). If you missed out on £30k of money owed to HMRC, then they will offset the entire tax credit, and after your claim you will only owe them £5.5k.

In other words, if you’re not up to date on your taxes, HMRC will take advantage of your tax credit claim to fix that.

This last concept, offsets against owed tax, still applies after 2012, for the foreseeable future (and we don’t expect HMRC to change their mind about it any time soon).

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