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The New SME Cap – Preventing Abuse of SME R&D Tax Credits

Following a period of consultation, HMRC are planning to implement significant changes to the R&D tax regime that will impact a considerable portion of SME claimants. These proposals are in the final stages of being ratified but are scheduled to be legislated in Finance Bill 2021. These new changes will have effect for accounting periods beginning on or after 1 April 2021.

Why?

“HMRC has identified (and prevented) fraudulent attempts to claim the SME scheme payable tax credit totalling over £300 million. In these cases, companies were set up to claim the cash available through the payable tax credit even though they had no R&D activity. HMRC also identified structures set up deliberately to claim the payable tax credit despite there being little employment or activity in the UK.

Budget 2018 announced that, to deter abuse, the amount of payable tax credit that a qualifying loss-making business can receive through the relief in any one year will be capped…. “

Source – HMRC Consultation – Preventing abuse of the R&D tax relief for SMEs

The initial HMRC design of the mechanism would have had quite brutal and far-reaching impacts on SMEs, however following consultation with industry and through the RDCC, this mechanism was redesigned.

Broadly speaking, LinkStep accepts the new design and understands the need for these new controls. Given that R&D Tax Credits are very attractive (at up to 33% cash value of the R&D expenditure), it can be simply too attractive for criminals to setup artificial structures that take advantage of this type of tax system. The reality can be seen in recent cases like this. However, this change will inevitably negatively impact significant numbers of legitimate UK companies undertaking qualifying R&D, and that these companies will generally be young and emerging, operating as ‘light’ as possible, often dedicated to an initial incubation/R&D phase and in need of funding. It is imperative that the resulting claim data over the next 12-24 months is carefully monitored, and that industry is carefully consulted with to understand if this cap needs to be re-considered in the future.

How will it work?

Currently, the only restriction on the value of R&D tax credits claimable is the value of the taxable loss that can surrendered for 14.5% R&D tax credits (being the lower of the company’s actual tax loss and 230% of the identified R&D expenditure).  This restriction still applies, but the new mechanism will work by capping the 14.5% R&D tax credit claimable to be a maximum of £20,000 plus 300% of the claimant company’s PAYE and NIC liabilities during a given accounting period.

The cap is only relevant if the company is operating in a tax loss position and looking to surrender the R&D enhanced expenditure for R&D Tax Credits. This is not applicable for companies with a Corporation Tax liability (in profits) and claiming R&D Tax Relief.

The immediate impact is for SMEs with little to no employees, where the majority of workers are contractors. In this situation, PAYE and NIC liabilities will be small to zero, resulting in a reduced R&D tax credit claim.

There are some saving exceptions:
(all of these conditions must be true to have the exception applied)

  • A company must be creating or preparing to create intellectual property, or managing the intellectual property which it holds.
  • These activities must be undertaken largely by employees of the company, and the company must have the right (alone or with others) to exploit the intellectual property.
  • The total of the company’s qualifying expenditure with subcontracted activities or externally provided workers are provided by a ‘connected company’ is no more than 15% of the total qualifying expenditure.

 There is also the possibility to surrender losses to maximise the R&D tax credit to the cap, and then carry the remaining losses forwards to utilise against future taxable profits – where the actual cash benefit will be realised at a later date.

Structuring your company and R&D claims

Weighing up the options on recruiting a new member of staff or taking on a short-term contractor can be a complicated decision. A qualifying member of staff will always yield a better claim benefit but solely from the R&D Tax claim perspective. In reality, R&D Tax will not be a company’s only consideration when deciding whether it is better to hire employees or contractors, or even subcontracting out an entire piece of work.

It is important to speak to a qualified Accountant to assess the tax and accounting implications from a holistic perspective, but also ensure that an R&D Tax expert feeds into these discussions to ensure that you are not compromising future claims unnecessarily. Unfortunately, the reality is that certain claimants will have no choice – the cap will have a negative impact on their claims.

Please note; this is a significant and complicated change, and this article is only intended to be a high-level discussion of some of the key points from the legislation. You should not consider this article as complete tax advice and should fully consult with an R&D Tax Professional and Accountant to understand and model any impact to your claims and future planning.

 

– Paul Mann, Managing Director @ LinkStep R&D Tax Services.

 

Draft legislation for this new measure can be found below:

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/934319/R_D_tax_credits_for_SMEs_-_Draft_FB20_legislation.pdf

https://www.gov.uk/government/consultations/preventing-abuse-of-the-rd-tax-relief-for-smes-second-consultation

 

The government has also published a Tax information and impact note (TIIN)

https://www.gov.uk/government/publications/preventing-abuse-of-research-and-development-tax-relief-for-small-and-medium-sized-enterprises/preventing-abuse-of-research-and-development-tax-relief-for-small-and-medium-sized-enterprises