Tax

Changes are Coming – Research & Development (R&D) Cap Introduced

Eugene O'Neill Eugene O'Neill

HMRC has identified and prevented £300m of fraudulent SME tax credit claims, and, as a result, have announced proposed big changes to the R&D scheme for some. Companies that will be adversely affected by these proposed changes have only days to voice their concerns before the consultation period closes.

Claimants with large subcontractor costs and low PAYE or NIC costs could see claims reduced significantly. The 2018 budget announced changes, which are intended to prevent abuse of the R&D small or medium sized enterprise (SME) scheme.

The changes being introduced are as a result of HMRC identifying companies that were set-up to claim cash credits even though they had no R&D activity. Structures were also being set-up to claim tax credits despite having no employment or activity in the UK.

In order to deter abuse, the government announced a cap on the amount of payable tax credits, which can be received by a qualifying loss-making company. From April 2020, the amount of tax credits a loss-making company can receive in any year through the SME scheme will be capped at three times the company’s total PAYE and NIC (for both employers and employees).

Unfortunately, some companies with genuine R&D activity will be adversely affected by the planned cap introduction. Companies which subcontract large amounts of their R&D activity and have low PAYE and NIC costs, could see their benefit all but wiped out. 

For example, a pharmaceutical start-up may have low staff costs but high subcontractor costs as they subcontract their testing to third parties. These companies rely heavily on the cash injection provided by the SME R&D tax credits. Some of these companies may not survive, as it is not possible for them to undertake the testing activities in-house due to the capital investment required.

One way of preparing for the upcoming cap would be to consider the cash extraction position for owner-managed businesses. 

In practice, many well-established owner-managed businesses may not have refreshed the cash extraction position for its directors / shareholders.

Many shareholders for owner-managed businesses are predominately extracting cash using dividends, as this was the advice given in the past. However, the tax gap between salary and dividends has reduced. If the shareholder is involved in R&D activities, it may be more tax advantageous to extract cash using a salary, rather than dividends. This is because salary qualifies for R&D tax credits whereas dividends do not. An added advantage to increasing salary and reducing dividends for a loss-making company with qualifying R&D activity is that it will increase your PAYE and NIC, which in turn will reduce the impact of the planned cap.

The government understands that some genuine companies could be affected by these changes. It is the wish of the government to keep the impact on genuine companies to a minimum and have an ongoing consultation period, which closes this week on 24 May 2019. If you are likely to be impacted by these changes, you should raise your concern with your tax adviser or specialist R&D tax credit advisor.