The UK’s research and development (R&D) tax credits scheme has been a boon for innovation in science and technology. Nearly £2 billion is awarded to SMEs alone each year, encouraging investment in new processes, products and services.

R&D is essential to a thriving economy and any work that seeks to resolve scientific or technological uncertainty can be eligible for the scheme. The government’s intention is for spending on R&D to reach 2.4% of GDP by 2027, as a study by HMRC shows every £1 of tax that is forgone in support of innovation stimulates between £1.53 and £2.35 of additional R&D.

However, R&D tax credits have been susceptible to fraud. Nearly £300 million of fraudulent claims to the SME scheme have been detected and prevented, so the government is making changes to the system.

What is changing?

In most cases of R&D tax credit fraud, a company was set up specifically to make claims, despite undertaking no R&D. HMRC also observed cases of expenditure outside the UK being re-routed through a UK entity to gain access to the scheme.

Prior to 2012, SME claims were limited by a cap linked to pay-as-you-earn (PAYE) and National Insurance contribution (NIC) liability. The government’s October 2018 Budget announcement revealed a new limit will be introduced to tackle the problem of abusive claims. Under the new system, a loss-making company’s payable tax credit through the SME scheme will be capped at three times its PAYE and NIC liability for that year.

Will I be affected?

Most companies engaging in genuine R&D activities will not see their claims affected by the change, although it will lead to some additional administration. The cap in effect until 2012 was equal to a company’s PAYE and NIC liabilities, rather than the new version’s tripling of that figure. The intention behind the move is to deter fraudulent claims, because companies with little activity in the UK do not typically employ many people or pay a significant amount through PAYE or NICs.

Genuine companies that engage in R&D in order to overcome a well-defined technical uncertainty are unlikely to spend more than three times their PAYE and NIC liability on such activity. However, in some circumstances the cap could prove to be a problem.

Under the SME scheme, businesses can claim relief on 65% of the cost of external agency staff who are actively engaged in their R&D project. For smaller companies and start-ups, the cost of these agency workers could well exceed their own PAYE and NIC liabilities.

Do I have a say?

The government is holding a consultation on how the cap should be applied, in the hope it can keep the impact on genuine companies to a minimum. Measures it has suggested include:

• Introducing a minimum threshold, so smaller claims are unaffected;
• A limit of one ‘below threshold’ claim so companies cannot split larger claims to take advantage;
• Allowing claims to include a ‘connected’ company’s PAYE and NIC liabilities if they are subcontracted for R&D work;
• Awarding tax credits up to the level of the cap, then allowing companies to access the rest if they build up enough PAYE and NIC liability in a future year.

The consultation will run until May 24th 2019 and the new cap will be in effect for the accounting period beginning in April 2020.

How should I prepare?

R&D tax credits are a complex area. The cap the government is introducing applies to the payable tax credit, which allows loss-making SMEs to claim up to 14.5% of the R&D aspect of their losses. The result of this tax credit is an immediate cash-flow benefit, but HMRC’s steps to limit abuse of the system have created a degree of uncertainty over how claims will be administered in the future.

R&D Tax Shop are experts in assessing whether a project is eligible for the scheme and can provide advice on calculating the relevant costs for your claim. Contact us today to discuss how you can ensure your own R&D efforts qualify.