Proposed cap on R&D tax credits may adversely affect life sciences SMEs

Life sciences expert Allistair Booth at Pinsent Masons, the law firm behind Out-Law.com, said that businesses that could be affected should respond to a government consultation on proposals to reintroduce a pay as you earn (PAYE) and national insurance contribution (NIC) cap on the amount of payable tax credit that a qualifying loss-making business can receive in any one accounting period.

"The government doesn’t want the cap to affect businesses genuinely carrying out research and development so it is important that businesses which may be affected take the time to respond to the consultation," Booth said.

"The cap will have a particular impact on life sciences SMEs, because (a) they don't often carry much head count and (b) significant elements of R&D in pre-clinical and clinical research will be outsourced," he said. "One solution may be to ask the government to carve out outsourced drug and device development expenditure."

The government announced in the Budget in October 2018 that it would be introducing a cap in order to combat fraudulent claims and prevent expenditure outside the UK being re-routed through a UK entity in order to claim the credits. HM Revenue & Customs (HMRC) says it has prevented fraudulent attempts to claim the SME payable tax credit totalling over £300 million. It says that abusive claims have risen substantially since a previous PAYE cap was removed in 2012.

The proposed cap will be set at three times the company's total PAYE and both employee and employer NICs liability for the year. It is intended that the cap will come into effect for accounting periods which commence on or after 1 April 2020. 

The government says that the proposed cap will deter abuse because fraudulent companies and those where the UK activities amount to little more than claiming the payable credit typically do not employ many people or pay PAYE and NICs.

However, the government is consulting on the cap before it is implemented as it understands that some genuine companies may have low PAYE and NICs liability relative to R&D spend and wants to keep any impact on them to a minimum.

The consultation document proposes a few measures to reduce the impact of the cap. These include applying the cap only to payable tax credit claims above a certain threshold, so that the smallest claims would be unaffected. However, to prevent abuse from groups making numerous claims at or below the threshold, the government intends to allow only one 'below threshold' payable tax credit claim per year for any given group of companies under common control.

The R&D cap would be three times a company's entire PAYE and NICs liability for the year in question. The government asks for views on a proposal to allow some of the PAYE and NICs liabilities of other group companies or connected parties in the calculation of the cap. This would bring into the calculation PAYE and NICs of workers engaged in an R&D project subcontracted by the company to its group or a connected party. It could also apply to the PAYE and NICs related to any externally provided workers used by a company.

If a company's payable tax credit is limited by the cap, it would still be able to claim a payable tax credit up to the level of the cap and carry forward any unused losses against future profits in the normal way. However, the government is also considering allowing companies affected by the cap to access the rest of their payable tax credit over the next two years if they have then built up enough PAYE and NICs liabilities.

The government particularly asks for input from companies which could still be affected by the cap, asking them to set out how many employees they have, how many staff are primarily engaged in R&D activity, the age of the company and the sector  they operates in. It also asks for any further proposal that could prevent abuse but ensure genuine companies can continue to benefit from the payable tax credit.

There are two separate R&D tax reliefs in the UK: the SME scheme and the R&D Expenditure Credit (RDEC). The RDEC offers a payable credit, while the SME scheme provides either a corporation tax deduction or a payable tax credit. The SME scheme is more generous than RDEC.

Where expenditure incurred by a SME qualifies for relief, a company can claim an extra deduction in calculating its taxable profits. That extra deduction is currently 130% of the qualifying expenditure, which means that the company obtains a total deduction of 230% (that is the original spend plus the additional deduction) of the original qualifying expenses.

The payable tax credit in the SME scheme enables loss-making companies, which could not immediately benefit from a corporation tax deduction, to claim a tax credit worth up to 14.5% of the R&D element of their losses and receive an immediate cash-flow benefit.

The consultation closes on 24 May 2019.