Changes to R&D tax credits – are you affected?

Introduction

In the autumn 2018 budget, the UK government decided that payments made under the SME R&D tax credit scheme will be limited by a cap based on the amount of employment taxes paid by the claiming company. This is probably the first significant limitation that has been placed on this most generous of incentives for many years.

HMRC is currently consulting on the changes, and as part of considering WOCO’s response, we decided to take a more detailed look at the proposal and its implications. Read on to see if your business might be affected by these changes.

What is proposed?

  • Under certain conditions, SMEs can claim a payable credit as a result of carrying out qualifying R&D. For more information, see this page.
  • From April 2020 that payment will be restricted to 3x the PAYE and NI payments made on behalf of employees carrying out R&D work.
  • This was proposed as an anti-avoidance measure, to address a scenario where a small company with no employees can subcontract significant amounts of R&D to an offshore partner, claiming significant credit payments along the way, but with no benefit to the UK economy

Those with longer memories might recall that the R&D scheme had a similar restriction in place when first set up, although this was scrapped in 2012 to encourage greater uptake of the scheme! It is also the case that the RDEC scheme also has a similar cap, although this affects a far smaller number of SMEs.

We believe that in addition to the targeted scenario, a couple of other types of business will be affected:

  1. “Virtual” start-ups, who develop innovative new products whilst keeping costs to a minimum by using relevant experts as needed, but without having the overheads of permanent staff.
  2. Foreign corporations looking to tap into the huge pool of available scientific and technological expertise in the UK. Often attracted to the UK by the R&D tax credit (which is of course one of the aims of the scheme!), they may establish a small subsidiary from which they can contract with UK companies to help them with their research.

WOCO has a number of clients falling into each category, in all cases engaged in ground-breaking research in the medical and pharmaceutical fields. I don’t think the government intends to penalise either type, so practical changes following the consultation might soften the impact somewhat. All the same, if you might be affected you should consider your response now as leaving things too late and trying to re-write history never goes down well with HMRC!

Minimising the impact of the change

From a practical perspective, the answer is simply to employ some of your R&D team directly, rather than relying on external workers and subcontractors. The way the cap has been structured means you can get quite good leverage for each employee. Let’s look at a concrete example:

  • A UK biotech start-up employs a research manager (who is an expert in their field) on a salary of £50,000 per year.
  • At today’s rates, that employee will pay £7,498 in tax, £4,964 in national insurance, and the employer will be subject to a further national insurance charge of £5,709. That’s a total of £18,171.
  • The payable credit cap would therefore be set at £54,513, and would be relevant if the company was loss making, which is the usual position for a tech start-up.
  • To qualify for that full payable credit, the company will have to spend a total of £163k on R&D, including the proportion of that employee’s time spent on R&D.
  • Alternatively, assuming the R&D manager is fully engaged in research then an additional £165k could be spent on external team members or subcontractors.

In summary, 25% of the total costs need to be spent on staff to ensure a company is not adversely affected by the proposed cap. In our scenario £220k of R&D expertise and development, including a full time employee can be secured for just £165k net.

Naturally this is a hypothetical example and your own specific circumstances will need to be taken into account before you commit to anything. Feel free to give us a call on +44 7752 057553 or e-mail at info@woco.ltd.uk to chat through the options. As we work on a “no claim, no fee” basis, any up-front advice will be free of charge!