The HMRC R&D PAYE cap

There are two PAYE caps on R&D tax claims, one for each of the claim categories: the large-company scheme (RDEC), and the more recent SME PAYE cap. This remains the case in Winter 2023, but things are set to change.

Changes to the R&D incentives are coming soon: the two categories (SME and RDEC) are set to merge, being integrated into a single monolithic scheme in April 2024. For now though, the PAYE caps still apply (though there are some exemptions). The RDEC cap has been around since the large-company scheme was established, but the SME cap is relatively new.

Why was the PAYE/NIC Cap introduced?

The SME R&D PAYE cap was introduced by the UK government to help protect the incentives where staff costs often comprise the largest amount of expenditure in a claim. R&D tax credits have been nefariously exploited in recent years, and the PAYE cap helps prevent fraud and abuse of the research and development tax incentives.

What is the PAYE & NIC Cap for SMEs?

The restriction itself is, for the most part, quite straightforward: it restricts the tax credit claimable by loss-making companies based on their PAYE/NIC liabilities during the year.

The cap applies to accounting periods which begin on or after 1^st April 2021.

With the PAYE cap in place, qualifying loss-making SMEs can expect to receive a maximum benefit of: £20,000 plus three times the company’s ‘relevant expenditure on workers’. The ‘expenditure on workers’ comprises a company’s total liabilities for PAYE/NIC among its employees and directors; it also includes PAYE/NIC for any connected EPWs and subcontracted R&D (subject to the proper restrictions).

The cap functions as follows:

The maximum payable credit is £20,000 plus 3x the relevant PAYE/NIC liability (i.e. ‘relevant expenditure on workers’).

The PAYE/NIC liability of individuals from connected EPWs/subcontractors can be included at the percentage attributable to their R&D contribution (this includes UK PAYE/NIC liabilities only). A company will be able to include related-party PAYE and NIC liabilities attributable to the R&D projects when calculating the cap, also multiplied by 300%.

The credit itself can be used against other corporation tax liabilities; in such cases it would not lead to a restriction.

Who will the PAYE/NIC cap affect?

The cap is primarily aimed at loss-making companies whose headcount is low in relation to the overall size of the claim. In particular it will affect those claims based on EPWs and subcontractors, and group companies where the majority of the R&D activity takes place overseas. Most notably, the cap will affect:

• SMEs with little-to-no payroll expenditure
• Businesses seeking to make a claim of an R&D tax credit over £20,000
• Businesses who split and recharge their labour costs among group entities
• Businesses who subcontract their R&D to related parties
• Businesses maintaining IP outside of the UK

Exemptions to the cap

In order to reduce the impact of the cap on the eligible UK businesses making good-faith claims and claiming correctly, a number of consultations on the mechanics of the cap have taken place. One notable outcome is that a company making a small R&D claim for a payable credit of less than £20,000 will not be affected by the cap.

Furthermore, no claim – of any size – will be capped if it passes two tests related to its staff expenditure and Intellectual Property (which includes ‘know-how’ and ‘trade secrets’). The cap will not apply to a company whose employees are developing or maintaining intellectual property; and whose expenditure on subcontractors or EPWs from a related party is less than 15% of its overall R&D spend.