Tax: Capping the SME R&D reliefs
HMRC are consulting on proposals for preventing abuse of the R&D tax reliefs for SMEs, and Donald Drysdale outlines the key issues involved.
R&D tax relief for SMEs
The government regards investment in research and development (R&D) as crucial to increasing productivity, and wants UK spending on R&D to reach 2.4% of GDP by 2027. R&D tax reliefs to encourage such investment are a core part of the government’s support for innovation.
A company which is a small or medium-sized enterprise (SME) and incurs revenue expenditure on R&D for an accounting period may claim an enhanced revenue deduction of an additional 130% – i.e. a total deduction of 230% of the expenditure.
To be treated as an SME for R&D purposes, a company must have fewer than 500 full-time-equivalent employees and meet at least one of the following criteria: it must have annual turnover (net of VAT) not exceeding €100m, or a balance sheet total not exceeding €86m.
If such a company has a ‘surrenderable loss’ (as defined) arising as a result of incurring revenue expenditure on R&D, it may opt to surrender that loss in return for a cash payment from HMRC (a ‘payable tax credit’) of 14.5% of the loss. The loss is then not available to carry forward. Special rules apply to allow payable tax credits on pre-trading R&D expenditure.
In certain circumstances an SME may claim ‘R&D expenditure credit’ (RDEC) under the separate R&D scheme that exists for large companies. For example, this is available to an SME on R&D subcontracted to it by a large company.
In summary, the R&D tax reliefs available to SMEs allow loss-making companies to claim tax credits with which they can receive an immediate cash-flow benefit.
Alleged abuse of R&D reliefs
Because the tax credits generate cash payments which companies receive from HMRC, they have become a target for abuse. Two types of abuse of the payable tax credits have been identified.
First, HMRC have identified and prevented a number of fraudulent claims, worth over £300m in total, involving companies that were set up to claim payable tax credit even though they undertook no R&D.
Second, HMRC have identified structures where expenditure incurred outside the UK was re-routed through UK entities which had little or no employment or activity and were set up wholly or mainly for the purpose of accessing the payable tax credits.
The scheme does recognise that some UK SMEs benefit from carrying out R&D outside the UK. However, this is different from manipulating the scheme to gain a benefit for activity which would have taken place anyway and would not otherwise have had anything to do with a UK business.
Capping R&D relief for SMEs
The Budget on 29 October 2018 announced that, to deter abuse, the amount of payable R&D tax credits that a qualifying loss-making business can receive through the relief in any one year would be capped with effect from 1 April 2020.
The cap will limit such a company’s claims to payable tax credits so that these cannot exceed three times the company’s total PAYE and NICs liability for that year.
Details of this new cap and questions relating to its design are set out succinctly in a new consultation paper published on 28 March and inviting responses by 24 May.
Another pre-existing restriction already means that HMRC need not make any payment in respect of R&D tax credits if the SME has any outstanding PAYE and NIC liabilities for the period in question.
Haven’t we been here before?
Some readers may recall that, until 2012, there was a cap on payable R&D tax credits.
For accounting periods ending before 1 April 2012, payable R&D tax credits to an SME could not exceed the company’s total PAYE and NIC liabilities for payment periods ending in the accounting period.
Another restriction excluded small claims by ensuring that, for accounting periods ending before 1 April 2012, the enhanced deduction was only available if R&D expenditure incurred was more than £10,000 in the accounting period.
Design of the new cap
The cap now proposed will be less restrictive than the provisions which applied before April 2012.
All the same, the government acknowledges that some genuine companies may have low PAYE and NICs liability relative to R&D spend and therefore could be affected unfairly by the new measure. It emphasises that they are not the intended target of the cap.
To avoid imposing unreasonable administrative burdens on small companies, the consultation asks whether there should there be a de minimis threshold – i.e. a level of claim which could still be allowed despite exceeding the three-times PAYE and NICs limit.
It suggests that, to prevent misuse of this de minimis threshold, its use within a group might be limited to only one such claim in any year. And it raises a number of questions about claims based on the aggregate PAYE and NICs of groups or connected companies.
Another possibility floated is that surrenderable losses blocked by the cap, if not otherwise used, might be eligible for carry forward as surrenderable losses which could then be exchanged for payable R&D tax credits in (say) the following two years.
In general, the government wants to find out more about the sort of SMEs likely to be adversely affected by the cap, and invites suggestions of alternative ways in which abuse of payable tax credits might be prevented.
It is unfortunate that a tax relief designed to encourage innovation should also attract those who wish to misuse it.
The R&D tax reliefs, while valuable, are already complicated enough that some SMEs entitled to claim them are reluctant to do so. The cap will make the claims process more complicated, and will inevitably result in the disallowance of some potential claims which would otherwise have been eligible.
If you have views which you’d like to share on the questions posed in the consultation, or on any other aspects of the proposals, please email the ICAS tax team.
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