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What is the Merged R&D Scheme’s PAYE and NIC Cap?

23rd Apr 2024
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R&D tax relief training and support

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The new Merged R&D Scheme has implemented a cap on the claim based on PAYE and NIC liabilities, but why was it introduced and what claims does it apply to?

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Claiming R&D tax relief gives businesses a cash credit or reduction in corporation tax. Because of historical abuse of the scheme, HMRC viewed claims as higher risk when a significant portion of the costs of R&D were spent on foreign EPWs and subcontractors connected to the claimant company. 

That’s why the new Merged Scheme contains a cap on the claim that’s based on the company’s PAYE and NIC liabilities. Your client will only be affected by the cap if they make heavy use of externally provided workers (EPWs) and subcontractors. If they do, here’s what you need to know.

Your client will be exempt from the cap if they meet these two conditions:

  1. The company must be preparing to create, actively creating, or managing intellectual property. Companies undertaking R&D generally meet this condition.
  2. No more than 15% of total R&D expenditure can be spent on connected EPWs or connected subcontractors.

The cap will only apply to a relatively small number of companies that claim relief, but it’s important to know how it’s calculated. Our free course – An Advisor’s Essential Guide to the Merged Scheme – goes into more detail, showing how you can calculate the cap depending on the length of the claim’s accounting period. It also covers other areas that have undergone significant change, like subcontracting and overseas expenditure.

How does the cap prevent abuse of the scheme?

Rather than constituting some arbitrary measure to make things more complicated for claimants, the PAYE and NIC cap had a very deliberate reason for its introduction.

Under the old SME scheme, HMRC noticed that some foreign companies set up UK-based shell companies to claim for R&D tax relief in a way that flaunted its intended purpose. 

The foreign company would provide funds to the shell company to spend on R&D activities that were then subcontracted back to the foreign company. Then, the shell company would claim for the R&D activities and funnel the money back to the foreign company. So, all the money was kept in a closed loop with no actual funds being sent anywhere other than their own pockets.

This is obviously not how R&D tax relief was meant to function in the UK, so it makes sense that HMRC sought a solution to stamp out this behaviour. But how does a cap based on PAYE and NIC put a stop to it?

Most of the shell companies didn’t actually employ any staff, so they didn’t have any PAYE or NIC liabilities. This makes a cap based on these liabilities a neat and effective solution to limiting this type of abuse of the scheme. 

If you want to learn more about the other measures introduced to further refine R&D tax relief, read our previous article in this series: How have qualifying costs changed in the Merged R&D Scheme?