Technical Officer Association of Tax Technicians
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R&D tax credit cap is reinstated


From April 2021 some smaller companies will have the amount of their R&D payable tax credits restricted. Emma Rawson explains how this cap may operate, and who will be affected.

16th Dec 2020
Technical Officer Association of Tax Technicians
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The idea of a cap on the payable R&D credit for SMEs is nothing new, with the previous cap being abolished back in 2012. At that time, HMRC indicated that the impact of this would be monitored, and reintroduction considered if the risk of fraud grew. 

Unfortunately, recent years have seen an increase in abuse of the SME scheme, with HMRC estimating it has detected and prevented fraudulent claims totalling over £300m. In these cases, companies are typically set up specifically to claim R&D credits, although the company has no R&D activity and or little employment or activity in the UK.

It was therefore announced in the 2018 Budget that a cap would be reintroduced, linked to the claimant company’s PAYE and NIC contributions, which would act as a proxy for UK activity.

How will the cap work?

There will be a threshold of £20,000, below which R&D tax credit claims will be allowed in full, subject to meeting the usual qualifying conditions. 

Claims for amounts in excess of £20,000 will be capped at three times the company’s total PAYE and NICs liability for that year. The NIC total includes both employer and employee contributions for all staff – not just those who work in R&D.

The draft legislation also provides for PAYE and NICs of related parties to be taken into account where these relate to contracted out R&D or externally provided workers. 


A loss-making company spends £200,000 on R&D and its total PAYE and NICs liability for the year is £5,000. Assuming it does not qualify for the exemption set out below, its payable credit will be capped at £35,000 – being the £20,000 threshold plus three times its £5,000 NIC and PAYE liability.

Exceptions to the cap

The cap was meant to be introduced from April 2020. However, there were concerns that the original proposals might affect not just fraudsters, but also legitimate businesses, so further time was given for consultation. 

We now have two important exceptions which should hopefully soften the impact of the cap.

Lower threshold

The first exemption is the £20,000 threshold – any claim below this will not be subject to the cap and the first £20,000 of any claims above it will also be allowed in full.

Management activity

The second exemption applies where:

  • the employees of the claimant company are creating, preparing to create or performing a significant amount of management activity in relation to relevant intellectual property; and
  • no more than 15% of their overall qualifying R&D expenditure is paid to a related party in respect of contracted out R&D or externally provided workers.

The second leg of this test should be relatively easy to apply, especially for those SMEs who have limited related-party R&D spend. However, the first leg may require some extra thought. 

What is IP?

In the draft legislation, the definition of intellectual property (IP) for these purposes includes patents, trademarks, registered designs and copyrights. In order to be ‘relevant’, the whole or greater part of the IP has to be created by the claimant company (ie the right to exploit the IP vests in the company, whether alone or jointly with others).

It may be relatively clear whether employees are creating or preparing to create such IP, but whether or not they are engaged in ‘management activity’ may be less obvious.

The draft legislation indicates that this means formulating plans and making decisions in relation to the development or exploitation of the IP. HMRC gives examples in the consultation response which include assessing markets, negotiating contracts and planning manufacturing. These are all things which HMRC believes that a company which is genuinely developing IP to exploit itself would be expected to carry out.

What should companies and their advisers do?

The £20,000 threshold will take affect for accounting periods beginning on or after 1 April 2021. Where a company’s accounting period straddles this date, it will effectively be treated as having two separate accounting periods – one covering the period up to 1 April 2021 (where the cap won’t apply) and one covering the period after (where the cap might apply).

If companies are carrying out R&D and likely to be loss making after 1 April 2021, then it should check what impact the cap may have on its ability to claim a payable tax credit. 

As a result of the two exemptions, many businesses could fall outside the scope of the cap. However, it will be important to ensure not only that claimants are truly ‘creating, preparing to create or managing’ qualifying IP, but also that they can evidence this should HMRC review a claim.

We don’t have any detailed guidance from HMRC as to what evidence it would expect to see. Based on earlier consultations, this might include things like board minutes, contracts and work plans.

Look ahead

Many businesses factor in the availability of R&D relief when looking at forecasts and budgets. It’s therefore worth checking the position and establishing what information will be needed before the cap makes its return in April 2021.

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