Month: February 2021

The rules on R & D tax relief for subcontractor costs will change from 01 April 2021. Disappointingly, the PAYE cap abolished in the 2015 Finance Act will reappear, restricting RD tax credit payments for small companies to the amount of PAYE contributions paid over to HMRC in the same accounting period. Important exemptions are also introduced and writes Maria Kitt, it is very important that companies with large subcontractor costs are aware of these.
The move comes as a response to several direct fraud cases where companies have openly abused the RD scheme by making frankly bogus payments to companies connected to the payee, nominally ‘subcontracting’ RD work. Two of these cases have made the press, but several more and several twists on this theme have not. Therefore, a blanket protection measure for the scheme was identified and after lengthy consultation with accountants and advisers, the rules have been honed to protect genuine RD companies and the exchequer alike.
From 01 April 2021, RD companies should be able to point to the creation or exploitation of intellectual property (not a defined term) as a result of their investment in RD where subcontractors payments exceed normal employee payments to prevent any ‘cap’ on the relief.
The full rules are summarised below and as ever please email if you require any assistance or advice, maria@tax-insight.co.uk

Subcontractor PAYE Cap, 01 April 2021

The detailed legislation that has now been unveiled shows that the government has taken steps to address the concerns that a number of small businesses that undertake valuable and genuine R&D activities could have been inadvertently penalised by the new legislation. The published legislation now includes a number of tests and exemptions for companies where, if satisfied, they will not be caught by the new rules.

New exemptions to the PAYE cap

The new rules will include a £20,000 claim threshold, below this amount the cap will not apply – so smaller claimants will be unaffected by the new rules. While this will come as a blow for some larger claimants, it means that the new rules are now only targeting companies that subcontract large amounts of their R&D to third parties. Large companies claiming RDEC are unaffected but continue to align RD relief with the PAYE contributions as before.

Exceptions

An R&D claim, of any size, will not be capped if the claimant company meets two tests:

• That the company’s employees are creating, preparing to create or actively managing intellectual property.
• That expenditure on work subcontracted to a related party, or externally provided workers provided by a related party, is less than 15% of the claimants overall R&D expenditure.

These new conditions are similar to requirements already present in the legislation for the UK patent box regime. However, in this instance the test is focussed on the management activities around the exploitation and development of intellectual property rather than its ownership. These rules have been designed to exempt companies with low PAYE and NIC, but which are nevertheless themselves engaged in genuine, substantial R&D.

Another helpful addition to the new rules is that a company will be able to include related party PAYE and NIC liabilities attributable to the R&D project when calculating the cap and these will be subject to the 300% multiplier.

For group companies with single source payrolls, detailed guidance will continue to operate to align the PAYE cap to the relevant RD claimant company.

Maria Kitt
February 2021

‘UK R & D tax relief cannot be granted unless there is clear evidence of a scientific or technological ‘advance’ in capability or competence. Sometimes this can be the full scale invention of a new product, process or system; sometimes it may be the slightest gradation of an improvement. Whatever the degree, the advance must be noticeable and evidence based.
HMRC’s approach is shown in the recent first tier tax tribunal case, writes Maria Kitt, in an enquiry dating back to 2012, HMRC rejected an engineering company’s claim to SME relief. What followed shows the depth of evidence required by a company to claim relief. This is a ‘helpful’ case, if disappointing for the company concerned. Further details can be read here…..

A First-tier Tribunal (FTT) judgement on the subject of an R&D claim, Hadee Engineering Co Ltd v Revenue & Customs, has recently been published that has important implications for all Research and Development (R&D) tax relief claimants but particularly companies that claim under the Small and Medium Enterprise (SME) regime.

In the judgement, the FTT agreed with HMRC in rejecting six out of seven projects that formed the basis of the company’s R&D tax claims, the seventh project was partially accepted. The key points were that the burden of proof in demonstrating activities meet the definition of a R&D project are with the taxpayer. It is not sufficient for the company to argue that they are the experts in their field of technology and HMRC should accept their assertions.

The FTT agreed that it was appropriate for HMRC to seek evidential proof to support the assertions of the ‘Competent Professional’ (taxpayer) and, therefore, retaining and cataloguing documentary evidence to support the claim is of critical importance. The FTT also focused on the qualification of the Competent Professional (the concept of the Competent Professional is central to R&D, it is the person with the right qualification, knowledge and experience in their field of science or technology who assesses what is eligible as R&D) chosen to assess the R&D Projects, they need to be experts not generalists.

HMRC also challenged whether the company met the conditions for the SME regime. Two of the three conditions challenged still remain relevant under the current rules and it is important that SMEs that perform R&D for customers consider whether the following two conditions have been met:

• First, to claim under the SME scheme the R&D expenditure must not have been subsidised directly or indirectly by any other person. This condition is not limited to grant funded innovation projects and has been more widely interpreted by HMRC to potentially include circumstances where R&D is performed in commercial situations e.g. the sale of a bespoke product; and
• Second, the R&D must not relate to activities contracted out by another party. It is clear from HMRC’s arguments that they consider that many contractual arrangements may be caught by this condition and this may exclude companies making SME claims where the R&D is to fulfill contractual obligations.
  SME companies that do not meet the above conditions may be eligible for the R&D Expenditure Credit that provides a cash benefit of circa 10.5 percent of qualifying expenditure as opposed to circa 25 percent.

The case has important lessons for all R&D tax claimants but especially SME companies claiming under the SME regime where the R&D is related to fulfilling specific customer requirements. This could include the sale of bespoke products or provision of bespoke services requiring R&D.

The case highlights the importance for companies making R&D claims to carefully consider conditions for the SME regime. It also highlights the importance of documenting the qualification criteria for R&D and the importance of making and retaining robust primary documentation supporting the basis adopted for the claim.