Preventing abuse of Research and Development tax relief

14 Dec 2020

As part of the draft clauses of the Finance Bill 2021, policy proposals on preventing abuse of Research and Development (R&D) tax relief for small and medium-sized enterprises (SMEs) were released on 12 November 2020.

These policy proposals draw from two consultations undertaken in Spring 2019 and 2020, both of which sought effective methods of preventing fraud and abuse by SME companies claiming the payable tax credit in respect of R&D expenditure.

The background

Loss making companies undertaking R&D or companies whose expenditure on R&D results in a profitable company returning a loss, have the ability to surrender these losses and claim a payment of 14.5% of the losses surrendered. However, HMRC states it has identified companies accessing the payable tax credit where there have been no R&D activities or structures specifically set up to claim the payable credit despite having little or no employment or R&D activity in the UK.

Restrictions were in place for employee expenditure prior to 31 March 2011, limiting the payable credit to the lesser of a percentage of the surrenderable loss or the PAYE and national insurance contributions (NICs) of the claimant company. These restrictions were abolished for expenditure after 1 April 2011.

The new legislation

On the assumption this legislation makes it to the FA 2021 and gains Royal Assent, the new legislation will be contained in s1058 of CTA 2009 and will introduce a cap of £20,000, plus three times the companies 'expenditure on relevant workers'. The term 'expenditure on relevant workers' means the company's PAYE and NICs for the period: importantly this is not limited to those engaged in the R&D work but is the companies own PAYE and NICs, plus any PAYE and NICs of connected persons undertaking subcontract R&D for or supplying workers to the company.

The new section, s1058D, will set out the only companies exempt from this cap. The exemption will be for companies where the employees create or actively manage Intellectual Property (IP) and do not spend more than 15% of qualifying R&D expenditure on subcontracting R&D to, or the provision of externally provided workers by, connected persons.

This measure is not intended to be restrictive but to ensure those companies who have low employment costs with IP arising from an R&D project gain the full tax relief for their innovation. Evidence to support their claims will be expected in the form of board minutes, business plans, license agreements for the IP or staff information (payroll, etc).

Contrast with the RDEC scheme

The Research and Development Expenditure Credit (RDEC) scheme already contains restrictions on the amount of credit which is paid, limiting the payable credit for loss making companies to the total expenditure on the PAYE and NICs of those engaged in the R&D projects for the accounting period, although there is no apportionment of the PAYE and NICs of those only partially employed in the R&D project, the full costs being eligible for inclusion. These restrictions are applied at step three of the repayable amount calculation, following the settlement of any corporation tax (CT) liabilities at step one and a restriction to account for the tax which would have been paid on the expenditure credit had the company been a profit making company at step two.

Forward planning

There are no specific record keeping requirements for the purposes of R&D tax relief: however, the usual CT requirement to keep sufficient records applies. SMEs do need to consider how they will substantiate the R&D expense to HMRC, and the key will be the payroll plus work-logs or timesheets, together with invoices from the providers of workers (for example agency workers) and the timesheets or work-logs and payroll and from connected subcontractors.

The full details of the proposals can be found here.

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