Within the Research and Development (R&D) world, there are multiple requirements and restrictions. Remembering them all can be tricky! So, here’s the latest information you need on Pay As You Earn (PAYE).
What’s the cap for the R&D SME scheme?
From 1 April 2021, HMRC introduced the Pay As You Earn (PAYE) and National Insurance Contributions (NIC) cap for R&D tax credits. Under the PAYE system, employers deduct income tax and National Insurance contributions from employees’ pay before they receive it. However, if an employee is directly or indirectly involved in R&D activities, their salary costs can qualify for R&D tax relief.
What are the restrictions on R&D tax relief under PAYE?
There are restrictions on the amount of R&D tax relief that can be claimed under PAYE. The cap is currently set at £20,000, plus 300% of the employee’s total PAYE and NIC liability for the relevant period. A company should calculate its own PAYE cap regardless of whether it’s in a group. In addition to a company’s own PAYE and NIC liabilities, if a company contracts out R&D activities to a connected company, it may include any PAYE and NIC staffing costs incurred by the connected company in performing the R&D activities. However, this is restricted to the time spent on qualifying activities.
Are there any exemptions from the cap?
There is an exemption from the cap if:
- your employees are creating, preparing to create, or managing Intellectual Property (IP), and
- your business does not spend more than 15% of your qualifying R&D expenditure on subcontracting R&D to, or the provision of Externally Provided Workers (EPWs) by, connected persons.
These restrictions are designed to prevent abuse of the R&D tax relief system and to ensure that the relief is targeted at genuine R&D activities.
What’s the cap for the R&D RDEC scheme?
For those that fall under the RDEC scheme, the restriction is slightly different and worth noting. The restriction depends on the total expenditure on R&D workers’ PAYE and NIC, which consist of PAYE and NIC liabilities in respect of:
- the employees of the company who are engaged on R&D activity, and
- any EPWs who are provided to the company by another connected group company for the purposes of qualifying R&D of the claimant.
In calculating the company’s own staffing costs, no restriction is made to the part of the company’s PAYE and NIC liabilities for the accounting period, where staff are engaged only partly on qualifying R&D activities.
So, if a staff member appears in the R&D claim relating to qualifying direct or indirect activity, then their full PAYE and NIC are included with no restriction — to omit the part that relates to non-qualifying R&D activity.
The EPWs figure is identified by calculating the appropriate percentage of expenditure on staff costs incurred by the relevant group company in providing the workers to the claimant company. This then forms part of the company’s PAYE and NIC liabilities for the accounting period. Staffing costs include those relating to any qualifying indirect activities included in the R&D claim.
Here’s an example so you can understand the formula:
- Employee: An individual employee’s PAYE and NIC amounts to £10k but they spend only 50% of their time on qualifying R&D activity. £10k is included in calculating the cap, with no restriction for non-qualifying activity.
- Externally Provided Worker (EPW): An EPW’s PAYE and NIC amounts to £10k. They spend 50% of their time on qualifying activity so the ‘appropriate percentage’ is 50%. The amount to be included in the cap is £5k.
Are there any restrictions on overseas expenditure and PAYE?
This may be further impacted by the up-and-coming overseas expenditure restrictions that will come into play for accounting periods beginning on or after 1 April 2024.
For both the SME and RDEC schemes, to incur qualifying expenditure, expenditure on payments to subcontractors is required to be UK expenditure or qualifying overseas expenditure.
For EPWs, for the expenditure to be qualifying, they must be subject to UK PAYE and NICs, unless it is qualifying overseas expenditure.
Overseas expenditure can still qualify where there are regulatory or other legal requirements where activities must take place outside of the UK — for example, clinical trials.
What to look out for
If you are under the SME or RDEC scheme, become familiar with the cap and restrictions above.
For companies that employ overseas subcontractors and/or EPWs, the PAYE restriction will decrease the potential R&D claim significantly, unless it falls under the qualifying overseas expenditure.
Additional information will also be required from 1 August 2023, to include both the employer PAYE reference number and the PAYE scheme reference number for qualifying EWPs.
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Author – Alenka Jessop