In October 2018, as part of the Budget, the Treasury released a document titled “Preventing abuse of the R&D tax relief for SMEs”. In it they recognise the effectiveness of R&D relief in encouraging innovation and stimulating the economy. However, they also claim to have found and prevented £300 million of fraud and want to prevent it from happening in future.
One fraudulent practice that they particularly keen to stamp out is the use of “shell companies” to wrongfully obtain tax credits. In this scenario, a “shell company” is set up, often as a subsidiary of a foreign company, employing few or no staff directly and generating little or no income. It is then recharged for the cost of staff engaged in R&D activities in other group companies. The R&D claim generates a large loss for the company which is surrendered to HMRC for a payable credit at an effective rate of 33.35%. The Treasury’s view is that, in this scenario, no work was being done that would benefit the UK economy or lead to increased employment and therefore the payment is not deserved.
The Treasury’s response is to propose a cap on all payable credits from April 2020, limiting the value to three times the company’s total PAYE and NIC liability for that year. For R&D claims where the loss exceeds this limit, the remainder will be carried forward against future profits (so they are not lost).
We are currently in a consultation period but make no mistake, this will happen and it looks as though the only concession will be that the first £10,000 of any payable credit will be paid as cash.
Is it likely to affect your company if it is making an R&D claim?
In my view, the answer is “probably not”. The document suggests that 95% of companies will be unaffected by this change. I tend to agree, and here’s why:
• If your company is claiming a reduction in its tax payment, or a repayment of tax already paid, there is no restriction. Having paid tax, or being due to pay tax is suggestive of a genuine trading company, so HMRC aren’t worried about you.
• For those companies claiming payable credits, the vast majority are genuinely engaged in UK based R&D, employing UK staff to do so. In fact, those salaries are most likely the largest single driver of the loss being surrendered. So there will almost certainly be sufficient PAYE and NIC to cover the value of the claim.
• For members of UK groups where R&D staff are held on one company’s payroll but recharged to another group member (say the main trading company), it looks likely that you will be able to take account of the PAYE/NIC in the company supplying the labour.
However, some legitimate companies will be adversely affected by the new measures. For example, companies with a small number of permanent employees that, for genuine reasons, delegate the bulk of technical R&D work to subcontractors. For these companies, where the scope of R&D is wide ranging, it makes sense to engage 3rd parties as and when they are needed rather than saddle the business with unnecessary permanent staff members. Unfortunately, in this scenario the impact of the cap could be huge.
Software development projects, for example, can run up eligible costs of hundreds of thousands of pounds without even breaking a sweat. Because many companies take on these projects when an opportunity is seen, they don’t retain such (expensive) specialist staff on the payroll. Also, these specialists tend to prize the freedom that comes with being a freelancer.
So what can you do?
One possible answer may be to make use of the emerging “gig economy”. Engage your technical people on short term, possibly part-time, contracts as and when you need them. This is relatively easy for UK based experts but it may be more of a problem if your software developer is based in India or Canada.
If you feel that your company may be affected by these changes and want to discuss it further; or if you are wondering if your company should be making a claim for R&D tax relief, please contact Haines Watts.