R&D tax credits for SMEs – are you affected by the cap?

If your company claims R&D tax credits for SMEs, you may remember the government proposed changes to the system in the 2018 Budget. At the time it announced that the amount of Research & Development tax credits a business could receive in one financial year would be capped.

The government wanted to introduce the change to help prevent abuse of the R&D tax credits system. HMRC had identified fraudulent claims totalling hundreds of millions of pounds. Some companies were set up to claim R&D tax credits, even though they didn’t actually undertake any research. Other firms claimed for the tax credits through a UK entity, even though its R&D expenditure wasn’t made in the country.

These changes have now come into effect.

So, what are the changes?

Changes to R&D tax credits for SMEs

These are the main changes you need to be aware of:

• SMEs can normally only claim up to £20,000, plus 300% of its total PAYE and NI contributions for the period.
• Companies that sub-contract some of the R&D work to a connected company can potentially claim 300% of the relevant PAYE and NI associated to that work (BUT see below for conditions of sub-contracting work)

The cap doesn’t affect SMEs making small claims under £20,000. However, for many businesses, these conditions could severely limit the amount of R&D tax credits they can claim.

Exemptions to the R&D tax credit cap

Thanks to the consultation carried out in 2020, the legislation also contains caveats. These are designed to ensure genuinely innovative businesses don’t lose out. If an SME meets both of these conditions, then it should be exempt from the R&D tax credit cap:

1. The company’s employees are creating, preparing to create or managing Intellectual Property (IP). These activities must largely be undertaken by the company’s own employees.  The firm must also have the right (alone or with others) to exploit the IP.
2. The company must not spend more than 15% of qualifying R&D expenditure on subcontracting the research and development, or on externally provided workers (EPWs)

When did the changes come into force?

The changes came into force for accounting periods beginning on or after April 2021.

Overall, the new legislation strikes a good balance between preventing abuse of R&D tax credits for SMEs and supporting genuinely innovative businesses. However, if you currently claim R&D tax credits or plan to do so in the near future, we strongly recommend talking to your accountant for advice. If you are THP client, please give us a call.