PAYE cap for R&D claims – the impact for life sciences

20 April 2022

The reintroduction of a PAYE cap for periods beginning on or after 1 April 2021 is starting to bite for companies filing their research and development (R&D) tax claims.

How will the PAYE cap reintroduction for R&D claims hit cashflow? And will it be a significant funding limitation for life sciences SMEs and start-ups?

Cashflow impact

Put simply, the PAYE cap restricts the repayable credit available to a company to £20,000, plus 300 per cent of its total PAYE and NICs liability for the period.

For companies with relatively low payroll bills (eg where founders are drawing lower salaries as the business seeks funding), but incurring high levels of R&D expenditure, this will have an immediate impact on cashflow.The PAYE cap reintroduction harks back to more punitive rules, which were scrapped in 2012, and is intended to reduce exploitation of the claims regime (its reintroduction follows a number of high-profile abuse cases). However, the blanket approach adopted will disproportionately impact small companies and start-ups, as they may rely on outsourced labour to get new science up and running before taking on in-house staff.

Significant funding limitation

Critically for the life sciences sector, the cap could be significant where:

collaborative work is undertaken; and
the company has a low UK payroll bill yet have significant costs on its connected party, subcontracted R&D activity.

Combined with the proposed upcoming restrictions on the payment for R&D conducted overseas from April 2023, these fundamental policy changes may significantly limit the funding available to SMEs in the sector.

Take the example of a UK company that subcontracts its analytical testing to a connected party, and also works with overseas contract research organisations. Historically, all of this expenditure would be allowable – but the benefits could dramatically fall away under the new and proposed changes.

What are the exceptions?

The cap will not apply where:

the intellectual property that arises from the R&D is actively managed by the company’s staff; and
the proportion of the R&D claim on related party subcontracting or externally provided workers does not exceed 15 per cent.

Additionally, to lessen some of this impact, when calculating the applicability of the cap a company will be able to include related party PAYE and NIC liabilities that are attributable to the R&D project.

How can life sciences companies prepare?

To prepare for this cap, companies must carefully consider how they structure and contract their R&D spend if they are to continue using the payable R&D tax credit under the current and proposed rules. For example, it may be worth SMEs considering whether the financial incentive of keeping the R&D in-house and investing in facilities outweighs the lower-risk model of outsourcing to subcontractors. Naturally, in this sector the reality of how contracts and research are structured will dominate the commercial arrangement and will need to be considered in the round.