The UK government finally re-introduced a PAYE cap for R&D tax credit claims this month following the March Budget.\r\nIt had been slated for introduction in 2020 but was postponed. Now that it is finally here, we\u2019ll look at who the winners and losers are, with a working example to show what accountants and tax advisers will have to do differently.\r\n\r\nA short history\r\nThere had been a PAYE cap in place before. This prevented firms from claiming payable credits worth more than the total amount they paid in tax and NICs deductions. This was scrapped in 2012 after complaints that it disproportionately hurt smaller, younger companies.\r\nUnfortunately over the ensuing years, abuse of the rules grew. HMRC investigators discovered numerous examples of claimants gaming the system and identified fraudulent claims worth around \u00a3300m. The decision was taken that a PAYE cap needed to be reinstated.\r\nThat\u2019s what happened earlier this month, however, it doesn\u2019t affect everyone. Only claims made under the SME R&D tax relief scheme will be affected, where losses are surrendered for cash. In this situation, the company receives a payable tax credit and this is where a lot of the abuse was occurring. Claims made by profitable firms or those made under the RDEC scheme for larger companies are unaffected by the changes.\r\n\r\nSo what has changed?\r\nAs of 1 April, SMEs that are loss-making will have their claims limited to \u00a320,000 plus three times the relevant expenditure on workers. When performing the calculations, accountants and tax advisers will calculate the surrenderable loss as usual and the credit remains the same at 14.5%.\r\nThe term \u2018relevant expenditure\u2019 applies to all staff \u2014 not just those engaged in R&D \u2014 and equates to the total amount the company pays in NICs and tax deducted through PAYE. To avoid double claiming, if the firm\u2019s employees have done any R&D work as Externally Provided Workers or Subcontractors for connected companies, then those costs are deducted.\r\nSimilarly, if any staff at connected companies have been engaged in R&D activity in a similar way for the claimant company then the relevant PAYE and NIC costs are included in the claimant\u2019s cap calculation. A rule concerning accounting periods that straddled the 1 April start date for the cap was shelved late on and this will make things much simpler for tax professionals. The new rule now only applies to accounting periods beginning on or after 1 April 2021.\r\n\r\nExemption\r\nThere is a single exemption to the cap, however, and firms have to satisfy two criteria for it to apply.\r\nFirst, the company needs to be creating or managing Intellectual Property (IP) such as patents, design rights, registered trademarks, copyright, performers\u2019 rights, plant breeders\u2019 rights, know-how or trade secrets.\r\nSecond, no more than 15% of the qualifying costs should be made up of connected party subcontractors or Externally Provided Workers.\r\nIf you want to rely on this exemption, you\u2019ll have to provide ample evidence and that will mean accurately recording all correspondence and meetings with IP lawyers and patent offices. It is not yet clear whether HMRC will interrogate all uses of the exemption, or police it with occasional checks.\r\n\r\nWho will be affected most?\r\nOnly a minority of companies will see a big impact from the introduction of the PAYE cap, because most will either be profitable or have a relatively small claim compared with the substantial cost of their PAYE and NIC tax deductions.\r\nThose companies hit hardest will likely be young companies that are making a loss and\/or have low payroll costs. The construction sector is particularly vulnerable because a large proportion of qualifying costs are often taken up by subcontractor expenditure.\r\nHowever, even where the cap limits an R&D tax credit claim, the enhanced loss can still be carried forward so the lost benefit doesn\u2019t evaporate completely. It just won\u2019t result in a cash benefit to the company and, of course, losses can now be temporarily carried back three years as announced in the March budget.\r\nByline by Nigel Holmes, head of R&D Technical Operations at specialist tax consultancy Catax.