The government has been conducting a consultation on the proposed changes from the last budget to the SME R&D tax credit scheme. The proposal is to introduce a cap on the amount companies can claim as payable credits based on their payroll tax contributions. We analysed the proposed cap a few weeks back in this article, and here we’ve decided to share our full response to the consultation itself.
20th May 2019
This document is the response from WOCO Limited to the May 2019 government consultation on R&D Tax Credits. WOCO is an R&D tax credit specialist agency established in 2013 and advising a wide range of clients on both R&D tax credits, RDEC and Patent Box.
WOCO is based at Alderley Park in Cheshire, a hub for world leading science & innovation, and work with a wide range of business types. We have extensive expertise and experience in dealing with businesses in the life sciences and pharmaceutical sectors, and represent a significant number of claimants potentially affected by the proposals under consultation.
General thoughts on the consultation
We acknowledge the risks of abuse of the scheme identified by HMRC, however we feel the proposed cap is too blunt an instrument and risks impacting large numbers of innovative companies, particularly in the life sciences and technology sectors. We estimate that approximately 25% of our clients would be adversely affected by the measures as currently proposed, despite them all being genuine innovators in their respective fields.
Section 3.5 of the consultation document suggests that abusive claims have increased substantially following the removal of the previous PAYE cap in 2012. We would dispute a direct causative effect between these statistics, given that significant efforts by both HMRC and companies such as WOCO in the intervening years have resulted in much better promotion and uptake of the schemes in general. We would be interested to see what statistics HMRC have relating to the number of abusive structures (where offshore expenditure is routed through a UK entity with no meaningful R&D in the UK) as a proportion of the total number of claims made?
Overseas investors and businesses have been attracted to invest in the UK directly as a result of the R&D tax credit schemes, which is after all one of the reasons the scheme exists at all. We feel that sending the message that such inward investment is no longer welcome is a particularly worrisome one given the current situation faced by the UK economy.
It seems that the focus of the abuse concerns relates to activities subcontracted overseas, so would it not make more sense to apply the proposed cap to this scenario? Looking at comparable foreign R&D tax credit schemes (for example Ireland, Australia or the USA), in practically all cases these schemes limit the amount of activity that can be conducted outside the home country.
A scenario where investment is made via a “virtual company” is a common approach in the life sciences & pharmaceutical sectors, where companies lack the capital to attract highly specialised R&D professionals to work for them or invest in the considerable infrastructure required to conduct R&D. In most cases the research and development activities are then subcontracted to specialist UK firms, creating significant benefits for the UK economy as a whole. This is not something we want to see targeted by the proposed measures. Requiring these companies to directly employ scientists and other competent professionals at such an early stage will significantly affect the risk profile and attitude of investors considering UK investments.
Specific consultation responses (WOCO comments in blue)
Question 1: If the cap is only applied for payable tax credit claims above a defined “threshold“, at what level would this be useful at reducing any potential administrative burdens on genuine companies?
While not our preferred solution. A threshold set at £230k of surrenderrable loss would set the cap at a level that would allow many genuine companies to claim, whilst reducing the potential attractiveness to those who seek to exploit the system in a way that does not benefit the UK economy. This level of threshold would be reached by a company spending £100k on R&D (up to £150k if subcontracted), and would set the proposed cap at £33,350.
Question 2: If a group was only able to submit one payable tax credit claim at or below a certain threshold per year, how would this fit with the way that claims are currently made? How common is it for more than one company in a group or common control entity to make a claim for the payable R&D tax credit?
So long as this measure does not stop multiple companies within a group claiming payable credits based on their own PAYE liabilities then we support this. It is not common for multiple companies within a group to claim payable credits, but it can happen, for example as a result of an acquisition or merger.
Where a “virtual company” is split into a group to claim multiple sub-threshold payments we agree this would likely be an abusive scenario and so should be excluded.
Question 3: If an element of the PAYE and NICs liabilities of another group or connected company were included as a part of the cap (where R&D has been subcontracted to it or EPWs provided by it), to what extent would this benefit companies? How much additional complexity would this add to claiming the payable tax credit?
This form of allowance would be necessary to allow the cap to function in a comparable manner to the equivalent RDEC cap, and within a group of companies would not add significantly to the complexity of making a claim. One exception is where the companies within a group have different financial year ends, which could make calculating the cap more difficult.
Question 4: Would it be practical for claimant companies to obtain the PAYE and NICs information from other group or connected companies? Are there any limitations to their doing so? Would the other company be willing to provide this information?
As above, within a group this is usually simple enough, and groups of companies generally try to operate with the same financial year end.
Where separate companies are acting as subcontractors or EPW providers, they are often reluctant to elect to become connected companies and disclose commercially sensitive information regarding worker remuneration. As a result, we believe this allowance, whilst necessary, will have a limited impact.
Question 5: How beneficial would surrendering carried forward losses, to claim a future payable tax credit when sufficient PAYE and NICs liability has been generated, be to a company affected by the cap? Would a time limit of 2 years be appropriate? How straightforward would it be to keep track of the origin year of the losses?
With the scheme set to take effect as proposed, this would be a welcome benefit, especially to accommodate growing start-up businesses.
It does, however, seem to defeat the purpose of payable credits which provide a much needed boost to cashflow for young and growing businesses. If a company is genuine and entitled to a payable credit it should be able to claim it immediately, as now. On the other hand, a company that appears to be attempting to abuse the scheme in the way that the PAYE cap is aimed at addressing, it should not be eligible for that payment at any time!
We believe that 2 years is insufficient given the time start-up companies can take to progress – we would propose 5 years as more appropriate.
The documentation required for a payable credit claim is already sufficiently detailed that we don’t feel that it will be too difficult to additionally keep track of the prior year losses.
Question 6: Would carrying forward losses make companies consider taking on more staff in the future – to unlock some (or all) of the rest of their payable tax credit?
From talking to our clients we don’t believe the benefit would be significant enough alone to do this. Nevertheless it is often a natural progression for companies to take on former EPWs and subcontractors as permanent employees, although in that case and assuming R&D continues, the additional PAYE and NI contributions would be needed to enable payable credits for the future years before they could be used for unlocking prior year payable tax credits.
Question 7: The government is interested in the characteristics of companies that could be affected by the cap. For example, if you are or represent a company likely to be affected by the cap, how large is the company in terms of employees? How many staff are primarily engaged in R&D activity? How old is the company? What sector does it operate in?
A number of our clients would be affected by the cap. The anonymous descriptions below represent just two such clients, both start-ups, although we can provide other similar examples on request.
Company A: Foreign owned drug development company
This company is a wholly owned subsidiary of a small US corporation attempting to develop and commercialise new pharmaceutical and medical treatments. They were attracted to the UK because of research in their field being conducted at UK universities, the highly sophisticated contract research organisations (CROs) present in this country, and also because of the generous R&D tax credit incentives available.
- Significant amounts (£millions) are being invested in developing and progressing treatments to clinical trials. This programme is currently under way.
- The company has no direct employees, and key scientific and technical leadership is provided by senior, highly qualified scientists engaged as EPWs, either via contracts with universities or their personal service companies.
- Research and clinical trials services are subcontracted to UK based CROs and universities. A minority of expenditure (around 20%) is associated with specialists and academic institutions based in Canada, USA and India.
- By our estimate the company supports full and part time work for 15-20 UK based individuals, with more anticipated if the company progresses to full clinical trials.
- As an investor-funded start-up, the US parent corporation is also loss making, so the losses incurred in the UK (against which payable credits are claimed) are not artificial.
Company B: Novel materials science and associated technology company
This company is UK based, and has received significant funding from both private investors and via large InnovateUK grants. Their technology is at an early stage of development yet has the potential to become a major new technology with applications across most areas of modern life.
- The company employs directly around 3-5 employees, although not all are directly involved in research and development.
- Leadership and scientific direction is provided by the employees, although salaries (and the corresponding PAYE contributions) are relatively low due to the focus on using resources to develop the technology itself.
- Research and prototype development has been subcontracted to UK based specialist organisations, with spending well in excess of £2m to date.
- Claims have been made under both the SME R&D tax credit scheme and the RDEC scheme (for the projects that received grant funding).
- The RDEC claims were significantly curtailed as a result of the PAYE cap that exists in that scheme, and the potential future value of those carried forward losses are relatively insignificant in comparison to the total accumulated losses to date.
- Significant claims have been made for payable credits under the SME scheme, and these allowed the company to maintain employment and get more value from the investment available. A PAYE cap here would have the same negative impact that the RDEC cap already does.
Question 8: What else could the government consider, regarding how the cap is applied to preventing abuse, to ensure genuine companies can continue access the payable tax credit? Are there any alternative measures that could prevent abuse of the payable tax credit?
As we said in our opening remarks, the most obvious suggestion is to apply the cap only in circumstances where offshore subcontracting or external workers are involved. This would allow the measure to more accurately target the identified abuse it is aimed at addressing.
From a practical perspective, this can be implemented by applying the cap only in cases where more than (say) 30% of qualifying expenditure relates to R&D activities conducted outside the UK. This is similar to restrictions present in other European R&D tax credit schemes, whilst allowing the UK scheme to remain one of the most attractive and competitive around the world.
To contact us regarding our response, please call William O’Brien on 07752 057553 or e-mail firstname.lastname@example.org.
20th May 2019