RESEARCH FOCUSED companies will have been rubbing their hands with glee. The Patent Box consultation, covered here last week, gives a reduced corporation tax rate for profits made on patented goods. Alongside this, the government proposed reforms to research & development (R&D) tax credits – all of which seem positive to business.
The range of measures are impressive: perhaps the most prominent are a potential move to “above the line” accounting, meaning R&D departments will see how much tax benefit they are bringing in, and a proposal to allow subcontractors to claim relief for their customers’ R&D.
But there are specific policies, some announced in the Budget and confirmed in the consultation document, that spell a real incentive for small and medium size enterprises (SMEs) conducting R&D. The provision that companies must spend at least £10,000 a year on qualifying R&D to receive credits will also be removed. The headline reform was the increase of the 175% relief on R&D expenditure to be taken off taxable profits for SMEs. The government pledged to increase this to 200% from April 2011 and 225% from April 2012
But perhaps the most intriguing reform is the removal of the PAYE/NICs cap on the amount of payable credit to loss making SMEs. The logical conclusion of this is that loss making SMEs may be able to claim more than they are paying in tax – effectively, receiving more money from the government than it has paid in tax to carry out R&D. Indeed, it could be the only relief of this nature, says John Whiting, tax director at the Office of Tax Simplification. So how many businesses will be receiving this apparent free state grant? And how will the government prevent this generous relief being abused?
According to the consultation document , there are around 70 claims a year that are limited by NIC/PAYE caps, which predominantly come from the smallest companies – over 70% of claimants have turnover levels below £2m.
One of the reasons that the number of companies affected is so low could be down to the relative small payable credit they have been able to get for surrenderable losses – 14%. Any company with ambitions to turn over a profit in following years would be far better off in the long run to hold the credits over and use them against a future corporation tax bill, bringing relief of 28%, says PwC partner Diarmuid McDougall.
But, for a start-up business, this immediate payable credit could be invaluable. And, as a consequence, many companies still do take up the payable credit – in 2007/2008, the last full year for which statistics are available, around 1,100 companies claimed payable credits, compared with around 3,700 claiming deductions from corporation tax liability, according to figures from the Office of National Statistics. A further 1,000 a year claim payable credits in combination with deductions.
So why are only 70 businesses hindered by the cap? This could partly be a case of the complexity of R&D credits. As the consultation says, the majority of those 70 businesses are small. And the reason for removing the cap is not to provide free money but to simplify the tax system. R&D relief is notoriously difficult to claim, perhaps because it is such an attractive relief and HMRC are aware of the potential to abuse. This could put some companies off, or they might not have the means to use professional tax advisers.
But even this does not tally with what advisers are saying. McDougall and Cathy Corns, a partner at Mercer & Hole, expressed their surprise at the number of businesses hindered by the cap, saying they have clients on their books who will benefit under the new proposals. This seems to the case among all advisors – Richard Godmon, a partner at Menzies, said he knew of “tens” of his clients in this position. Replicated across the country, this would run into thousands, and not tens of businesses that will be benefit from this reform.
Perhaps the reason the government knows of no more than 70 businesses affected is because of the cap itself. Many start-up small businesses take money from investors, Godmon says. The owners do the research themselves, keep employee numbers down and therefore keep their PAYE/NIC costs minimal. With the cap removed, we may see many more businesses claiming payable credits.
Another reason the take-up may be even higher is because of the further proposals for an advanced assurance system, which will inform companies whether they will qualify for a relief before undertaking work, says Godmon. The removal of the cap and the simplification of the credit for businesses should see far more small companies taking up payable loans.
There is a slight caveat in all this, however. The 14% rate of payable credit on a business’s qualifying credit is soon to become 12.5% and will go down even further when the 225% relief is introduced, McDougall points out. This is because R&D relief is approved by the European Commission (EC) as state aid, which brings benefits accordingly. But EC regulations prevent member countries from giving state aid of more than 25% of a company’s spend.
At 14% payable credit of what will be a 200% SME rate, this will mean that companies would get 28% state aid – thereby against EC regulations. The 225% SME rate is subject to approval of state aid approval as a result.
But it is still an attractive proposition for SMEs. And, as with any attractive relief, it attracts fraudsters. Indeed, the only question the government asks about the removal of the cap in the consultation is what safeguards should be introduced.
However, further safeguards may not be too necessary. “Historically, R&D tax credits haven’t been the ‘happy tap’ you turn on and money flows in,” says Anita Monteith, technical manager at the ICAEW tax faculty. HM Revenue & Customs is notoriously thorough in checking R&D claims and it has set up specialist units to deal with them. Before the units were set up, there were complaints from businesses about having to answer the same enquiries year after year. In this case, it would take a very sophisticated fraudster to claim this relief.
If anything does have to be done, says ACCA head of tax Chas Roy Chowdhury, then it might be a move back to using paper filing from online filing, which is more susceptible to fraud. For a tax relief, possibly the only one of its kind, that gives a business more than it has paid in tax, this might require special measures, such as paper filing.
Whatever the responses throw up, this is a huge opportunity for start up businesses focussed on R&D and the government has been widely praised for such a move. The Treasury has costed the policy at £5m. But this estimate could rise as SMEs understand the implications and simplification makes it easier for them to take advantage. If this does indeed encourage a dynamic research-led SME sector, the government would consider this a price worth paying.
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