Two common R&D tax credit stumbling blocks for start-ups
Picture the scenario: a new technology startup. The founders invested £250,000 into the development of some new technology. The company is burning through the cash at a rate of knots and so they’re looking forward to recouping a chunk of it by claiming R&D tax credits under the ‘R&D tax credit scheme’ – something they’d heard about somewhere not long ago… In their minds, the tax credit had already been ear-marked for the next phase of work.
But two HUGE (yet surprisingly common) issues were about to put a hole through the R&D tax claim:
- Most of the costs were subcontracted to third party developers. This is fine in principle but under the R&D tax incentive rules such costs are restricted to 65% of the costs incurred (where the subcontractor is unconnected). The logic here is to eliminate the ‘profit’ element made by the subcontractor on the R&D work to get closer to an employee scenario. So here, in one swoop, almost half of the qualifying R&D costs and therefore claim had gone…!
- The company’s accounting period ended on 31 March 2012 and, for periods ending before or on this date, any R&D tax credit is capped by the PAYE / NIC suffered by the company in the period. This company had no employees (they’d subcontracted out all of the work) and had paid themselves no salary so there was £nil PAYE liability and therefore £nil repayable R&D tax credit. If the accounting period had ended just one day later, the company would have fallen within revised rules whereby the PAYE / NIC cap falls away. Ouch.
Of course, we should not lose sight of the fundamental issue of whether the company’s activities qualify for R&D tax purposes in the first place? If so, the company could still get a good result overall (a significant enhanced loss carried forward in the 31 March 2012 period end to offset against future trading profits and a potential repayable tax credit on qualifying activities and costs incurred in its next period ended 31 March 2013 and onwards) – just not perhaps as good as the founders had understood from the outset.
Fortunately, given the relaxation in the rules for accounting periods ending after 31 March 2012, the PAYE cap is no longer a problem – although it can still bite for retrospective claims (which can be made until 31 March 2014).
This is often a problem with tax incentives – there are almost always traps for the unwary…