The PAYE/NIC Cap for R&D Tax Credits

R&D tax credits are a valuable incentive for many UK companies, but they aren’t without complications. The largest portion of costs that companies claim is usually staff costs, but there are limits to be aware of.

The PAYE and NIC cap limits how much payable R&D tax credit a loss-making company can receive as a cash refund.

The cap changed materially in April 2024 when the old SME R&D tax relief scheme was replaced. If your accounting period started on or after 1 April 2024, the rules you need are those under the Merged Scheme and ERIS.

What is the PAYE and NIC cap?

The cap ties the amount of payable R&D tax credit directly to a company's UK payroll costs. HMRC introduced it to ensure that cash payments flow to companies genuinely contributing to the UK economy through employment. Before the cap, it was possible for a company to conduct R&D overseas, channel costs through a UK entity, and claim a cash refund with little meaningful UK presence.

For accounting periods beginning on or after 1 April 2024, overseas costs (staff, subcontractors and EPWs) are largely no longer eligible, so the chance of a claiming for excessive overseas subcontracting and accessing the UK tax benefit on this is significantly reduced, but the cap still exists.

The cap only applies to loss-making companies claiming a payable cash credit. If your company is profitable and using the R&D expenditure credit to reduce its corporation tax liability, the cap doesn't apply.

How is the cap calculated?

The formula is:

£20,000 plus 300% of your company's total PAYE and NIC liabilities for the accounting period.

PAYE and NIC liabilities means the employer's PAYE and National Insurance Contributions (both employer's and employee's NIC) across all staff and directors for the period, not just those involved in R&D. You should disregard deductions for statutory maternity, paternity or parental leave, statutory sick pay, and child or working tax credits.

Where you've used subcontractors or externally provided workers (EPWs) from a connected company, you can include their R&D-attributable PAYE and NIC in the calculation. Only include the R&D portion: if a connected EPW split their time 50/50 between R&D and other work, you include 50% of their PAYE/NIC costs.

One anti-abuse rule applies: you can't count the same payroll obligations through multiple connected entities. If PAYE/NIC liabilities from a connected party are already included in another entity's cap calculation, they can't be included again.

Short accounting periods

If your accounting period is less than 12 months, the £20,000 buffer is pro-rated. A six-month period gives a buffer of £10,000. The 300% multiplier is not pro-rated.

Worked example

Company A is loss-making. Its total PAYE and NIC liabilities for the year are £100,000.

Cap = £20,000 + (300% x £100,000) = £320,000

If Company A's R&D credit calculates at £180,000, it's well within the cap and receives the full amount. The cap would only restrict the claim if the credit exceeded £320,000, which could happen with significant subcontracted costs.

What changed in April 2024?

For accounting periods starting on or after 1 April 2024, the old SME R&D tax relief scheme was replaced by two new schemes: the Merged Scheme and the ERIS Scheme. The PAYE and NIC cap applies under both.

Under the Merged Scheme (which applies to most companies), if your payable credit exceeds the cap, the excess isn't lost. It's carried forward as an expenditure credit that can be offset against a future corporation tax liability.

Under ERIS (Enhanced R&D Intensive Support), which applies to loss-making SMEs spending at least 30% of their total expenditure on R&D, the formula is the same, but the consequence is different. Any excess beyond the cap is not carried forward. It's lost for that period.

If your accounting period started before 1 April 2024, the old rules still govern that claim.

Does the cap affect most companies?

In practice, no. The cap is designed to catch a specific situation, and most companies doing genuine UK-based R&D will be comfortably within it.

The companies most likely to be affected are those relying heavily on overseas subcontractors or EPWs, keeping their UK PAYE and NIC liabilities low relative to the size of their claim. This scenario is also less likely to arise going forward, since eligible overseas R&D costs were significantly restricted for accounting periods beginning on or after 1 April 2024.

Are there any exceptions?

Yes. A company's payable credit is uncapped if it meets both of the following conditions:

• Its employees are creating, preparing to create, or actively managing intellectual property (IP) that the company owns
• Its expenditure on subcontracted work or EPWs from a connected party is less than 15% of its total R&D expenditure

The IP work must be carried out by employees of the company. Directors who are also employees can qualify; directors who are not employees cannot. The activity can include preparatory or management work, such as scoping a patent application, managing litigation, or overseeing relationships with external IP specialists.

If both conditions are met, the £20,000 plus 300% formula doesn't apply, and the full payable credit is available.

Key takeaways

• The cap applies to loss-making companies claiming a payable cash credit only. Profitable companies using the credit to offset corporation tax are not affected in the same way.
• The formula: £20,000 plus 300% of total PAYE and NIC liabilities. This uses all-staff PAYE/NIC for the period, not just R&D employees.
• Under the Merged Scheme, any excess above the cap is carried forward. Under ERIS, it isn't.
• Most genuine UK R&D businesses won't hit the cap. It targets entities with minimal UK payroll relative to their claim.
• An IP exception can remove the cap entirely. If your employees are creating or managing IP and connected-party subcontracting is below 15% of R&D spend, your claim is uncapped.

If you're uncertain whether the cap affects your claim, or want to check whether your company qualifies for the IP exception, don't leave it to chance. Contact Myriad to discuss your specific situation.