Impact on R and D tax relief

This article was updated on 31 July 2020 to reflect confirmation that IR35 rule changes will take effect from April 2021.

From 6 April 2021 new rules for off-payroll labour are being extended into the private sector.

The off-payroll working tax regime (commonly referred to as IR35) was brought into effect in 2000. It mandated that individuals providing services through an intermediary company (usually a personal services company - PSC) would be required to operate PAYE and NI Contributions on the payments made from the contracting company (the client).

Historically, by procuring services from PSCs, private sector clients have been able to transfer employment law responsibilities, obligations and employer’s NICs to the PSCs. From April 2021, these obligations and responsibilities will now sit at the door of the client, leading to increased administration and liabilities. The public sector has been impacted by these rules since April 2017.

Many clients are taking a view that the administration to ensure compliance with the rule changes restricts the benefits of using off-payroll labour and are looking for alternative ways to engage and contract with its workforce, including bringing those PSC workers onto payroll.

Should the client decide to convert its off-payroll workers to employees, this will mean increased costs to the business due to employer NIC and pension contributions on top of salary payments. Moreover, while the PAYE burden and NIC bill of the individual worker will increase, the individuals gain employee benefits of holiday, sick pay and employer pension contributions.

However, for the client, where off-payroll workers convert to employees, the additional cost burden may be partially offset if these individuals are engaged in eligible research and development (R&D) activities.

R&D benefits available

Companies submitting R&D claims can benefit from:

• a 130 per cent enhanced deduction, in addition to the usual 100 per cent deduction for expenditure on R&D (for the SME regime); or
• a 13 per cent taxable R&D expenditure credit (RDEC) for the large company scheme.

Loss-making companies may be able to surrender losses for a payable credit, under either scheme.

For expenditure on off-payroll workers, the outlay which can be included in an R&D claim is, broadly speaking, restricted to 65 per cent of the associated eligible costs, whereas eligible employees’ and directors’ costs can include the entire relevant portion of salaries, employer’s NICs and employer pension contributions incurred by the claimant company.

As the 65 per cent restriction is not levied on employee costs, it follows that if the same activities are carried out by employees, rather than off-payroll workers. A greater R&D benefit will be available to the claimant company, through tax relief or RDEC credits, thus offsetting a portion of the salary costs to the business.

Key considerations

With these changes affecting a growing cohort of organisations, careful consideration is needed to determine whether your business will be impacted and what steps are needed to be taken to mitigate risks and exposure.

Companies may be unsure of whether they need to meet these reforms (only the smallest organisations with less than 50 employees, turnover under £10.2m per annum and balance sheet under £5.1m will not be affected by these changes, though end user services may be impacted if they are a fee payer) and care should be taken if you are approaching any of the specified small company threshold limits.

Companies should be clear on HMRC’s expectations regarding the worker assessment, such as reviewing whether the workers are a legitimately self-employed trader, or if another agency is already meeting the PAYE obligations.

For companies making R&D claims, consideration should be given as to how these changes will affect the category of costs under which any eligible R&D expenditure is claimed, or whether expenditure incurred for off-payroll workers in R&D claims has been subject to the appropriate treatment for IR35 purposes.

For more information on the key aspects of these rules and the impact, please get in touch with Ross Wilkinson.