HMRC R&D SME & RDEC PAYE Cap

HMRC RDEC & ERIS PAYE Cap

There are two PAYE caps on R&D tax claims, one for each of the claim categories: the merged scheme (RDEC), and the Enhanced R&D Intensive Support scheme (ERIS). There was previously also a PAYE cap on the now-defunct SME scheme.

The PAYE caps on the two R&D schemes are the same, but the results between the two can differ, as we will explain.

Why was the R&D PAYE/NIC Cap introduced?

The R&D PAYE cap for SME and RDEC was introduced by the UK government to help protect the incentives where staff costs often comprise the largest amount of expenditure in a claim. R&D tax credits have been nefariously exploited in recent years, and the R&D tax credit cap helps prevent fraud and abuse of the research and development tax incentives.

What is the R&D PAYE/NIC Cap?

The restriction itself is, for the most part, quite straightforward: it restricts the tax credit claimable by loss-making companies based on their PAYE/NIC liabilities during the year.

• The cap applies to accounting periods which begin on or after 1st April 2021.
• With the R&D PAYE cap in place, qualifying companies can expect to receive a maximum benefit of:
• £20,000 + 3× your company’s ‘relevant expenditure on workers’.

‘Expenditure on workers’ comprises a company’s total liabilities for PAYE/NIC among its employees and directors. It also includes PAYE/NIC for any connected EPWs and subcontracted R&D (subject to proper restrictions).

For accounting periods shorter than 12 months, you need to proportionally reduce the £20,000 figure.

The cap functions as follows:

• Maximum payable credit = £20,000 + (3 × relevant PAYE/NIC liability)
• The PAYE/NIC liability of individuals from connected EPWs/subcontractors can be included at the percentage attributable to their R&D contribution (UK PAYE/NIC liabilities only)
• Companies can include related-party PAYE and NIC liabilities attributable to R&D, also multiplied by 300%

In the merged RDEC scheme, any amount in excess of the PAYE cap can be carried forward and contribute toward your next claim.

In ERIS, however, any tax relief amount in excess of the PAYE cap will be lost.

Who will the R&D PAYE/NIC cap affect?

The cap is primarily aimed at loss-making companies whose headcount is low in relation to the overall size of the claim. In particular, it affects:

• SMEs with little-to-no payroll expenditure
• Businesses seeking tax credit claims over £20,000 without sufficient payroll
• Group companies recharging labour costs among entities
• Companies subcontracting R&D to related parties
• Companies maintaining IP outside the UK

Exemptions to the RDEC & ERIS PAYE/NIC cap

To reduce the impact on genuine claimants, HMRC offers exemptions:

• Companies making small claims (less than £20,000) are not affected by the cap
• No claim will be capped if the company passes both of the following tests:
  1. Employees are developing or maintaining Intellectual Property (IP)
  2. Expenditure on subcontractors or EPWs from related parties is less than 15% of total R&D spend

Also explore our guide about enhanced R&D intensive support for loss-making SMEs.

FAQs

Is there a limit on R&D tax credit?

Yes.

• In the merged RDEC scheme, the limit is 20% of qualifying R&D expenditure (worth ~15% net of tax).
• For ERIS, the limit is 14.5% of your surrenderable loss – not subject to tax – giving an overall benefit of 27%.
• The PAYE/NIC cap limits the amount claimable to:
• £20,000 + 3× total PAYE and NIC liabilities, with exemptions in certain cases.

What is the PAYE cap exemption?

The PAYE cap exemption applies to companies that meet two criteria:

1. Employees are creating, preparing to create, or managing Intellectual Property (IP)
2. Spend at least 15% of qualifying R&D expenditure on unrelated subcontractors or external workers

This exemption helps R&D-intensive businesses claim above the cap threshold.

Is RDEC taxable income?

Yes.

The RDEC tax credit is taxable at the normal Corporation Tax rate (19%–25%), and must be shown as income when calculating pre-tax profit.

This is why it’s often called an “above-the-line” credit.

How is RDEC calculated?

RDEC is calculated at 20% of qualifying R&D expenditure.

This credit is taxable, so after Corporation Tax, the net benefit is typically ~15%.

The credit can:

• Offset a tax liability
• Be paid as cash, if no liability exists (subject to caps or limits)

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