If your company is loss-making and claiming R&D tax credits as a cash refund, the PAYE and NIC cap could limit how much you receive. It is one of the more misunderstood parts of the UK R&D tax credit system, and a lot of what you will find online is out of date.
The cap changed significantly in April 2024 when HMRC replaced the old SME R&D tax relief scheme. If you are preparing a claim now, or your accounting period started on or after 1 April 2024, the rules you need to understand are those under the Merged Scheme and ERIS.
This article explains what the cap is, how to calculate it, and what the April 2024 changes mean for your claim.
What is the PAYE and NIC Cap?
The PAYE and NIC cap limits the amount of payable R&D tax credit a loss-making company can receive as a cash refund. It ties the credit directly to the company's UK payroll costs.
The cap only applies to loss-making companies that are receiving a payable cash credit. If your company is profitable and using the R&D credit to reduce its corporation tax bill rather than receive a cash refund, the cap does not apply in the same way.
HMRC introduced the cap 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 all of its R&D overseas, channel the costs through a UK entity, and claim a cash refund with little to no UK presence to show for it.
How is the cap calculated?
The formula is straightforward. The maximum payable credit your company can receive is:
£20,000 plus 300% of your company's total PAYE and NIC liabilities for the period.
PAYE and NIC liabilities means the employer's PAYE (Pay-As-You-Earn) and NIC (both employers and employees National Insurance Contributions) obligations across all employees and directors for that accounting period, not just those involved in R&D activity. You should disregard any deductions for statutory maternity/paternity/parental leave, any statutory sick pay, or child or working tax credits.
Relevant expenditure on workers will also include any subcontractors or externally provided workers (EPWs) from a connected company. You only need to include the R&D portion of an EPW cost; e.g., if only 50% of the work done by an EPW was R&D, you only need to include 50% of their PAYE/NIC costs.
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 plus 300% of liabilities for that period. The 300% multiplier itself is not pro-rated.
Worked example
Company A is loss-making. Its total PAYE and NIC liabilities for the period are £100,000.
Cap = £20,000 + (300% x £100,000) = £320,000
If Company A’s R&D credit calculates at £150,000, it is well within the cap and receives the full amount. The cap would only apply if the credit was more than £320,000.
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. Two schemes now apply depending on your company's circumstances:
- Merged Scheme. This applies to most companies. The PAYE and NIC cap applies to payable credits under this scheme. If your credit exceeds the cap, the excess is not lost outright; it may be carried forward as an expenditure credit to offset against a future tax liability.
- ERIS (Enhanced R&D Intensive Support). This applies to loss-making SMEs who spend 30% or more of their total expenditure on R&D. It carries a more generous credit rate. The PAYE cap also applies to ERIS claims, though the mechanics interact with the scheme slightly differently.
Before April 2024, the cap applied only to the old SME scheme. It now applies to all companies claiming. If your accounting period started before 1 April 2024, the old SME rules still govern that period.
Does the cap affect most companies?
In practice, no. The cap is designed to catch a specific situation, and most SMEs doing genuine UK-based R&D will be comfortably within it.
The companies most likely to be affected are those that rely heavily on overseas subcontractors or externally provided workers, keeping their UK PAYE and NIC liabilities low relative to the size of their claim.
Going forward, this is less likely to occur as eligible overseas costs have been slashed since April 2024.
One thing worth noting is the anti-double counting rule. If subcontractors or externally provided workers connected to your company are included in the R&D claim, their PAYE and NIC liabilities can only be counted once across connected entities. You cannot inflate the cap calculation by counting the same payroll obligations through multiple routes.
Is the cap different under the different schemes?
The PAYE and NIC cap applies to ERIS claims as it does to the Merged Scheme. The formula remains the same: £20,000 plus 300% of PAYE and NIC liabilities. The difference is in how it is applied when calculating your credit.
ERIS applies to loss-making SMEs spending at least 30% of their total costs on R&D. It offers a more generous credit rate than the standard Merged Scheme and is specifically designed to support highly R&D-intensive businesses.
Under the ERIS scheme, you can only claim up to the cap; any credit in excess of the cap is lost.
For those claiming under the Merged Scheme, if the tax credit amount exceeds the cap, any excess is carried forward as an expenditure credit that you can claim in the next accounting period. The cap is assessed at Step 3 of redeeming your credit.
Are there any exceptions?
HMRC does allow some companies to claim their payable tax credit even without the cap.
A company’s claim of any size will be uncapped if it meets both of the following criteria:
- its employees are creating, preparing to create or actively managing intellectual property (IP) that the company owns
- its expenditure on subcontracted work or externally provided workers provided by a related party is less than 15% of its overall R&D expenditure
Any IP work must be carried out by employees of the company (not directors, unless they are also employees). This could include preparatory work like scoping, registering a patent, litigation, or any significant management activities. Though you’ll likely use lawyers or patent experts, your team must manage those relationships.
Need Help With Your Claim?
The PAYE and NIC cap affects far fewer companies than people expect. If you have UK employees and your R&D claim is proportionate to your payroll, you are unlikely to be limited by it.
Tax Cloud handles the cap calculation automatically as part of your claim. Our team reviews every submission before it goes to HMRC, so you can be confident the figures are correct. If you have questions about how the cap applies to your situation, get in touch and we will walk you through it.
