The R&D landscape has been full of change in recent years and one of the key changes is now coming into practice, with the change in overseas expenditure – specifically a restriction on Subcontractors and Externally Provided Workers (EPWs) expenditure.
For accounting periods beginning on or after 1 April 2024 new R&D restrictions apply and can have a significant impact on the eligible expenditure of R&D claims that utilise overseas subcontractors and/or workers.
Before 1st April 2024, companies could claim overseas costs with 65% restrictions being applied if not connected. However, if the companies were connected, they could claim all of their R&D expenses. This made it easy for companies working on new projects in the UK to get tax relief. Now, new rules limit which overseas costs can be claimed, and some companies are changing their structure to get the most benefit from UK R&D tax relief.
With the new rules, payments to foreign subcontractors and EPWs cannot get R&D tax relief unless there is an exception. This aims to focus R&D efforts in the UK, which the government supports to make the UK a leader in innovation. However, this rule might lead companies to move their R&D work to other countries or face fewer benefits if they don’t qualify for the exceptions.
The exemptions themselves are very broad and situational, however HMRC have published many examples that can be used to help understand if these have been met.
What is the general rule?
Money spent on EPWs (employees) whose earnings are not fully or partly taxed by UK PAYE and payments for R&D done outside the UK do not count as qualifying expenses under both enhanced R&D intensive support (ERIS) and new R&D expenditure credit (RDEC), unless there is an exception.
What are the exemptions?
Exemptions apply in circumstances where there are conditions necessary for the purposes of the R&D being undertaken. This could be that overseas subcontractors and EPWs:
- Are not present in the UK or
- Are present in the location where the R&D is undertaken and that it would be entirely unreasonable for the company to replicate it in the UK.
“Conditions” includes in particular:
- Geographical, environmental or social conditions
- Legal or regulatory requirements as a result of which the research and development may not be undertaken in the UK.
This list is not exhaustive.
However, conditions are disregarded to the extent that they relate to:
- The cost of the R&D
- The availability of workers to carry out the R&D.
Meaning of “necessary”
Necessary is not defined in statute and takes its ordinary meaning. If the R&D cannot proceed unless a condition is met, that condition is necessary for the purposes of the R&D.
Just because it is necessary to carry out one or more activities of the R&D project outside the UK does not mean that other activities of the project meet this test.
Each must be judged on its own merits.
Meaning of “not present in the United Kingdom/present in another location”
What matters is the conditions that exist at the time the R&D activity is undertaken. HMRC expects that when planning a project, a company would consider different options and identify the best way forward. This planning should help explain and support the choices made.
Meaning of “entirely unreasonable”
Whether it is entirely unreasonable for the company to replicate the conditions in the UK will depend upon the R&D, the circumstances of the company and the reason for undertaking the work abroad.
In particular, time pressure may affect this. Time pressure may arise either from the demands of the R&D itself (samples may have a limited life, a particular result may be needed before the next iteration of a test run) from commercial, legal or contractual factors or from a mixture of both.
There may be evidence to demonstrate this in project planning documentation, commercial documentation or less formally (communications between staff or between companies as the project evolves). Time pressure will affect different companies in different ways, depending on their size, resources and capacity.
There will be circumstances where it is obvious that time pressure is relevant, such as where unexpected events occur which disrupt or change plans. In other cases, time pressure will be apparent at an earlier stage when it becomes clear that some necessary condition will not be present in the UK. Each company’s circumstances need to be taken into account – what is entirely unreasonable for one may be reasonable for another.
Whether or not conditions can be replicated in the UK is not necessarily an either/or question. It may be possible to replicate them in part, either numerically or qualitatively.
What are some examples?
Example 1
A SME life sciences business undertakes a range of clinical trials which include overseas EPW / subcontracted activities. Some clinical trials relate to treatments for diseases more commonly present in the UK. The company uses a global clinical research organisation (CRO) to identify clinical trial participants, and UK and overseas clinical trial sites are used.
The work could theoretically all happen in the UK – there are no regulatory requirements to carry out the studies overseas. However, the company is keen to utilise an ethnically diverse population sample (which is becoming increasingly important to regulators); to achieve this diversity they need to undertake the trials in multiple overseas locations.
This can also help speed up patient recruitment. There are many reasons for choosing to do the work in other countries. As there is no regulatory requirement for overseas activity, this exemption does not apply. However, it is important to look at other reasons, such as the faster patient recruitment and the advantages of having a diverse group of patients. This could make the company eligible, especially if they can’t find enough patients in the UK.
Example 2
The company wishes to carry on destructive testing of its product, using a commercial testing lab (to which the work would be contracted).
If suitable test facilities exist both in the UK and abroad, the following apply:
- If a UK test facility is available on the required timescale, the activity would not qualify if contracted outside the UK because the necessary conditions exist in the UK.
- If there is a tight schedule and UK facilities are booked at the needed times, it would be unfair to expect the company to set up the activity in the UK if it has to be done outside the UK.
- If suitable test facilities do not exist in the UK, the question is whether the company (not somebody else) can reasonably replicate them in the UK.
- If the company cannot manage a testing facility well or if the facility won’t be used much, it would not make sense for the company to create it. In this situation, the exemption would apply if the work is done outside the UK.
- If the company already operates similar facilities in the UK which could be easily adapted (assuming other factors do not prevent this) and provide the capacity required, it could be reasonable to expect it to do so. In this case, the condition that it would be entirely unreasonable for the company to replicate in the UK would not be met.
- If there is a tight deadline and building a facility in the UK would take too long, it would not be fair for the company to build it in the UK if the work is done outside the UK.
As this is a very broad area, we have created a brochure with further detail of the exemption, including more examples of this in practice – please see here.
It is vital to get ahead of the curve on this point as it is almost impossible to take retrospective action on this area of a claim.
If you have any questions, please reach out to us at rdtax@ct.me.
