The UK Government has made substantial changes to the R&D scheme in the last year, aiming to incentivise companies to conduct their R&D activities in the UK and boost innovation.
One of these changes relates to overseas expenditure incurred by a company on its R&D activities, and will apply to accounting periods beginning on or after 1 April 2024.
New restrictions will be introduced aimed at encouraging companies to conduct their R&D activities in the UK. Firstly, any subcontractor expenditure must be incurred in the UK. Any expenditure that’s not incurred in the UK will only qualify for R&D purposes if all the following factors apply:
- the conditions necessary for the R&D are not present in the UK;
- the conditions are present in the locations where the R&D is undertaken; and
- it would be wholly unreasonable to replicate the conditions in the UK.
If the expenditure is not incurred in the UK, the three factors above must apply for the cost to be treatable as a “Qualifying Overseas Expenditure” (QOE). The legislation gives examples of these conditions as being geographical, environmental, or social. While HMRC does not provide an exhaustive list, in their view this includes:
- medical factors, such as incidence of a disease or availability of volunteers to trial a drug or other medical treatment;
- animal or plant distribution; and
- the presence of machinery or facilities to which a company may require access.
One such example would be where state-of-the-art facilities are only available overseas and it would be wholly unreasonable to replicate these conditions in the UK. However, conditions relating to the cost of the research and development, or the availability of workers to carry out the research and development in the UK, will not be accepted.
Legal or regulatory requirements may also be relevant. For example, if testing a drug must be done according to a method agreed by a regulatory body, and that body explicitly dictates that the activity must take place in a particular country, then the conditions would likely be met. HMRC, however, would expect to see clear, independent, evidence that this was in fact the case.
Whether it’s considered to be “wholly unreasonable” will be determined on a case-by-case basis and take account of the R&D activities that are being undertaken, the company, and the reason for the work being done overseas.
Externally Provided Workers (EPWs) will also be subject to the overseas restriction. They will need to be paid via UK payroll if the costs are to be claimable for R&D, unless the expense is deemed to be a Qualifying Overseas Expenditure, as detailed above.
There are no exemptions to these restrictions for connected companies at this stage. This means that a group with an overseas subsidiary who undertake all or some of the R&D activities of the group should be cautious as to how these restrictions may affect their R&D claim going forward. They need to ensure they meet the three factors covered above.
It is important that companies seeking to claim R&D tax credits are aware of the upcoming changes and how they may impact their qualifying expenditure. With this in mind, companies can plan and prepare their business and R&D activities accordingly. If you have any questions, please contact the R&D team at rdtax@ct.me.
Author: Dave Philp, R&D Tax
