Upcoming changes from 1^st of April 2024 onwards

The R&D Tax Credit landscape has gone through many changes recently. Besides the new merged scheme and R&D intensive SME schemes coming in force in 2024, HMRC has also published a draft guidance this spring with upcoming changes to expenditure on overseas subcontractors and EPWs.

For accounting periods beginning on or after 1 April 2024, expenditure on overseas subcontractors and externally provided workers (EPWs) for R&D activities will generally no longer qualify for R&D tax credit claims. Fortunately, there are some exceptions to these overseas restrictions (more on them later).

The eligibility of subcontractor payments will depend on the location of the subcontractor activities. If some take place in the UK while others do not, the expenditure will have to be reasonably apportioned to take into account only the UK based activity in the claim.

Regarding EPWs, the company or staff provider is required to pay UK taxes (PAYE and Class 1 NIC) for that worker in order for them to be eligible for a claim.

These overseas restrictions apply only to subcontractors and EPWs but do not apply to staffing costs, consumables, software, data and cloud computing, or payment to clinical trial participants, which will all still be eligible even if the expenditure takes place overseas.

What are the exceptions to the rule

As mentioned previously, there are some exceptions for these overseas contracting rules. The R&D work you perform outside of the UK could be eligible even if the subcontractors or EPWs are not subjected to UK PAYE/NI if all of the following conditions are met:

• the conditions necessary for the R&D are not present in the UK
• the conditions are present in the location where the R&D is undertaken, and
• it would be wholly unreasonable for a company to replicate them in the UK.

It is the company’s responsibility to determine if all these conditions are met and to keep the necessary justifying project documentation. HMRC might ask for such project records in the case of a compliance check.

The draft guidance includes a non-exhaustive list of examples of what situations could be considered “wholly unreasonable” for a company to replicate in the UK in their R&D activities. We mention a few of them below:

• A company needs to carry experiments in a testing facility. If such facility is not available in the UK in the project timescale and it would be unreasonable for the company to replicate such testing facilities in the UK, this type of expenditure could be eligible.
• Medical circumstances related to disease incidence or the availability of clinical trial participants, for example. The draft guidance mentions how in cases where the relevant databases show that a percentage of trial participants could be sourced from the UK but doing so would significantly disrupt the business plan resulting in delays and increased execution risk, such expenditure could be eligible for a claim.
• Physical, geophysical, or environmental circumstances (deep ocean research, volcanic or geologic conditions, animal or plant distribution, etc.)
• A company needs access to machinery or facilities which are not present in the UK.
• Legal or regulatory requirements, for activities which must take place in a specific country or follow the requirements of recognised regulatory bodies.

The main point to take home is that if you cannot reasonably replicate the conditions of your R&D activities in the UK and as such you have to complete them overseas, then those R&D activities may still be included in your R&D claim.

What is not considered an exception to the rule

The HMRC guidance highlights that using the cost of R&D activity and the availability of workers in the UK as the sole reasons to carry R&D activities overseas is not considered as exception to the rule. However, the HMRC does provide some examples in which the previous reasons are accompanied by others that would open the possibility of claiming such activities for an R&D claim.

For example, if for a specific project the raw materials are only available overseas and shipping them to the UK would incur into high costs and significant carbon footprint. Only considering the cost of R&D is not a valid factor but if environmental concerns and the need to not disrupt the project supply chain are major factors to consider, then the expenditure might be eligible.

Don’t hesitate to get in touch!

We understand that the there are plenty of changes upcoming and a significant amount of new information recently provided by HMRC. Furthermore, the ambiguity and complexity of this new information can be overwhelming. Thus, please don’t hesitate to contact us if you’d like to discuss how the new legislation applies to your circumstances. At FRS we have a team of experts than can help you easily identify if your contracting R&D and any other part of your R&D claim is eligible and follows the HMRC guidance. We will help you prepare a robust claim and make sure you are taking full advantage of the R&D incentives available for you.