Amid mixed calls to delay the introduction of new Research & Development (R&D) rules, HMRC have published draft guidance on new rules for Contractors and Externally Provided Workers (EPWs).
From 1 April 2024, most SMEs will make Research & Development (R&D) claims under a new merged version of the R&D Expenditure Credit (RDEC) scheme. Loss-making, R&D-intensive SMEs will continue to use their version which will become a separate scheme based on the former SME-enhanced expenditure scheme.
There have been calls by both the House of Lords and the Institute of Chartered Accountants in England and Wales (ICAEW) for the government to postpone the start of the new merged scheme until 2025. Meanwhile, HMRC are working on new guidance and it appears that it will go ahead as planned.
One new feature of the changes is a ban on claiming R&D relief for overseas outsourcing costs (apart from a few limited exceptions) and will restrict claims for Contracted work and Externally Provided Workers (EPWs), where the work is not undertaken in the UK.
HMRC's new guidance pools many examples to illustrate the major changes to the way relief is claimed for contractors and EPWs.
Highlights of the changes to contracted-out R&D
| Provider | Restriction | Exception |
| Contractor | Must be located in the UK | Where activity necessarily takes place abroad |
| EPW | Earnings must be subject to PAYE and NICs | As above |
- The new contractor restriction rules move claims from a contracting company that is undertaking the R&D to the company that plans, initiates and funds the R&D.
- Contractors will still be able to claim relief for R&D but this will only be in cases of what is termed 'hidden R&D': broadly situations where a supplier undertakes its own R&D activities and bears its own R&D costs without passing on these excess costs to the supplier.
- Under the new rules, entities will have to list the externally provided workers (the external resources who augment the company’s technical team) working on R&D activities, along with the staff provider’s PAYE reference, to confirm these individuals are UK-based.
Eligible overseas sub-contracted expenditure will only be allowed where the conditions required for the R&D do not exist in the UK and it would be wholly unreasonable to replicate them.
- Cost and staffing (including expertise) are not acceptable conditions.
- Where the UK location requirement is to be partially met, R&D costs can be apportioned on a just and reasonable basis between where performed between the UK and overseas.
Overseas expenditure on contracted-out R&D, and on payments for EPWs who are not subject to UK PAYE/ National Insurance Contributions (NICs), may still qualify for relief if three circumstances 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.
- It would be wholly unreasonable for the company to replicate the conditions in the UK.
Draft Guidance
In February 2024, HMRC published draft guidance on Research & Development tax reliefs concerning new contracting out rules and overseas restrictions and it includes examples of both the restrictions and exceptions.
Useful guides on this topic
R&D: At a glance
What is Research and Development (R&D) relief? How to claim R&D relief? How does small company R&D relief work? Can individuals claim R&D relief? This is a freeview 'At a glance' guide to Research and Development (R&D) relief.
R&D: Staff costs, subcontractors & reimbursed expenses
What staff costs qualify for relief? Who are externally provided workers? Can you claim sub-contractor costs? Do reimbursed employee costs qualify?
R&D: Research and Development Expenditure Credit (RDEC)
What is the R&D Expenditure Credit (RDEC) Large Company Scheme for R&D relief? How does it work?
External links
Research and development tax reliefs: new contracting out rules and overseas restrictions
ICAEW: House of Lords reports on Finance Bill
