CONTENT UPDATED JANUARY 2019
Research and development (R&D) projects often require work to be outsourced to other parties. This does not prevent you from claiming R&D tax credits, but there are a number of important things to consider.
While many R&D projects can be carried out internally, there can also be elements that are subcontracted to third-party companies, outsourced to freelance developers, or carried out by an organisation’s international offices operating overseas.
Many of the organisations we support at ForrestBrown carry out R&D projects that incorporate significant elements of work being carried out elsewhere. This does not prevent them from claiming – let’s explain why.
In 2021, the government launched an R&D tax reliefs consultation and then published a report that outlined proposed changes to the R&D incentive. If implemented these reforms will impact those carrying out R&D overseas significantly – we recommend reading our article on the R&D tax reliefs report and our recommendations.
Subcontracted R&D activities
When you subcontract your research and development work outside of your organisation, you may still qualify for R&D tax credits. Subcontracting R&D means that you have engaged someone else to carry out part of your R&D project e.g. testing activities. Importantly, you retain the overall risk associated with the project.
The subcontracted work does not necessarily need to be R&D activity itself. It only needs be part of a wider R&D project to resolve some scientific or technological uncertainty.
The subcontracted work to be included in your R&D tax credit claim can itself be entirely routine when looked at in isolation, but if it forms a necessary part of your wider R&D project, it may be included.
Additionally, subcontracted R&D activities don’t have to take place in the United Kingdom. The subcontractor doesn’t even need to be based in the UK.
Claiming for subcontracted work
The fine details on claiming R&D tax credits for subcontracted work.
Do you require skills that can only be found in a handful of global locations? Or are you subcontracting (potential R&D activity) to Central and Eastern Europe or Latin America for greater cost efficiency? You may still claim R&D tax credits, provided a scientific or technological advance is being sought.
- If the subcontractor who is carrying out the work on your behalf is not connected to you in any way, you can claim 65% of the amount you have paid for the R&D work.
If you subcontract to a connected party (e.g. a group company) you’ll need to consider what actual costs were incurred by the subcontractor in delivering the work. If the subcontractor has incurred staffing costs, consumables, software and payments to externally-provided workers (EPWs), you can claim the lower of the sum of these amounts or the payment you’ve made for the services.
What costs qualify for R&D tax credits?
Understand what costs can be included in an R&D tax credit claim.
Is it really subcontracting?
Before claiming for subcontracted work, it is important to verify that the work really is subcontracted.
Identifying and properly classifying the work is crucial to the treatment of R&D expenditure in your claim. A lack of understanding of the subcontractor relationship in a claim can lead you to make a claim for the incorrect value.
For example, if you simply purchase the output of someone else’s R&D, they would claim relief on the costs they have incurred in providing those goods or services to you. This is true, even if they are based outside of the UK. It is important to consider who carries the risk associated with the R&D being carried out.
R&D tax credits can be complex and not carrying out a detailed analysis of your expenditure may result in under-valuing your R&D claim, or in HMRC asking for more information.
At ForrestBrown, R&D tax credits is all we do. We’re in constant dialogue with HMRC to ensure we keep abreast of changes in legislation and operational practice, which keeps our advice uniquely informed. It’s a winning formula.
Below we consider a number of ways in which you may have outsourced, or worked with others on your R&D, and the effect this has on your R&D tax credit claim.
When more than one company collaborates on an R&D project – with each party incurring its own costs, and jointly benefiting from the results of the project – it is classed as collaborative R&D.
In this instance, each company can claim R&D tax relief on the amount of qualifying expenditure incurred on the project. If one of the companies is located outside of the UK, this does not prevent the UK company from claiming for the R&D expenditure it has incurred.
Externally provided workers
If you have engaged an agency, recruitment firm or other supplier to deliver additional resource for your project, these costs may fall within the externally provided workers (EPW) category.
EPWs are individual workers provided via a staff provider, who work under the direction of your internal team. The EPWs do not have to be physically situated in your office, or even inside of the UK.
Externally provided workers don’t count as subcontracted R&D, but these costs tend to be classified as subcontractors for accounting purposes, so distinguishing between the two categories is important.
Money spent on externally provided workers still counts towards your qualifying expenditure.
Where your company and the party providing the EPWs are unconnected, qualifying R&D expenditure is restricted to 65% of the payment made for the services. For connected parties, e.g. if the EPWs are provided by a group company, you can claim the lower of the payment made and the staffing costs of the EPW provider.
If you have outsourced the manufacture of a prototype to someone else, this is not subcontracted R&D, but the expenditure may fall within the ‘consumable items’ category. If your supplier fabricated the prototype to your specification and provided you did not sell the prototype to a customer, it could qualify.
Companies claiming under the large company scheme (RDEC) can only claim subcontracted R&D expenditure if the activities are subcontracted to:
- An individual, or partnership of individuals, or
- A qualifying body (meaning a university, charity or research institution).
These rules also apply to SMEs who make claims for RDEC due to grant funding or carrying out R&D as a subcontractor.
If the university, charity of research institution you have subcontracted R&D to is situated outside of the UK, you might still be able to include the expenditure, but you have to apply for approval to the Treasury.
RDEC is the R&D tax credit incentive for large companies
Groups of companies
R&D tax credit claims are made as part of a company’s Corporation Tax return, therefore where R&D is undertaken by a group of companies, careful consideration is required. This ensures that expenditure is claimed within the relevant company, and under the correct category for R&D tax credit purposes.
Complexity tends to arise where a company is:
- Operating transfer-pricing agreements amongst group companies.
- Cross-charging elements of expenditure between different companies within a group structure.
- Outsourcing elements of expenditure to other ‘connected parties.’
If your UK operations form part of a larger international business, the treatment of R&D expenditure can be more complex. There may be opportunities to recoup costs incurred within other parts of your group’s international operations.
However, this is typically less straightforward, and will depend on your corporate structure and the contractual arrangements between group companies.
Overseas branches of UK companies
If research and development activity is carried out by a division of a UK-based company, but this division is based overseas, it could still be eligible for R&D tax relief. This assumes that your overseas branch is a permanent establishment, whose activities are within the scope of UK Corporation Tax.
The most important thing to remember is that there is no geographical restriction on R&D tax credits. The validity of your claim is based on your qualifying R&D activities and the level of qualifying expenditure – not where the R&D work was conducted.
As far as partnerships are concerned, they cannot claim R&D tax relief. In this sense, we are referring to Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs), as they are not registered for UK Corporation Tax.
However, corporate partners within an LP or LLP may be able to benefit from R&D tax credits if R&D is carried out by the partnership, due to the way corporate partners are taxed.
LLPs were once seen as being a particularly tax efficient structure. However, over recent years, changes to the way LLPs are taxed, and new rules regarding salaried members and corporate members, mean this is unlikely to still be the case.
Do you still have questions?
If you’re looking for professional advice, get in touch to see if we can help.
With one of the largest teams of chartered tax advisers specialising in R&D tax credits in the UK, ForrestBrown are leaders in this field: R&D tax credits is all we do.
Knowing the correct treatment for different elements of expenditure, and how to communicate this to HMRC is crucial. Improper expenditure-treatment can make tens of thousands of pounds of difference to your potential claim value and could even result in the claim being rejected. Our award-winning process protects you from this and ensures you get everything you are entitled to.
Give us a call on 0117 926 9022 or email us at firstname.lastname@example.org to find out more.