Subcontracted R&D under the Merged R&D scheme

The rules around claiming contracted-out R&D work has historically been one of the most complicated parts of the UK’s R&D tax relief schemes, and an area where a huge amount of error has been made.

Under the new Merged R&D scheme, HMRC has made extensive changes to the rules around contracted-out R&D, aiming to:

• Encourage claimant companies to use UK-based subcontractors;
• Clarify which party is eligible to claim relief when R&D is subcontracted, and;
• Ensure that no two companies can claim for the same R&D costs.

These changes mean that advisers need to start working with their clients ahead of claiming, for periods starting on or after 1st April 2024, to ensure that these clients are keeping sufficient records of contractual arrangements and making the changes necessary to their ways of working to ensure that they can continue to claim R&D at an effective level for their organisation.

Overseas restrictions

Under the merged scheme allowable subcontractor costs are restricted to payments made for subcontracted activities carried out in the UK.

There’s no restriction on payments made to subcontractors based overseas, as long as the work is physically carried out in the UK.

This is the same of connected and unconnected subcontractors and applies regardless of the nature of the company or claim.

Having said that, HMRC have allowed exemptions to these restrictions where the ‘conditions necessary for the purpose of the R&D’:

• Are not present in the UK;
• Are present in the location where the R&D is undertaken, and;
• Could not wholly reasonably be replicated in the UK.

Conditions could be geographical, environmental or social, or refer to legal or regulatory requirements. Essentially, the only conditions that don’t allow a company to claim an exemption are where the work was only done overseas due to cost of the R&D or availability of workers.

Ownership of the R&D

Under the Merged scheme HMRC have clarified which party can claim for contracted-out R&D, and it all comes down to two main factors – who initiated the R&D, and who was aware of the need for the R&D to be undertaken.

In any arrangement, HMRC expects that the projects will be included in the merged scheme claim for the company that ‘takes the decision to undertake or initiate R&D’. This means that a company can claim for R&D contracted out by them to a third party if:

• They enter into a contract for activities to be done for them;
• The activities done to meet the contract include R&D and;
• It is reasonable to assume that they intended R&D of the sort to be carried out when entering into the contract.

Conversely, a company can claim for R&D done to fulfil a contract if:

• They took the initiative to undertake the R&D;
• The company contracting out the work did not intend for (or know about) R&D to be done to fulfil the contract and;
• The work meets HMRC’s criteria for eligible R&D.

In practice, this will mean that some SMEs will see their claims shrink due to large companies now being able to claim for contracted-out R&D, whereas others will be able to increase their claims to include work done on their own initiative to fulfil a contract.

HMRC have also stated that blanket R&D clauses in contracts stating that any work done to fulfil the contract belongs to the contracting party will not be enough to prove that they intended for R&D to be done – there would need to be evidence that they understood the exact nature of the required R&D, and that they were the initiators of it.

Additional Information Form (AIF) requirements

Taking all of this into account, far more information is needed about contracted-out R&D and subcontractors than ever before, and the merged scheme AIF reflects this. The new form requires, for all firms carrying out subcontracted R&D on behalf of the claimant company:

• Name
• Where they are registered
• Registered number
• How much qualifying expenditure was spent on this firm
• Why the claimant company believes the work to be exempt from the overseas restrictions, if relevant

As you can see, these details will allow HMRC to check both that the work qualifies under the overseas restrictions rules and ensure that no two companies can claim for the same R&D work.

Helping your clients

It’s important that claimant companies are prepared for these changes, so the least advisers should be doing is communicating them to their clients. Over and above this, we’d recommend having conversations with your clients about their R&D, and encouraging them to think about:

• Contractual arrangements – are they clear enough to decide who owns the R&D?
• Overseas subcontractors – would these costs be exempt? Could the work be done in the UK in future?
• What are the financial implications of moving contracted out R&D to the UK vs. excluding overseas subcontractors from the R&D tax claim?

Feel free to contact us to learn how WhisperClaims can support your practice with efficient, streamlined & compliant R&D tax claim preparation.

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