From April 2024, HMRC will apply new restrictions on what your business can claim from your overseas R&D expenditure. Overseas costs relating to externally provided workers (EPWs), subcontractors and contributions to independent R&D (such as payments to universities) will no longer be eligible – except, broadly, where it is wholly unreasonable for the company to replicate the conditions in the UK.
The change was originally meant to come into effect from April 2023, however it was announced in the Spring Budget 2023 that HMRC planned to delay the implementation of overseas expenditure restrictions by one year. This delay is to give them time to consider how the restrictions might work with the potential merged R&D relief scheme. Fortunately, it also gives businesses conducting R&D overseas extra time to prepare for the changes.
While the delay may result in further changes, this blog explores in detail everything that we know so far about the 2024 rule changes for claiming tax relief on overseas R&D expenditure. It also offers guidance on the planned new qualifying overseas expenditure (QOE).
How are the rules changing for R&D overseas expenditure?
The rules currently allowed you to claim for R&D Tax Credits that were either partially or wholly outsourced to overseas subcontractors or externally provided workers (EPWs). For the accounting periods on or after 1st April 2024, you can only outsource work carried out in the UK – although there are exemptions, which the government defines as qualifying overseas expenditure (QOE).
Where a company uses externally provided workers (EPWs) to carry out R&D, expenditure on those workers will only qualify if their earnings are taxed through PAYE and they National Insurance Contributions (NICs) or their work relates to R&D activity outside the UK that qualifies under the new exemptions.
What counts as qualifying overseas expenditure for R&D
There are three factors that must be met in order for R&D spend on work conducted abroad to count as qualifying overseas expenditure.
- The necessary conditions for carrying out the R&D are absent in the UK.
- The location where the R&D takes place has the necessary conditions.
- Replicating the conditions in the UK would be wholly unreasonable.
Let’s drill into each of these individually!
1. The necessary conditions for carrying out the R&D are absent in the UK
Sometimes it just won’t be possible to do the work in the UK. This might be due to:
- geography
- environment
- social factors
- other conditions not present in the UK
Examples of work that can’t be conducted within the UK potentially include volcanic, seismologic, zoologic, botanic, oceanographic, mining, deep sea or climate change R&D – to name just a few. There may also be certain regulatory or other legal conditions that require work to take place in specific areas, such as clinical trials.
The government concedes that their legislation isn’t exhaustive but, generally, they suggest that reasons preventing work from being carried out within the UK should relate to physical (or material) factors such as:
- animal or plant distribution
- medical factors (e.g., the number of cases of a particular disease or the availability of volunteers for clinical trials)
- the existence of specialised machinery or facilities, which are essential for R&D
2. The location where the R&D takes place has the necessary conditions
This is the simplest of the three factors because you just need to demonstrate that where you’re working has the necessary conditions that were absent in the UK. For example, suppose your R&D activity involves using sensors to study dangerous earthquakes. In that case, you’ll need to work in high seismic hazard zones such as the Circum-Pacific belt, the Alpide belt, or the mid-Atlantic Ridge (all of which are outside the UK).
3. Replicating the conditions in the UK would be wholly unreasonable
Whether on not something is considered “wholly reasonable” will vary from company to company, and from R&D project to R&D project.
If there are R&D facilities, such as specialist commercial labs, that only exist abroad it may be considered to be wholly unreasonable for a UK company to create the facilities themselves. This might be because your business doesn’t have the expertise to do so, or it might be because it wouldn’t be commercially viable to create such a facility. There may also be a limited time frame for you to be able to carry out the R&D, and it would take too long to create the facilities yourself – or alternatively, there may be existing UK facilities but they are fully booked, preventing you from carrying out your R&D in a reasonable timeframe.
If however, the necessary R&D facilities do exist in the UK (and are available) or, if your existing facilities are similar and could reasonably be adapted, then you would be reasonably expected to carry out the work on home soil.
What is excluded from qualifying overseas expenditure for R&D?
Many businesses previously chose to outsource R&D abroad because it was either cheaper or too hard to find the right skillset within the UK. Unfortunately, you will no longer be able to claim for subcontracted work carried out overseas that was commissioned due to the cost of the R&D work or the availability of skilled workers as these are now classed as “excluded factors” under the new rules.
Why are the rules changing for R&D overseas expenditure?
The government wants to ensure that when they pay out tax relief, they’re predominantly doing so for work that’s done within the UK. This is part of HMRC’s objective of “refocusing the reliefs towards innovation in the UK” and Jeremy Hunt’s mission to “make the United Kingdom a science superpower”.
It’s not yet clear if these new measures will boost R&D activity in the UK as intended. To learn more about Leyton’s view on the exclusions for overseas subcontracted work and the cost of externally provided workers, read our response to the draft legislation for the upcoming Finance Bill 2022-23.
How can my business prepare for the changes to overseas R&D expenditure?
If, for the accounting periods on or after 1st April 2024, you plan to claim for overseas expenditure for either subcontracted work or EPWs, you’ll need to be able to demonstrate that it was necessary to conduct R&D outside of the UK.
A good way to prepare for this would be to collect evidence showing why the work could not be done in the UK. Evidence might include correspondence from a regulatory body or a reference to the relevant legislation stating that activities must occur in a particular country.
Even if you are carrying out R&D with EPWs employed within the UK, you may still need to prove that expenditure was subject to PAYE and National Insurance Contributions (NICs). It’s therefore recommended that, where possible, you collect evidence of PAYE and NIC for all payments to EPWs.
Find out more about overseas R&D expenditure
While the rule changes on overseas expenditure have now been pushed back to 2024, your business can still plan for what’s to come. As long as the material circumstances cannot be replicated in the UK, or it would be wholly unreasonable to replicate the circumstances, and you’ve chosen to carry out the R&D in an area where the necessary conditions exist – then your expenditure is likely eligible as QOE.
If you have a question that is specific to your business’ overseas expenditure, we’d be glad to help. Speak to one of our experts.
