The treatment of contracted-out R&D

The treatment of contracted out R&D in the UK has recently changed, with new rules tightening which subcontracted activities qualify for tax relief, and who can claim. Read on to explore the updated guidelines and their impact on businesses, as well as how to adapt to maximise R&D tax benefits under the new scheme.

What is a contracted R&D scheme? 

A contracted R&D scheme refers to research and development work that a business outsources to a third party rather than carrying out in-house. Businesses are often motivated to outsource their R&D as it gives them access to specialist skills and advanced technologies that may not be available internally. Outsourcing R&D also improves efficiency by freeing up time for internal teams, often reducing the costs of hiring another full-time team member to fill the skills gap. The outsourced approach is especially common in industries like pharmaceuticals, manufacturing, software development, and engineering, where external expertise or equipment is essential to drive complex R&D projects forward, whilst still ensuring resources are managed effectively. 

Why has the treatment of contracted-out R&D changed? 

The treatment of contracted-out R&D has changed to better align tax relief with companies that make strategic decisions and bear the financial risks of R&D activities. Previously, subcontractors could claim relief for R&D work they performed, even if they were not the primary decision-makers. Under the merged R&D scheme, the new guidelines ensure that only the company initiating and managing the R&D project can claim relief for contracted tasks. This shift aims to incentivise businesses to keep R&D activities within the UK, fostering domestic innovation and boosting economic growth. 

What are the benefits of contracting out R&D? 

Contracting out R&D offers several strategic benefits for businesses. For one, it’s often more cost-effective than building in-house teams, helping companies avoid long-term staffing and infrastructure costs. Outsourcing also gives access to specialised expertise and cutting-edge technologies that may not be available internally. Businesses can also benefit from greater flexibility, as outsourced resources can be adjusted based on specific project needs. From tackling complex challenges to managing multiple R&D streams, outsourcing helps businesses to stay compliant without overstretching internal capacities. 

What changes have been made to contracted out R&D? 

A number of specific changes have been made to the treatment of contracted-out R&D. Businesses must be aware of these changes so that they can effectively adapt to stay compliant and maximise potential benefits. 

Overseas R&D 

From April 2024, tax relief will no longer apply to subcontracted R&D carried out overseas. However, limited exceptions exist. Relief may still be available if the R&D requires conditions not present in the UK that cannot be reasonably replicated. For example, specific clinical trials or environmental factors could impact a business’s ability to carry out R&D work in the UK. Cost or staffing availability alone won’t qualify. In order to remain eligible, businesses must justify why overseas work is essential. 

Subcontracted R&D definition 

The definition of qualifying subcontracted work has been narrowed under the new contracted-out R&D scheme. Only payments to subcontractors who are either based in the UK or carrying out the R&D activities within the UK are eligible for tax relief. This change aims to encourage domestic innovation and ensure public funding supports UK-based research. Work performed overseas, regardless of the subcontractor’s location, no longer qualifies unless specific exemptions apply, reinforcing a focus on UK-centred R&D efforts.

Qualifying subcontractors 

HMRC has refined definitions of “qualifying bodies,” “individuals,” and “entities” eligible for subcontracted R&D tax relief. Under the new rules, only subcontracted work to UK-based qualifying bodies (such as universities and research institutions), individuals, or entities conducting the R&D in the UK will qualify. This change excludes overseas subcontractors unless the work is physically undertaken in the UK. 

What are the business implications of the treatment of contracted-out R&D? 

The new treatment of contracted-out R&D brings significant business implications. Companies must now provide more detailed information about subcontracted R&D in their tax relief claims. This will likely lead to increased administrative burden, which can be especially impactful on smaller teams. Justifying subcontracted work, especially if performed outside the UK, becomes more challenging due to stricter eligibility rules, which could impact the feasibility and scope of R&D partnerships. As a result of these complications, businesses may want to take the opportunity to work with R&D tax specialists, who can help them to navigate the new requirements and maximise available tax relief.

How Rayner Essex can help

Rayner Essex offers expert guidance in navigating the evolving landscape of R&D tax relief, including contracted-out R&D guidelines. With extensive experience in R&D accounting and compliance, our team ensures businesses remain aligned with HMRC requirements as they evolve, while maximising tax benefits. We provide accurate, tailored advice to help justify subcontracted work and manage increased documentation demands. Our specialist support simplifies complex claims, helping you focus on the growth and success of your business. 

Want to ensure your business can effectively adapt to the changes to contracted-out R&D? Get in touch with our team of R&D specialists today to find out how we can help.