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Your company's size impacts your R&D tax claim. SMEs and large companies have different criteria, all the more important to know for scheme changes in 2024.
The SME and R&D Expenditure Credit (RDEC) schemes will be replaced with the Merged Scheme for accounting periods beginning on or after 1st April 2024, which comes with its own updates to how costs can be claimed. One of the bigger changes under the Merged Scheme relates to overseas expenditure.
Under the previous schemes, companies could largely claim for staff, subcontractors, externally provided workers, software and consumable items. This included any workers abroad, without restriction. However, this is no longer the case. Businesses need to be clear on the new rules before preparing a claim, or risk having to repay their credit at a later date.
With changes to the R&D tax relief incentive to make the claiming process simpler came additional changes to improve compliance and reduce error and fraud in the schemes. One of these was the ban on overseas costs for R&D tax claims.
For accounting periods beginning on or after 1 April 2024, expenditure on overseas subcontractors and externally provided workers (EPWs) for R&D activities will largely no longer qualify for R&D tax claims. This means the subcontractor or EPW must physically do the R&D in the UK. There is no restriction on nationality.
Fortunately, this restriction does not apply to other cost categories like staffing costs, consumables, software, data and cloud computing, or payments to clinical trial participants.
Whether the overseas restriction applies to subcontractor payments depends on the location of the worker’s activities. If some activities take place in the UK and some do not, the payment should be apportioned on a just and reasonable basis, so that only the UK-based activity is included.
For EPWs, the company or staff controller is required to operate PAYE and account for Class 1 NIC in respect of the worker. This can usually be worked out by asking the staff controller.
The company must self-assess that it meets all the conditions for relief, including the overseas restrictions. In some cases, it may be clear where the activities occur; in other cases, confirmation from the subcontractors or EPWs may be necessary.
It will still be possible to claim for overseas subcontractor payments and externally provided workers not subject to UK PAYE/NI, if all the following conditions are met:
It is down to the company to consider whether all the conditions apply. HMRC may request evidence under a compliance check, so project documentation showing the options and justification should be retained.
The guidance provides a non-exhaustive list with supporting examples of what could be considered ‘wholly unreasonable’ for a company to replicate the R&D activity in the UK. These include:
Essentially, if you cannot reasonably replicate the conditions for your R&D in the UK and thus can only complete your R&D overseas, this expenditure may still be included.
The guidance makes it clear that cost or worker availability alone won't be allowed as a valid exception to the new rules. In other words, you can’t justify using overseas subcontractors or EPWs just because they’re cheaper or easier to hire. However, the rules seem more flexible if cost or availability isn’t the sole reason for choosing overseas options.
HMRC provides an example where the cost of R&D and time pressure prevent the R&D from being undertaken in the UK. The time pressure of waiting until a new facility is developed in the UK would be considered ‘wholly unreasonable’, allowing overseas subcontractor costs to be claimed. Another example is that raw materials are only available overseas, and the alternative would be to incur high costs and carbon footprint to ship the materials to the UK. The cost of the R&D can’t be considered as a valid factor for overseas expenditure; however, if environmental concerns and the need for a steady supply of material were overriding factors, they might be relevant.
Seeking to lower the cost of R&D and/or limited availability of workers in the UK are not enough on their own to justify claiming for overseas expenditure. However, when combined with additional factors which meet the conditions discussed above, they can improve the argument that overseas expenditure was required.
The ban on overseas expenditure aims to boost domestic innovation and support UK talent. This aligns with the UK’s wider efforts to increase investment in domestic R&D.
Ultimately, the goal is to reduce spurious or fraudulent claims, as well as those that abuse the scheme by using a UK entity to claim back the majority of their costs which are overseas.
To this end, HMRC also introduced a cap on the R&D tax credit to ensure the tax benefit goes to the companies that deserve it. In this instance, SMEs can only claim a payable tax credit of up to 300% of their combined PAYE and NIC liabilities, plus a £20,000 buffer.
Alongside the Additional Information Form (AIF) and the Claim Notification requirement, HMRC have added in extra hoops for businesses to jump through to encourage qualifying companies only to claim. So far, we’ve seen a decrease in suspicious SME claims, so it seems to be working!
HMRC recommends claimants of overseas expenditure provide evidence of the selection process and compare the options of subcontractors, to substantiate any claim of this kind.
This change may be unwelcome to some, as those relying heavily on international subcontractors or agency staff will face higher costs transitioning to UK-based teams or losing the tax benefit for these costs.
Some companies that seek to maintain their tax benefit will have additional administrative work to complete the move to UK-based teams. These businesses must assess their R&D operations and complete costing analysis to ensure that they are taking advantage of the scheme in the most effective way.
Fortunately, in the pharmaceutical industry, clinical trial volunteer payments can still qualify overseas, but staff costs for administrating these clinical trials will be ineligible (unless they can meet the exception criteria).
In the IT sector, some companies might seek to bring software development and testing activities in-house or to UK-based contractors.
At Myriad, we recommend a full audit of current R&D activities, especially with the updates to subcontracting rules under the Merged Scheme. The entire supply chain may need review to ensure that your company is obtaining the maximum benefit possible. Businesses with international elements should explore options to shift activities to the UK where feasible.
With the risk of compliance checks remaining high, it’s important for every claim to be robust and defensible. At Myriad, we take on that risk for you.
Our promise to you is simple: we stand firmly behind our advice. If a claim submitted by us is challenged, we'll defend it free of charge. If it is rejected, we won't charge you any fees. We'll cover any HMRC penalties and even compensate you for your time.
Get in touch with the experts at Myriad to navigate the complexities of the new rules and ensure compliance.
HMRC will not appeal tribunal rulings favouring SMEs on R&D tax credits. Decisions clarify subsidy rules, offering hope for ongoing claims. Further guidance expected early 2025.
Your company's size impacts your R&D tax claim. SMEs and large companies have different criteria, all the more important to know for scheme changes in 2024.
The new Additional Information Form (AIF) is required for Creative Tax Relief claims from April 2024. Ensure compliance and secure your tax credits with this guide.
Please contact us to discuss how working with Myriad can maximise and secure R&D funding opportunities for your business.
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