R&D Tax Relief and Overseas Costs: What the Rules Mean for Your Claim

R&D rarely respects borders. A UK software company might use developers in Poland. An engineering business might test in a facility in Germany. A life sciences company might run trials across several countries.

Until recently, much of that spend could be included in a UK R&D tax relief claim. For accounting periods beginning on or after 1 April 2024, under both the merged scheme and Enhanced R&D Intensive Support (ERIS), that is no longer the case. The government's stated aim is for the relief to support R&D carried out in the UK.

Which costs are affected?

Two categories are restricted:

• Payments to contractors (subcontracted R&D): Can be claimed when the R&D is carried out in the UK, or the spend is qualifying overseas expenditure.
• Externally provided workers (EPWs), such as agency staff: Can be claimed when the worker's earnings are subject to UK PAYE and National Insurance, or the spend is qualifying overseas expenditure.

It is the location of the work, or the payroll status of the worker, that matters. Where the supplier is registered is not the test. A UK-registered contractor doing the work overseas is caught. An overseas-owned contractor doing the work in the UK is not.

What is not affected?

The restriction is specific. It does not apply to:

• Staff costs for your own employees.
• Consumable items used in the R&D.
• Software, data licences and cloud computing costs.

Those categories have their own rules, but the overseas restriction on contractors and EPWs is not one of them.

When can overseas costs still qualify?

There is an exception for what the legislation calls qualifying overseas expenditure. All three of the following must be true:

1. The conditions necessary for the R&D are not present in the UK.
2. Those conditions are present in the location where the R&D is carried out.
3. It would be wholly unreasonable for the company to replicate those conditions in the UK.

The conditions in question can be geographical, environmental or social, or they can be legal or regulatory requirements. HMRC's guidance gives examples along these lines:

• Research that needs a particular physical environment, such as deep ocean conditions or a specific climate.
• Clinical trials that need a patient population not available in the UK in sufficient numbers.
• Work that must take place in another country because a regulator there requires it.

"Wholly unreasonable" is a high bar, and it is meant to be.

What does not count?

The legislation is explicit on two points. The following are not conditions necessary for the R&D:

• The cost of the work. Cheaper day rates overseas are a commercial reason, not a qualifying one.
• The availability of workers. Being unable to recruit the right skills in the UK does not meet the test either.

That second point surprises many companies. Specialist skills shortages are real, and for some technologies the expertise is concentrated abroad. It may fully explain why the work went overseas. It still does not make the cost claimable.

Are there exceptions for Northern Ireland?

Companies registered in Northern Ireland that claim under ERIS are not subject to the overseas restrictions on contractor and EPW costs, although a separate limit applies to the additional relief they can receive. The rules here are detailed, so take specific advice if this applies.

What should companies do now?

A few practical steps make a real difference.

1. Map where the work happens. For every contractor and agency arrangement, record where the R&D is physically carried out.
2. Check payroll status for EPWs. Are the workers paid through UK PAYE and National Insurance?
3. Ask why the work is overseas. If the reason is cost or skills, assume it will not qualify. If the reason is environment, population or regulation, document it.
4. Keep evidence at the time. Board papers, project plans and regulatory correspondence written during the project carry more weight than an explanation drafted two years later.
5. Model the effect before the year starts. For some companies, moving work to the UK changes the numbers. For others it does not. Either way, it is better to know.

Is it worth restructuring how R&D is delivered because of a tax rule? Sometimes yes, often no. The commercial case should lead. What is not sensible is finding out at claim time that a third of the expected relief is not available.

Frequently asked questions

Can I claim R&D tax relief for overseas subcontractors?

Generally no, for accounting periods beginning on or after 1 April 2024. Payments for subcontracted R&D carried out outside the UK are excluded unless they meet the narrow test for qualifying overseas expenditure.

What is qualifying overseas expenditure?

It is spend on R&D carried out overseas where the conditions necessary for the R&D are not present in the UK, are present in the overseas location, and it would be wholly unreasonable to replicate them in the UK. Those conditions can be geographical, environmental, social, or legal and regulatory.

Does a shortage of skilled workers in the UK justify overseas R&D costs?

No. The legislation specifically states that the availability of workers and the cost of the work are not conditions necessary for the R&D.

Do the overseas rules apply to my own employees working abroad?

The restriction applies to contractor payments and externally provided workers, not to the company's own employee staffing costs. Other rules may still be relevant, so the facts should be checked.

When did the overseas restrictions start?

They apply to accounting periods beginning on or after 1 April 2024.

Key takeaways

• The restriction applies to contractor payments for R&D carried out outside the UK, and to externally provided workers who are not paid through UK payroll.
• The exception is narrow and based on geography, environment, population or legal and regulatory requirements.
• "It was cheaper" and "we could not find the skills here" do not satisfy the exception.
• Costs such as your own employees, consumables, software and cloud computing are not caught by this particular restriction.
• Review overseas arrangements before the year starts, not when the claim is being prepared.