Over the past few years, there have been several significant changes to the R&D Tax Relief schemes regarding contractor fees. As a general rule, 65% of contractor fees paid to an arms-length (non-linked) company are an eligible R&D expenditure. For a linked company, 100% of contractor fees are eligible. However, there are restrictions depending on the nature of the contractor relationship and the location where the work is performed.
The new R&D Contractor Rules
Under the new merged R&D Tax Credit scheme, which commences for accounting periods beginning on or after 1st April 2024. HMRC is applying new rules and changes regarding contractor fees.
Essentially, these new rules aim to prevent both the company and the contractor from making an R&D claim for the same work. Also, to determine who has the right to make the R&D claim related to the work undertaken by the contractor: the company paying (payor) the contractor or the contractor actually performing the work. So, at the core of this is the question, “Did the payor intend for R&D work to be carried out on its behalf?”
HMRC looks at various factors to determine which of the two parties can make the R&D Tax Credit claim, which include:
- If the R&D is incidental to the supply of a product or service, it is not contracted out. This indicates the contractor can then make the R&D claim.
- If the contractor has a limited degree of autonomy, R&D is more likely to have been contracted out. Indicating that the payor can then make the R&D claim.
- The contractor has limited financial risk in undertaking the work, indicating the R&D work has been contracted out. Indicating that the payor can then make the R&D claim.
- The contractor does not retain Intellectual Property (IP) ownership arising from the R&D project, indicating the R&D work has been contracted out. Indicating that the payor can then make the R&D claim.
Often, judgement is required to weigh the above factors. Some of the factors may indicate the payor can claim, while others indicate the contractor can claim. RDP has extensive experience in making this judgement call.
This change concerns both new R&D Tax Credit schemes: a) R&D Intensive Loss-Making small or medium (SME) enterprises, and the new merged R&D Expenditure Credit (RDEC). The new rules apply to accounting periods beginning on or after 1st April 2024.
Payments to contractors for R&D activities will now need to be undertaken:
- in the UK or
- outside the UK in very limited circumstances (see below)
So, in other words, R&D must be undertaken in the UK to the extent that the activities undertaken by the contractor actually take place in the UK (see exceptions below)
HMRC states that this would include expenditure(s) by the contractor for:
- Employees of the contractor who are engaged in R&D activities and carrying out their duties in the UK
- Consumable items used by the contractor in R&D activities, which are used or consumed in the UK (note they may be sourced from elsewhere)
- Software, data and cloud services used by the contractor for R&D activities undertaken by workers in the UK (although the software, data or cloud services may, again, be sourced elsewhere)
- Payments to clinical trial volunteers located in the UK
It is also very important to note that there are “look-through” rules. If the contractor is based in the UK but the contractor’s R&D activities are carried on outside of the UK or partially carried on outside the UK by the contractor. Then the activities carried on outside of the UK will not qualify unless it meets specific exceptions (see below).
An apportionment of the costs will need to be made where some activities take place in the UK and some elsewhere. The split needs to be made on a reasonable basis, which may include factors such as:
a) The number of workers in the UK vs. overseas
b) The proportion of salary costs attributable to the UK vs overseas, or
c) The number of days worked in the UK vs overseas.
Exceptions: Where R&D contractor work outside of the UK qualifies
There are 3 circumstances where R&D contractor work carried on outside of the UK qualifies. In this case, all 3 of the following conditions must apply for the R&D contractor expenditure to qualify:
- The first circumstance is that conditions necessary for the R&D are not present in the UK
- The second is that the conditions are present in the location where the R&D is undertaken; and
- The third is that it would be wholly unreasonable for the company to replicate the conditions in the UK
Here is an example HMRC provides as a circumstance where an R&D activity takes place outside of the UK and that would qualify as an eligible R&D activity for UK R&D Tax Credit purposes.
A company is conducting R&D to develop a prefabricated wall panel for an overseas market. Which has different regulatory standards/building practices from the UK. Development requires the company to work closely with construction companies local to this market to evaluate the constructability of prototypes. This clearly requires conditions (the presence of alternative construction practices) that are not present in the UK. It would be wholly unreasonable to replicate these conditions in the UK, and these conditions exist in places outside of the UK. Therefore, this activity would be satisfactory if undertaken in a location where the necessary conditions arise.
With over 10,000 R&D Tax Credit claims successfully prepared, RDP has the practical experience and knowledge. To guide you through the complexities of contractor-based R&D Tax Credit claims.
So, contact us today to discuss how changes to contractor fees can affect your claim, get assistance with your next submission or if you have any questions about our R&D Tax Credit services.