R&D Tax Credits – R&D work done outside of the UK: Staff, Contractors and Externally Provided Workers (EPW)

by | Dec 17, 2024 | R & D Tax Credits | 0 comments

R&D Tax Credits – R&D work done outside of the UK: Staff, Contractors and Externally Provided Workers (EPW)

There have been significant changes to contractor and EPW payments within the R&D Tax Credit scheme. We have summarised these changes below.

Foreign Contract Payments

Effective for accounting periods commencing after 1st April 2024. Companies will no longer be permitted to claim contract fees for R&D work done outside the UK, except in rare circumstances. This is going to affect many companies. Particularly those claiming software R&D projects where they are paying developers working outside of the UK. It was rare for a country that has an R&D Tax Credit scheme to permit these foreign-based costs to be claimed in the first place. As most government policies focus on government assistance that incentivises companies to use contractors within a country. This promotes increasing the skill set of people within the country.

What qualifies for the Foreign Contractor Payment

To qualify for the exception, 3 criteria must be present for the foreign contractor payment to qualify:

  • 1) conditions necessary for the R&D are not present in the UK
  • 2) conditions are present in the location where he R&D is undertaken
  • 3) it would be wholly unreasonable for the company to replicate the conditions in the UK

The following example is provided by HMRC in their draft guidance document of 27th May 2024. Which deals with 3) above and whether it is wholly unreasonable to carry out or replicate the conditions in the UK.

The company wishes to carry on destructive testing of its product, using a commercial testing lab (to which the work would be contracted).

If suitable test facilities exist both in the UK and abroad

The following apply:

  • If a UK test facility is available on the required timescale. The activity would not qualify if contracted outside the UK because the necessary conditions exist in the UK
  • If there is time pressure and UK facilities are available but are fully booked on the required timescale, condition 3) would apply if the activity were undertaken outside the UK.
  • If suitable test facilities do not exist in the UK. The question is whether the company (not somebody else) can reasonably replicate them in the UK.
  • If the company does not have the expertise or capability to effectively own and run a testing facility, or the facility might see little use, making its creation uncommercial it would be wholly unreasonable for the company to do this. In this case, condition 3) would apply if the activity were undertaken outside the UK.
  • If the company already operates similar facilities in the UK. Which could be easily adapted (assuming other factors do not prevent this, for example, that doing so would prevent the facility from being used for other necessary work) and provide the capacity required, it could be reasonable to expect it to do so. In this case, condition 3) would not be met if the activity were undertaken outside the UK.
  • If there is time pressure, and the replication of a facility in the UK would take too long, condition 3) would apply if undertaken outside the UK.

This example demonstrates some nuances to the exception that companies should be aware of. Particularly where they are at capacity for space on their R&D project.

R&D work done outside of the UK

Externally Provided Workers (EPW)

A similar rule to restrict foreign worker costs also applies to Externally Provided Workers (EPW).

The example provided by HMRC in their draft guidance of 27th May 2024 is as follows:

A UK company engages an unconnected staff provider (and there is no election for connected person treatment) to supply 10 specialist workers as EPWs to meet a particular need. Because their skills are in short supply, the staff provider is only able to provide 6 workers in the UK. They will work at the customer’s UK site. The staff provider is able, via its international networks, to locate 4 additional workers who are based in Mexico. They do not wish to relocate temporarily to the UK, and it is agreed that they will perform their functions remotely.

The workers based in the UK are subject to UK PAYE/ NIC, those based in Mexico are not. The UK customer makes a single staff provision payment to the staff provider to cover the provision of the 10 workers. Assuming that the wage levels are the same. 6/10 or 60% of the staff provision payment is qualifying earnings and therefore 65% of the payment is qualifying expenditure.

Staff and EPW’s

There are however some further nuances. First, the above rules do not apply to staff on PAYE. In other words, UK employees on PAYE can perform R&D activities anywhere in the world. Here is another HMRC example that sets out the difference between UK employees and EPW’s

A construction business sends a team of UK engineers overseas for 18 months to work on a specific construction project for a client. Which includes developing new construction techniques on-site. The UK engineers continue to be paid via the UK payroll and also work with locally based EPWs who need to be present on-site to support the R&D activity.

The overseas restrictions do not apply to staff costs so does not affect the payment for the UK engineers.

As the EPWs need to be on-site, and the site is abroad (and clearly can’t be replicated in the UK). Then the EPW costs will also satisfy the exemption criteria although the business should be prepared to state why they need to be on-site.

This area is very complex, and companies need to consider R&D work outside of the UK very carefully. RDP can assist in making these eligibility determinations. If you have any questions, please do not hesitate to contact us