Overseas R&D expenditure: What qualifies under new rules?

For accounting periods beginning on or after 1 April 2024, the UK’s R&D tax landscape has undergone significant change. One of the key changes has been the introduction of restrictions on claiming expenditure in relation to R&D activity taking place overseas. This will impact how businesses approach to R&D claims featuring overseas R&D expenditure.

Overview

The general rule applies to claims made across both the new merged RDEC scheme and the enhanced R&D intensive support (ERIS) scheme. Under this rule, overseas R&D expenditure on subcontractors and externally provided workers (EPWs) no longer qualifies for relief within an overseas R&D claim.

Where R&D is contracted out to a third party, the work must be physically carried out in the UK for the expenditure to qualify. If part of the work is carried out overseas, the costs should be apportioned on a ‘reasonable basis’. This ensures that the overseas element is excluded from the claim. Similarly, where EPWs carry out R&D on behalf of a company, their earnings must be subject to UK PAYE and NICs. This is required in order for their costs to qualify.

When overseas R&D still qualifies for tax relief

Exceptions – qualifying overseas expenditure

There are some exceptions to the above rule which would allow expenditure on R&D work conducted overseas to qualify as part of an overseas R&D claim. The three stipulations the expenditure must meet are as follows:

• Conditions necessary for the purposes of the R&D undertaken are not present in the UK
• Those conditions are present in the location where the R&D is undertaken
• It would be wholly unreasonable for the company to replicate those conditions in the UK

Specifically, these conditions could be necessary due to geographical, environmental or social reasons. They may also arise as a result of legal or regulatory requirements. However, conditions related to the cost of carrying out R&D or the availability of workers are disregarded and should not be considered.

Whether replicating conditions in the UK is ‘wholly unreasonable’ depends on company circumstances and the type of R&D undertaken.

It may also be affected by time pressure in particular. This assessment should be made by the company. HMRC would expect the claimant company to carry out detailed analysis at the project planning stage. This planning can then be used to justify their choices, especially where an overseas R&D claim is being made.

HMRC have provided some examples to help with understanding these conditions. These examples can be found here. This is not an exhaustive list, however. As above, detailed analysis should be carried out based on the individual facts of the claim to determine whether any overseas R&D claim includes qualifying expenditure.

How to support an R&D claim featuring overseas expenditure

Claiming for EPW and subcontractor costs

Where a claim is to be made for costs relating to EPWs or contracted out R&D, it is important that you have considered whether the costs relate to work in the UK. If they relate to work overseas, you should consider whether they meet the conditions to qualify as part of an overseas R&D claim.

Where a claim is to be made for qualifying overseas expenditure, it is important that evidence to support the claim is retained. In the event of a compliance check, HMRC will expect that you are able to provide evidence to support your position. This includes contracts and emails.

Summary

The new overseas restrictions create additional complexities when making an R&D claim featuring overseas R&D expenditure. Early planning and consideration, including careful documentation of evidence can help to avoid potential pitfalls.