Subcontracted R&D – To claim or not to claim?

 

14 February 2025

 

4 min read

 

Subcontracting can be a tricky situation in an R&D tax claim, but it doesn’t necessarily mean you can’t claim.

 

In this post, we look at the new R&D tax rules and how they might affect your eligible contracted-out R&D expenditure.

 

KEY TAKEAWAYS

 

  • Understand HMRC’s new merged R&D tax relief scheme.
  • Identify which subcontracted costs qualify for claims.
  • Ensure all subcontracted work is performed in the UK.
  • Prove that you initiated and intended the R&D activity.
  • Engage competent professionals to manage and define R&D.
  • Seek expert advice to avoid HMRC compliance pitfalls.

 

Subcontracting can be a tricky situation in an R&D tax claim, but it doesn’t necessarily mean you can’t claim. HMRC launched the new merged R&D tax relief scheme last year and revised the rules on subcontracting expenditure – leaving many companies confused about which subcontracted costs they can (or cannot) include in their R&D claims.

 

Why The Changes?

 

Under the New Merged R&D scheme rules – which apply to all companies with accounting periods commencing on or after 1 April 2024 – subcontracting activity is a common (and sometimes subtle) area of difficulty for applicants.

 

This is due to HMRC making extensive changes to the rules around contracted-out R&D with three main objectives:

 

  • Encouraging UK-based subcontractors: Only work carried out in the UK counts.
  • Avoiding double claims: Preventing two companies from claiming for the same R&D costs.
  • Clarifying eligibility: Establishing which party can rightfully claim the relief.

 

What is Subcontracted R&D Work?

 

In simple terms, subcontracted R&D is where you pay another company or individual to undertake R&D activity on your behalf. Alternatively, it may refer to situations where you are contracted by another entity to perform R&D work.

 

Is Overseas Expenditure Restricted?

 

Yes. Under the Merged Scheme rules, all subcontractor activity must be carried out in the UK. Even if the subcontractor is based overseas, the work itself must be done in the UK.

 

However, there are exceptions if the necessary conditions for the R&D:

 

  • Are not available in the UK,
  • Are available in the location where the R&D is undertaken, and
  • Cannot reasonably be replicated in the UK.

 

Who Owns the Eligibility for Tax Relief?

 

Under the new Merged Scheme, the right to claim R&D Tax Relief belongs to the company that initiates or decides to undertake the R&D. This all comes down to two main factors:

 

  1. Who initiated the R&D?
  2. Who was aware of the need for the R&D?

 

This means that:

 

  • A company can claim for R&D contracted out by them to a third party, if it is reasonable to assume that they intended such R&D to be carried out when entering into the contract.
  • Whereas a company can claim for R&D undertaken to fulfil a contract if they took the initiative to undertake the R&D.

 

HMRC have also stated that blanket R&D clauses in contracts stating that any work done to fulfil the contract belongs to the contracting party will not be enough to prove that they intended for R&D to be done. Now the R&D being claimed for must be specifically covered by the scope of the contract, and there must be evidence that the company understood the exact nature of the required R&D and that they initiated it.

 

The Vital Role of Competent Professionals

 

A dangerous preconception that some companies have is “We paid for this whole development, therefore it’s our R&D.” The truth can be more complex. Some companies do indeed commission a piece of work (say within software development), but do not themselves have the ‘competent professionals’ who would be able to recognise when R&D (as defined by HMRC) starts and ends – or even if it exists at all.

 

Without competent professionals directing the work – and in particular, the resolution of technical challenges that may arise in the project – it can be hard to justify this as R&D. More likely, HMRC would argue that the company was simply setting a specification for another company to implement, as opposed to defining a piece of subcontracted R&D.

 

Conclusion

 

These types of discussions can get very nuanced and it’s hard to give definitive guidance beyond what’s in HMRC’s manual – much depends on the nature of the underlying facts and representing those in the correct way to HMRC.

 

The upshot is that while claims can be disarmingly simple to submit, they can be bafflingly complex to submit. Companies must get to grips with these new rules if they want to continue claiming for subcontracted R&D, avoid HMRC penalties, and stay compliant.

 

And as HMRC continues to improve its policing of the scheme, mistakes will be caught more often and with greater financial consequences for applicants.

 

With this in mind, it is therefore advisable to seek advice from a reputable specialist, experienced in the technical and legislative aspects of R&D tax relief before preparing and submitting your claim.

 

Talk to us

 

If you need any further clarification on R&D subcontracting rules or wish to discuss your own R&D tax relief-specific circumstances — please get in touch with ABGi.  Our team can help you identify the qualifying elements of your projects and ensure your claims stand up to scrutiny.