Contracted out R&D tax relief UK: who can claim under the new merged scheme?

What are the new ‘contracted out’ R&D rules?

There have been big changes made to the eligibility of R&D undertaken by third parties when claiming tax credits. For businesses claiming for accounting periods beginning on or after 1 April 2024, contracted out R&D HMRC legislation now makes it harder for contractors to receive these benefits.

The government has made these changes to reward people who decided to innovate. These new R&D merged scheme contracted out rules affect all business sizes – large companies and SMEs.

What is contracted out R&D tax relief?

Under the new R&D merged scheme contracted out rules, HMRC defines R&D as ‘contracted out’ when a business pays another company to carry out research and development on their behalf. The paying company must have expected R&D work to take place when making this contract.

Contracted out R&D HMRC regulations define criteria as:

• An entire commercial project – The contractor completes R&D and other activities
• An entire R&D project – The contractor completes all of the R&D activities
• Aspects of an R&D project – The contractor completes certain parts of its overall R&D work

Three conditions must all be met for R&D to meet contracted out R&D CIRD rules:

1. Contract exists – There is a contract (written, verbal or implied) which includes R&D activities
2. R&D is undertaken under the contract – The contractor carries out R&D as part of the contract’s obligations
3. R&D was intended or contemplated at contract – When the contract was made, the customer expected R&D would be undertaken

Who benefits from tax credits when R&D is contracted out?

Under the new rules for contracted out R&D tax relief, the claim rights generally lie with the customer:

• If your business is the customer (commissioner) – you will generally claim under the new regime
• If your business is the contractor (you carry out R&D for a customer) – you will not usually be able to claim, unless very specific contracted out R&D conditions apply
• If you’re a subcontractor further down a supply chain – you will normally not claim when the subcontracted work feeds into a customer’s R&D project

What is the ‘intended or contemplated’ test for R&D?

The most significant change in the definition of contracted out R&D tax relief is the strong focus on the ‘intended or contemplated’ requirement. Section 1133 of the Corporation Tax Act 2009 states that the customer must have intended or contemplated that R&D would take place when hiring a contractor.

This means if you didn’t know at the time of contract that the work counted as R&D, then the claim may belong to the contractor.

What’s the meaning of ‘intended or contemplated’ in R&D under contracted out R&D HMRC guidance?

You must show that you intended or contemplated undertaking R&D by documenting contracts, IP ownership agreements and statements of work (SOW). Without this detail, HMRC may decide the contractor – not the customer – is the rightful claimant.

What does ‘irrelievable’ mean and how does it affect R&D for contractors?

There are narrow instances when a contractor can claim. This is when the customer is ‘irrelievable’ – meaning that they are not eligible to claim themselves. In these cases the contractor may become the party eligible to claim under the contracted out R&D tax relief rules:

• The customer is not liable for UK Corporation Tax – for example an overseas entity
• The project is initiated by the contractor – and not at the request of the customer
• The customer fails to show the ‘intended or contemplated’ test – even though R&D occurred

Overseas subcontractor R&D: what are the territorial restrictions?

From 1 April 2024 under the merged scheme, overseas subcontractors R&D is generally not eligible. The intention is to direct the relief towards R&D activity located in the UK, boosting domestic innovation. The rule applies to contractor payments and EPW arrangements where the underlying R&D occurs overseas.

What is the wholly unreasonable R&D overseas exemption?

Under overseas R&D expenditure rules (following the merged scheme), there is only one exception that allows overseas work to qualify. This is if the R&D would be ‘wholly unreasonable’ to carry out in the UK because specific conditions are only present overseas (geographic, environmental, social, legal).

For example:

• A UK-based biotech company needs to test a deep-sea sensor in a particular ocean habitat not present in UK waters
• A pharmaceutical trial must use a distinct patient population under foreign regulation

Practical decision guide: who should claim for your contracted R&D?

Here’s a quick self-assessment checklist. If you answer ‘yes’ to most of these questions, you may be the right claimant:

• Were you the customer? – You must have entered the contract and decided R&D was required
• Did your contract and SOW specify R&D? – You must deal with technological advance, uncertainty and IP risk
• Did you bear the risk? – You must retain major control/ownership over the output
• Did the work happen in the UK? – If overseas, it must meet the ‘wholly unreasonable’ test
• Were you the contractor? – If you simply executed R&D at the customer’s instruction, you likely cannot claim
• Is your client an irrelievable entity? – If they’re not UK tax-liable, you may be eligible to claim instead
• Are your contracts and documentation aligned? – These must meet contracted out R&D tax relief rules and the overseas subcontractors R&D restrictions

Next steps for compliance: protecting your contracted out R&D tax relief claim

To ensure compliance and maximise your R&D tax credits for subcontractors:

• Review your existing contracts, MSAs and SOWs – Ensure they clearly reflect intention, risk, location and ownership
• Update your procurement and contract-management processes – To capture the new documentation requirements (decision records, alternatives considered, risk allocation)
• Engage specialist support – With the complexity of the new contracted out rules, involving an expert can help you avoid HMRC enquiries or costly penalties

Contracted out R&D tax relief – FAQs

 

What are the contracted out R&D HMRC rules?

Contracted out R&D HMRC regulations define this as work arranged by a customer under contract with a contractor, where the customer intended at the outset that R&D would take place. The customer also needs to retain decision-making and risk.

Subcontracted R&D vs contracted out R&D – what’s the difference?

The R&D merged scheme contracted out rules dictate that subcontracted R&D is about who does the work, while contracted out R&D is about who decides what research is done. In contracted out R&D, the customer pays for the R&D to be performed, while subcontracted R&D happens in a supply chain of multiple parties.

Can a UK company claim R&D tax relief for using an overseas subcontractor?

After the 1 April 2024 R&D merged scheme contracted out rules, overseas subcontracted work is not eligible unless it would be ‘wholly unreasonable’ for the work to take place in the UK due to a lack of necessary geographic or environmental conditions.

If a company contracts out its R&D, can the subcontractor claim instead?

Who claims R&D tax credits, contractor or customer in the UK? Subcontractors generally can’t claim R&D tax credits under R&D merged scheme contracted out rules, as the company hiring them is the one who bears risk and is therefore the eligible claimant. If the customer cannot claim, the subcontractor may then become eligible.

What documentation should I keep to support contracted out R&D tax relief?

Keep contemporaneous records like contracts, SOWs, and board/minute records that evidence your decision to undertake the R&D. This includes documentation of risk allocation, where the work was performed (UK vs overseas), and any procurement chain records.

Can Contract Research Organisations (CROs) claim?

Since the roll-out of the merged R&D scheme (1 April 2024), CROs can only claim if the company that commissioned the R&D is ineligible to do so – e.g. an overseas business or a charity. However, if the CRO initiated the research independently, it may still qualify.

What were the rules for subcontracted R&D before 1 April 2024?

Under the old rules, large companies could claim subcontracted R&D costs if the work was done by a qualifying body. SMEs could claim 65% of payments to unconnected subcontractors. When SMEs carried out R&D for large companies, they claimed under RDEC, not the SME scheme.

How can Alexander Clifford help me claim contracted out relief?

With enquiries increasing, it’s more important than ever to meet compliance standards. 

If you’d like expert support to ensure you meet the new contracted out R&D tax relief rules, or help understanding overseas subcontractors R&D restrictions, our specialist consultants can help. 

Contact us today for a free eligibility review.