R&D Tax Credits: Subcontractor and EPW rules are changing

Companies across the UK will be affected

Following the Spring Budget of 2021, the government laid out plans to review the R&D Tax Credits scheme in relation to subcontractors and Externally Provided Workers. It’s a substantial update that will affect thousands of companies up and down the UK. Here we take a look.

R&D Tax Credits in brief

R&D Tax Credits were launched in the UK in the year 2000 as a government-backed tax incentive to encourage business innovation. Where a company has invested money in advancing scientific or technical knowledge - that benefits the whole field, not just the company itself - then R&D Tax Credits could well follow.

It’s a generous scheme too, currently offering up to 33% (with these rates changing in April 2023) of a company’s eligible retrospective R&D costs back. The award is offered either as a reduction in Corporation Tax, or (for loss-making companies) a cash credit. Where subcontractors or Externally Provided Workers have carried out activities relating to the R&D project, a proportion of their invoice can also be included in a claim.

Despite being lucrative, the scheme is also somewhat complex and applying for the relief is far from straightforward. Therefore, we strongly recommend reading through our R&D Tax Credits information to understand more.

Subcontracted activities and R&D Tax Credits: How does it work at the moment?

When your company uses another entity (person or business) to carry out R&D work for you, it’s classed as subcontracted R&D.

SMEs can typically claim 65% of the eligible costs of R&D work that’s subcontracted out, as long as the subcontractor is unconnected. If they are connected (subsidiary, branch or through person’s with significant control), then the claim will be based either on the eligible expenditure of the contractor, or the R&D payment made to them - whichever is less.

Companies claiming under the RDEC branch of the scheme can only use subcontractors that are individuals, a partnership of individuals, or a qualifying body for the expenditure to qualify.

For R&D tax purposes, subcontractors don’t currently have to be UK-based, and neither must the work happen on UK soil. Furthermore, the actual work that the subcontractor has carried out doesn’t have to be R&D itself when considered in isolation. However, it should be an integral part of your company’s wider R&D project.

What are the now legislated changes?

UK companies will not be able to claim R&D costs if the R&D activities occurred abroad. At the moment, a company may be based in the UK but have an R&D team working in Poland, for example. So, effectively, the government is currently footing a large part of the bill for this. But under the new rules, this will stop.

Although this - in theory - will save the government money, it’s also going to hit many UK companies hard where they subcontract their R&D overseas. It may also make collaboration between the UK and other countries much less attractive.

The new rules will take effect from accounting period starting on or after the 1st April 2023.

There are some narrow exceptions:

Where factors such as geography, environment, population or other conditions that are not present in the UK are required for research (for example, deep ocean research), and where there are regulatory or other legal requirements for certain activities to take place in specific territories (for example, clinical trials).

The exemptions will not include cost, or workforce availability.

How does this compare to R&D tax claims in other parts of Europe?

R&D Tax Credits are also available in various forms throughout Europe. To give some context, it’s interesting to understand how the rules relating to subcontractors are administered in other European countries compared to the UK. We’ve picked Ireland, France and Germany as R&D big hitters to look at.

Ireland

“R&D is crucial for both Ireland and the rest of the world because it plays an essential role in economic success.” - Tax Cloud Ireland

In Ireland, R&D Tax Credits can be claimed on subcontracted R&D as long as the work took place anywhere in Ireland, the European Economic Area, or the UK. Credit claimed will either be a maximum of 15% of the expenditure the company has incurred itself on R&D activities, or €100,000 - whichever is the greater. However, companies can only claim the above if they’ve incurred at least the same level of expenditure themselves on qualifying activity. In other words, if a company carries out no inhouse R&D at all - it instead subcontracts everything out - then it can’t be included in an R&D Tax Credit claim.

We cover this, alongside other costs that can be claimed, in our recent blog for our Myriad Ireland site: What Costs Can You Include in Your R&D Tax Credit Claim?

France

“Over a period of 19 years, ranging from 2000 to 2019, the gross domestic expenditure on research and development (GEPD) as a share of the gross domestic product (GDP) rose, peaking in 2014, when this figure represented almost 2.3 percent of the French GDP.” - Statista

France’s R&D Tax Credits scheme was started back in 1983 but only really took off in the early 2000s. Currently, a 30% Research Tax Credit can be claimed on qualifying R&D expenditure (up to €100 million of eligible expenditure, 5% thereafter). A 20% Innovation Tax Credit is also available for SMEs, up to €400,000 of eligible expenditure. This was launched in 2013.

Subcontracted R&D activity is claimable, as long as the R&D work took place either in France or elsewhere in the EEA. Unlike Ireland however, this doesn’t include the UK.

Research expenditure subcontracted to approved private research organisations are capped at an amount equal to three times all other eligible expenses, up to a maximum of €10 million. If looking to claim R&D Tax Credits, companies in France can also only subcontract out R&D to accredited private providers and those approved by the state. Furthermore, the ceiling on subcontracted R&D expenditures can be raised from €10 million to €12 million where R&D has been contracted out to state-funded providers.

In addition, technological watch costs (subscriptions to scientific associations, purchases of scientific articles, subscriptions to technical journals and scientific databases) can be claimed although capped at €60,000

Myriad Associates is excited to have recently launched in France, helping French companies achieve the R&D tax awards they deserve. You can find out more about the scheme and how to claim on the Myriad France website.

Germany

“Germany has invested more funds in research and development (R&D) in recent years than ever before. The Federal Government’s expenditure on R&D rose by 9 billion euros between 2005 and 2018 to 17.3 billion… this represents an increase of about 92%.” - Federal Ministry of Education and Research

Despite its major contribution to EU R&D as a whole, the German R&D tax incentive scheme was only established in 2020. It’s still a generous one though, offering a 25% tax deduction for R&D labour and subcontractor costs. The maximum amount claimable is €1 million per company per year (or group/holding if the company forms part of a bigger organisation). The award is administered either as a reduction in tax liability, or as a cash credit.

For contract research, 60% of money paid out to the contractor is taken into account. The percentage represents a flat-rate share that is intended to correspond to the contractor’s share of labour wages.

If you would like to discuss any aspect of R&D tax relief, including subcontractor costs, please feel free to get in touch for advice.