R&D tax credits can make a significant financial contribution towards the cost of developing new technology. However, with the introduction of the merged R&D scheme for accounting periods starting on or after 1 April 2024, there are many changes to the rules to be aware of. Some changes are restrictive, but the new rules for contracted out R&D may benefit larger businesses.  

The old rules 
 

Under the previous rules, companies claiming under RDEC (research and development expenditure credit) could only claim for the costs of outsourcing their R&D when the work was sub-contracted to a limited number of ‘qualifying bodies’ (e.g. universities and other not for profit organisations) and to individuals or partnerships. Small and Medium sized Enterprises, (SMEs), however, could claim 65% of the costs of qualifying subcontractor payments.  

Merged scheme rules: contracted out R&D  
 

The rules for contracted out R&D under the new merged regime have been modelled on the old SME regime but with some important modifications. Under the merged R&D regime, all companies can claim for qualifying payments for contracted out R&D where these three conditions are met:   

1. There must be a contract (even if not specifically for R&D work). 
2. To meet the obligations under the contract, R&D work is actually undertaken by the contractor (or their subcontractor). 
3. “It is reasonable to assume, having regard to the terms of the contract and any surrounding circumstances, that the person [principal /customer] intended or contemplated when entering into the contract that research and development of that sort would be undertaken in order to meet those obligations.” 

To fulfil the third condition, it is vital that the principal/customer has “competent professionals” (i.e. someone with the technical knowledge to understand what scientific or technical uncertainty was required to fulfil the contract) who are involved in the contract negotiation and are in a position to articulate the R&D required.  

In addition, HMRC will consider the following factors when determining whether the principal/customer can make an R&D claim for the contracted-out R&D:  

• Will they own any intellectual property (IP) created? 

• Do they bear the financial risk in undertaking the work? 

• Do they oversee the R&D such that the contractor has limited autonomy? 

• Do they have the ability to decide how the R&D is ultimately to be exploited? 

• Does the decision to undertake the R&D flow from the customer’s wider strategy or an immediate tactical challenge recognised by the contractor? 

• Is it evident that contractor specialises in providing R&D services and the contract is typical of those R&D activities? 

Merged scheme rules: R&D claims by contractors 
 

Contractors can still make a claim for R&D relief in the following circumstances:  

• Where the customer did not “intend or contemplate” contracting out R&D at the time of the contract (see above), or 

• They are carrying out their own in-house R&D that is unrelated to a customer contract, or 

• Where the customer is an "ineligible company" (e.g. a charity, an association, health service body), or  

• The principal/customer is not carrying on a taxable trade in the UK (e.g. Government body or overseas customer). 

Additionally, where a group company contracts out R&D to another group company, both companies can enter an election for the company undertaking the R&D to claim the R&D relief. 

The changes also mean that a company can claim relief for contracted out costs, where it contracts out its R&D to a company, which in turn contracts out the R&D to another subcontractor. This was previously disallowed. 

It is worth noting that overseas costs cease to qualify for R&D tax credits for accounting periods beginning on or after 1 April 2024, so regardless of which party claims the R&D, it must be carried out in the UK. 

Planning for a ‘Yes you can’ 
 

To enable a valid claim, contemporaneous documentation and evidence of how the above conditions are met should be prepared and retained. It is not enough to have a blanket clause in all contracts stating that you, as principal/customer, will be entitled to claim the R&D relief.  

In addition, it is vital to have a competent professional involved in defining the scope of work to be undertaken by the contractor and in the contract negotiations. You may also wish to include a collaboration clause in the contract to ensure that you get access to all the data you need to make the R&D claim. 

The new rules may be accommodating to large businesses but a high level of advance planning and contemporaneous record keeping will be needed to support claims for contracted out R&D, so putting good processes in place for all IT and development projects will help you access this valuable relief when it is available.  

A review of existing contracts will also need to be undertaken to understand whether the associated costs will qualify for R&D tax relief. 

To find out more visit: www.bdo.co.uk/en-gb/services/tax/innovation-and-r-d-tax-incentives