New rules for overseas expenditure - R&D Tax Reliefs (2024/25)

With the recent updates to R&D tax reliefs starting from 1st April 2024, significant changes have been made regarding  spending on overseas projects involving third-party services.

These all apply for accounting periods beginning on or after 1 April 2024.

New overseas R&D restrictions

For accounting periods beginning on or after 1 April 2024, expenditure on overseas R&D activities performed by contractors or third-parties will generally no longer be allowed.

The exception to the general rule is where conditions necessary for the R&D are not present in the UK, and are present in the overseas territory and it would be wholly unreasonable for the claimant to replicate them in the UK. 

If you have staff on the UK payroll, paying UK PAYE, then their costs are not affected by these new rules and it is still fine if some of their R&D activity is performed abroad – an example might be a site visit to a laboratory overseas than undertakes some testing.

Externally provided workers

But where you are contracting out R&D activity that takes place overseas or engaging third party “externally provided workers” that are not liable to UK PAYE, then you will not be able to claim their costs, bar certain conditions.

The guidance from HMRC clarifies that for payments made to contractors, it is the location of the activity that determines whether the overseas restriction applies, whilst for payments for externally provided workers (EPW), it is whether the EPW’s earnings are subject to UK PAYE and Class 1 NICs that determines whether the restriction applies.

What HMRC will require

HMRC will require any claimant company to have an understanding of where their supply chain is based and where the R&D being undertaken is being performed and, to the extent that where some activity takes place in the UK and some not, the payment to a contractor (or supplier of EPWs) should be apportioned to the UK element of the activity on a just and reasonable basis.

The guidance does suggest that HMRC’s approach when requesting evidence that the R&D was undertaken in the UK should be pragmatic and proportionate to the risk; for example, “if a contractor is small and has a UK trading address, evidence of this address would be sufficient.” 

Exceptions to overseas R&D restrictions

Overseas expenditure on contracted out R&D, and on payments for EPWs who are not subject to UK PAYE/ NIC, may still qualify for relief if certain circumstances are met – these are:

• That conditions necessary for the R&D are not present in the UK;
• That the conditions are present in the location where the R&D is undertaken; and
• That it would be wholly unreasonable for the company to replicate the conditions in the UK.

All three of these must apply for the expenditure to qualify for the exemption.

Non-exhaustive examples

Non-exhaustive examples are given of fact patterns that may suggest it would be ‘wholly unreasonable’ for the claimant to replicate conditions in the UK; these include:

• Time pressure to undertake the R&D, e.g. from a commercial, legal, or contractual perspective, or where the R&D itself demands it (e.g. where samples have a limited life);
• Medical circumstances, such as incidence of a disease, or availability of participants to trial a drug or other medical treatment;
• Physical or geophysical circumstances;
• Presence of machinery or facilities to which a company may require access;
• Environmental sustainability; and
• Legal or regulatory requirements (including explicit legislative requirements, as well as requirements, decisions, guidance, and agreements of regulatory bodies).

If you are conducting R&D activities overseas, you should consider if the exemptions to the overseas restriction would apply. There are a number of practical examples included in the guidance to help.