Subcontracted R&D: All You Need to Know

Understanding how subcontracted R&D fits into tax relief schemes is essential for businesses aiming to optimize their financial approaches while fostering innovation. Submitting an R&D tax claim as an in-house cost when it was in fact subcontracted is one of the biggest mistakes often seen for R&D tax claims.

We will explore the specific features of Subcontracted R&D within various tax relief frameworks, highlighting important factors for both Small and Medium-sized Enterprises (SMEs) and larger corporations. 

From qualifying criteria to financial implications, our goal is to equip you with the knowledge to make well-informed decisions about utilizing subcontracted R&D to propel your business growth.

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SMEs can typically seek reimbursement for up to 65% of the payments made to subcontractors, provided the subcontractor maintains no connection with the company. 

However, if there is a connection, such as shared shareholders, the claim will be based on the lesser of either:

1. The Eligible Expenditure of the Contractor: the expenses incurred directly by the subcontractor for the R&D activities. These expenses include labour, materials, and other costs directly associated with the R&D project.
2. R&D Payment Made to the Subcontractor: the actual sum paid by the company contracting the subcontractor for the R&D services. It includes the payment made to the subcontractor for their contributions to the R&D project.

SMEs can include payments for various activities, such as staffing costs, externally provided workers, and consumable items directly related to subcontracted R&D.

From 2024, under the new merged scheme, in cases where R&D is conducted under a contract, the new R&D expenditure credit and the increased support for loss-making R&D intensive SMEs as of April 2024 allow the customer to claim for R&D that has been contracted out, with some exceptions. 

R&D is considered contracted out when it is reasonable to assume that the customer intended or anticipated this type of R&D. This could cover an entire commercial project, a full R&D project, or aspects of an R&D project, with the rules applying equally to all scenarios. 

However, if a company contracted to work for a customer conducts related R&D and it’s not reasonable to assume the customer intended or anticipated such R&D, then the contractor can claim for it, provided they meet other relief rules. This isn’t R&D contracted to the company under the new rules because the decision to initiate the R&D is made by the contractor.

The updated legislation, CTA09/1133, defines when R&D is contracted out or not, affecting sections 1042D, 1042E, 1042F, 1052, 1053, and 1053A, which outline what expenses a company can claim.

There are instances where the contractor can make a claim even if the conditions of CTA09/1133 wouldn’t normally be met, like when the customer isn’t a UK taxpayer and therefore couldn’t make a claim themselves. These cases are explained further in section 7.5 and below. Understanding CTA09/1133 is crucial for determining who can make a claim in a given situation and to prevent double claiming.

Subcontracted R&D:

• Subcontracted R&D occurs when a company hires an external entity, known as a subcontractor, to perform specific research and development activities on its behalf.
• The subcontractor is responsible for carrying out tasks related to the company’s R&D projects, contributing specialized skills or expertise to a particular aspect of the research.
• The company pays the subcontractor for the services rendered, and these payments may be eligible for subcontractors R&D tax relief, particularly for SMEs. The subcontractor may or may not be connected to the hiring company.

Subsidized R&D:

• Subsidized R&D involves a situation where external funding or financial support is provided to a company to facilitate its research and development activities.
• The support can come in various forms, such as grants, loans, or other financial incentives, and it aims to encourage and assist the company in pursuing innovative projects.
• Unlike subcontracted R&D, where the company pays the subcontractor for services, in subsidized R&D, the financial support is usually provided to the company directly or indirectly by a third party, such as a government agency or a private organization.

Key Difference:

• In subcontracted R&D, the company pays an external entity for services related to R&D.
• In subsidized R&D, the company receives financial support from an external source to help fund its own R&D activities.