In this article, we will be exploring how a company’s R&D tax position is affected by various connections to overseas companies. We will be exploring the following cases:
- UK company subcontracting R&D to a foreign company
- UK company that is a subsidiary of a foreign company
- UK company that has overseas subsidiaries
UK companies subcontracting its R&D to a foreign company
Expenditure on subcontracted R&D is allowable under the SME (Small & Medium-sized Enterprises) scheme only. To claim under the SME scheme (where the claim value is up to 33.3% of qualifying costs), the group must have less than 500 full-time equivalent employees and either less than €100m in annual turnover, or less than €86m in assets. The RDEC scheme offers a pre-tax benefit of 12% of qualifying costs.
A common misconception about the R&D scheme is that subcontracted R&D work must be carried out within the UK borders to qualify for the scheme. In reality, the qualifying work can take place anywhere in the world, providing that it meets the definition of subcontracted R&D for tax purposes and it is being funded by the UK-based company making the claim. It’s worth noting that you can only include 65% of qualifying subcontractor costs in your R&D claim as opposed to 100% of qualifying costs of full-time employees.
If you are not an SME and claiming under the RDEC scheme, you cannot include any subcontractor costs in your claims regardless of where the work is done.
However, if you have overseas individuals who are working on a qualifying R&D project, you may still be able to include them in your claim as externally provided workers (or EPWs). The main difference between these and subcontractors is usually that they will be under your company’s direction, supervision and control while carrying out the qualifying work.
In order to be considered EPWs, workers must be engaged through a 3rd party staff controller. This could be an agency, an offshore development house, or a group company. If the staff controller is a group company or by joint nomination with the staff controller, you will be designated as Connected parties for R&D purposes and instead of claiming 65% of the payments made to the staff controller, you will be able to claim the lower of the payments to the staff controller and the actual underlying costs of the controller.
Sensible R&D planning at the time of contracting with an offshore development company can often yield significant future benefits. Where offshore development takes place with open commercial arrangements, and clear visibility as to the underlying cost base, using the joint nomination rules for Connected parties will allow a company to claim more than the usual 65%.
Finally, after April 2020, the cash benefit of R&D claims whether RDEC or payable credits will be limited to 3 times the value of their PAYE and National Insurance liabilities for that year. This will clearly affect companies that subcontract their R&D while having minimal UK staff costs. More on this here.
UK company that is a subsidiary of a foreign company
A company that is a UK-based subsidiary or branch of a foreign company, and which carries out qualifying R&D activities, is still eligible to make an R&D claim providing it falls under UK Corporation Tax. Under the SME scheme, a company cannot claim for R&D that is subcontracted to it, which includes from a group company. However, assuming that there is a commercial reason to do so, and that it is not artificial, careful structuring to ensure that it is not subcontracted R&D, together with the appropriate supporting documentation will allow the relief to be successfully claimed.
UK holding company that has overseas subsidiaries
A UK-based holding company with overseas subsidiaries can also claim R&D tax relief normally under both the SME and RDEC scheme. Once again, the type of scheme is determined by its size, turnover and assets. However, if it is claiming under the RDEC scheme it may be able to include 100% of qualifying R&D costs rather than 65%, if it subcontracts its R&D work to its overseas subsidiaries or EPWs. This is because the foreign subsidiaries are considered ‘connected companies’ so the normal restrictions that govern subcontracted R&D do not apply.
It is worth noting that company structures and relationships between holding companies, subsidiaries and subcontractors can be complex and must be considered on a case-by-case basis when preparing an R&D claim. Nevertheless, we hope you found this general guide useful.
If you would like some obligation-free advice about your specific case, feel free to contact us.