If your R&D project involves contractors, specialists, or other personnel overseas, you might have heard that these costs can no longer be included in your R&D tax credit claim.
Though your foreign costs are largely no longer eligible for R&D tax relief, there are some exceptions to this rule. We’ve broken down what you need to know.
Can non-UK costs be included in an R&D tax credit claim?
Since April 2024, the rules around overseas costs tightened significantly. Under the Merged Scheme, which now applies to all companies with accounting periods starting on or after 1 April 2024, only activities physically performed in the UK by subcontractors and externally provided workers (EPWs) can be included in a claim.
This means that if you're paying an overseas contractor or an EPW who isn't subject to UK PAYE or National Insurance, those costs are excluded by default. The purpose of this restriction is deliberate: the government wants the scheme to reward and incentivise innovation happening on UK soil.
This applies to where their work was carried out, with no prejudice to their nationality or the subcontracting company’s usual location. An EPW who is Polish and works for a company headquartered in the US will still qualify if they carry out their R&D work in the UK. Likewise, a British person working for a British company but that is subcontracted to carry out their work in France will not qualify.
It's worth noting that this restriction applies specifically to contractors and EPWs. Your own employees' staff costs are treated differently, so if your employees travel abroad to carry out R&D work, you can still include those costs (same as any other eligible cost).
What are the exceptions to the overseas rule?
Some overseas costs can be claimed, but only in very specific circumstances. HMRC does allow overseas contractor and EPW costs to be claimed if all three of the following conditions are met simultaneously:
- The conditions necessary for the R&D are not present in the UK
- The conditions are present in the location where the R&D is being undertaken
- It would be wholly unreasonable to replicate those conditions in the UK
All three must apply; meeting one or two isn't enough. If your situation doesn't satisfy each condition, those overseas costs will need to stay out of the claim.
But what does 'wholly unreasonable to replicate in the UK' actually mean? HMRC provides a non-exhaustive list of situations it would consider to meet this threshold. These include:
- No suitable UK test facility available within the project timescale, and it would be unreasonable for the company to build or replicate one
- Medical circumstances, such as the incidence of a particular disease in a specific population, or the availability of clinical trial participants in a given location
- Physical or geophysical conditions, such as deep oceans, high altitudes, volcanic or seismic environments, or deep mines required for particle detection
- Access to specific machinery or facilities that only exist overseas
- Legal or regulatory requirements, such as rules requiring that certain activities are carried out in a particular country or under a specific recognised regulatory body
This list isn't exhaustive, so other scenarios may qualify. But the common thread is clear: the overseas location must offer something genuinely impossible, or wholly impractical, to replicate at home.
Cost or convenience won't cut it. Using an overseas contractor because they're cheaper, faster, or more familiar to your team is not a qualifying reason.
A practical example
Company A is a pharmaceutical business developing a treatment for a tropical disease with a very low incidence rate in the UK. To run Phase II clinical trials, they need a minimum number of eligible participants, which simply aren't available here. The company partners with a research organisation in West Africa, where the disease is prevalent, to conduct the trials. Because the medical conditions required for the R&D genuinely don't exist in the UK, Company A can make a strong case that the overseas costs should be included in their claim.
By contrast, Company B is a software business that uses an overseas development team because they've worked with them for years and their rates are less costly than what can be found in the UK. The R&D could be carried out by UK-based developers, but the company prefers its existing relationships. Those overseas contractor costs would not qualify.
How do you evidence an overseas cost claim?
If you believe your overseas costs meet the qualifying conditions, documentation is critical. HMRC will scrutinise these claims carefully, so you'll want to build your evidence file contemporaneously, not months after the fact.
Useful evidence includes:
- Correspondence or reports showing why the specific conditions don't exist in the UK
- Regulatory or legal documentation requiring the activity to be carried out in that location
- Evidence of attempts to source equivalent UK facilities or participants, and why these were unsuitable or unavailable
- Contracts with overseas parties that clearly describe the nature of the R&D being undertaken
The stronger your documentation, the better positioned you'll be if HMRC opens a compliance check. With the number of enquiries into R&D claims rising in recent years, this isn't a risk worth taking lightly.
What about claims before April 2024?
If your accounting period began before 1 April 2024, different rules applied. The UK-only restriction on contractors and EPWs was introduced as part of the Merged Scheme, so earlier periods would be assessed under the SME Scheme or RDEC Scheme rules that were in place at the time.
If you're claiming for a period that crosses 1 April 2024, be aware that you can't split the rules. The claim is governed entirely by whichever scheme applies to that accounting period, even if most of the costs fall after the transition date.
Key takeaways
- Under the Merged Scheme (for accounting periods beginning on or after 1 April 2024), overseas contractor and EPW costs are excluded by default
- An exception exists, but all three qualifying conditions must be satisfied simultaneously
- Cost and convenience are not qualifying exceptions; the conditions must be genuinely impossible or wholly unreasonable to replicate in the UK
- Industries most likely to have qualifying overseas costs include pharmaceuticals, geoscience, and deep-sea or extreme environment research
- Evidence should be gathered contemporaneously and kept on file in case of a compliance check
Overseas R&D costs can still be claimed, but the rules are narrow and HMRC's scrutiny of R&D claims is greater than ever. Getting this right matters for the value of your claim and your compliance position. If you're unsure whether your overseas costs qualify, our team can help you work through the detail before you submit.
To find out whether your R&D claim includes costs that could be at risk, get in touch for a free consultation.
