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New guidelines: changes to overseas expenditure R&D tax relief requirements from April 2024

To refocus R&D investment and innovation domestically, for the purposes of R&D tax relief the government is changing what qualifies for overseas expenditure both pertaining to you and any business that you may subcontract your work starting April 2024. If you are a business looking to claim R&D relief, or are helping a business which is claiming, we suggest you familiarise yourself with the new guidelines and if you have questions, please reach out to us.

Following the Spring Budget 2023 announcement, R&D tax relief has outlined the overseas expenditure changes that are due to come into effect for both the R&D Expenditure Credit (RDEC) and SME R&D tax relief schemes. If your accounting period begins on or after 1 April 2024, these changes will affect your claim. This legislation also includes other changes to the R&D tax relief scheme, such as expanding eligible costs and a new R&D tax relief rates, which we’ve written separate articles on.

When a limit on overseas expenditure was presented, many accountants and R&D consultants had opposing words, including ourselves. However, with the publishing of the draft legislation, we now know that this change is happening so what are some things to keep in mind?

What is changing for overseas expenditure?

If your business conducts most of its work overseas and has overseas expenditures, the new changes to the R&D tax relief scheme may require you to shift your approach. To a large extent, R&D work undertaken outside the UK will not qualify. If work is partially undertaken within the UK, any related costs should be apportioned to only reflect the UK element of the activity.

There are three factors that may make overseas costs eligible for the tax relief, all of which have to be met to be eligible. The three factors are:

  • Conditions (geographic, social, environmental) necessary for the R&D are not present in the UK
  • The required conditions are not present within the UK but are presented overseas where the R&D will be undertaken
  • It would be wholly unreasonable to replicate the conditions in the UK

There is some ambiguity regarding the concept of wholly unreasonable as it will rely on the unique factors of each business. However, this means that if enquired, businesses will need to demonstrate evidence to HMRC why they deemed undertaking R&D in the UK as unreasonable.

Additionally, HMRC states:

‘it may be that there is time pressure, requiring use of a facility abroad which could be replicated in the UK, but would take too long, or that UK facilities are available, but are fully booked on the required timescale’ (1.2).

We believe that there will be some contention between what businesses consider as time pressure versus HMRC. Figuring out what the appropriate scale of time to warrant taking your R&D abroad will most likely be tested and moulded through tribunal cases. Nonetheless, it’s still an encouraging option should there be a requirement.

It is worth noting that HMRC will not consider the overseas expense as eligible where the sole reason for undertaking R&D abroad is related to the cost of labour. However, if there are legislative requirements, treaties and/or similar obstacles preventing work from being carried out in the UK, this could qualify.

What about connected parties?

The draft guidance makes no distinction between connected party subcontractors and EPWs and those provided by third parties when deciding whether an overseas expenditure qualifies. Instead, in Chapter 2 of Part 13 of CTA 2009 (relief for SMEs on the cost of R&D) section 1134 the definition of relevant subcontractor expenditure for connected parties was extended to include ‘UK or qualifying overseas expenditure’.

Note that under the RDEC scheme, as per the current guidelines, subcontractor costs are not allowed, unless work is subcontracted to an individual, a qualifying body (such as a university) or a partnership of individuals. Nonetheless, all provisions reinforce the rules outlined above.

Therefore, the new limit of what qualifies as overseas expenditure will consider everything as one and the same and to comply with the new rules, businesses contracting work to subcontractors will need to ensure the work is done within the UK. Monitoring this for connected parties should be straightforward, however, for unconnected party this presents a challenge and most likely will require specific contractual clauses.

The legislation will also introduce section 1132A in the Corporation Tax Act 2009 called ‘qualifying earnings’, which outlines what qualifies as an expense for externally provided workers. Going forward for externally provided workers to qualify, instead of the restriction being based on where the work is undertaken, it will now be based on where the worker pays their taxes.

Next steps

We understand that this new ruleset will present challenges for some businesses that undertake R&D overseas. If you have questions about these changes and what it means to your clients or your business, feel free to reach out.

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