Consultation outcome

Research and development tax reliefs: new contracting out rules and overseas restrictions – draft guidance

Updated 27 March 2024

1. Overview

Legislation included in the Finance Bill (‘the Bill’) introduces changes to the research and development (R&D) reliefs, which apply for accounting periods beginning on or after 1 April 2024 (subject to transitional provisions).

In particular the legislation:

• restricts the extent to which contractor payments for R&D and payments for externally provided workers (EPWs) can qualify for R&D relief where the R&D activity takes place overseas, and
• introduces new rules for contracted-out R&D.

This is draft guidance on the effect of both these changes. It does not address other aspects of the legislation. We will publish full guidance on the changes made later in 2024.

The Bill makes these and wider changes by amending the Corporation Tax Act 2009 (“CTA09”). This draft guidance should be read alongside the Bill and the existing legislation. The Bill has not yet received Royal Assent, so the final version may differ from that in the Bill as introduced. The guidance itself may also change. No-one should take irreversible actions based on this draft guidance.

References to legislation, unless otherwise noted, are to provisions of CTA09 as they would be after amendment by the Bill. They include references to existing sections of CTA09 which are not amended by the Bill, existing sections of CTA09 which the Bill amends and new sections of CTA09 which the Bill adds.

For context, the R&D legislation in the Bill itself is structured as a clause (clause 2) which provides that a schedule (Schedule 1) has effect. The changes referred to above are all made by Schedule 1. Schedule 1 also makes changes to other relevant legislation as well as direct provisions about how all the changes come into effect. Schedule 1 is organised in paragraphs rather than clauses or sections because that is how Schedules are broken down.

2. Overseas expenditure: restrictions on eligibility for R&D reliefs of contractor payments and of payments for externally provided workers

For contractor payments the restriction in the legislation applies through the location of the activity. For EPWs, it applies through a requirement that the EPW’s earnings are subject to Pay As You Earn (PAYE) and Class 1 National Insurance contributions (NIC).

For both contractor payments and EPW payments there are exceptions where the R&D activity meets certain conditions – broadly, that the activity necessarily takes place abroad. See the sections 6.1 for the detailed conditions.

The draft guidance below explains what is meant by the location of R&D, and discusses cases where exceptions apply.

3. Overseas expenditure: contractor payments

The new rules apply to accounting periods beginning on or after 1 April 2024 and affect both the additional support for R&D intensive loss-making small or medium (SME) enterprises and the new merged R&D Expenditure Credit (RDEC). Under the new rules, to qualify for relief, expenditure on payments to contractors is required either to be incurred on R&D undertaken :

• in the UK (CTA09/1134(3)(e), CTA09/1136(3))

or

• outside the UK in the circumstances described in CTA09/1138A(2).For guidance on the application of this section, see section 6.1 and following ones below.

3.1 R&D undertaken in the UK

This requirement applies to the activities of the contractor, i.e. the company being paid to carry out the work.

R&D is undertaken in the UK to the extent that the activities which are part of the R&D project actually take place in the UK, regardless of where the factors used for the R&D project (such as materials) are sourced.

This would therefore include expenditure by the contractor on:

• employees of the contractor who are engaged in R&D activities and carrying out their duties in the UK
• consumable items used by the contractor in R&D activities, which are used or consumed in the UK (note they may be sourced from elsewhere)
• software, data and cloud services used by the contractor for R&D activities undertaken by workers in the UK (although the software, data or cloud services may, again, be sourced elsewhere)
• payments to clinical trial volunteers located in the UK

To the extent that the condition is partially met, with some activity taking place in the UK and some not, the contractor payment should be apportioned to the UK element of the activity on a just and reasonable basis. This will depend on the company’s circumstances, but it could, for example, be based on:

• the number of workers in the UK vs. overseas
• the proportion of salary costs attributable to the UK vs overseas, or
• the number of days worked in the UK vs overseas

3.2 Evidence to support a claim

Responses to draft guidance on overseas expenditure have requested detail of what evidence might be required to support this aspect of a claim. In claiming relief for contractor payments, a company is self-assessing that the expenditure meets all the conditions for relief, including the overseas restrictions. The company needs to take reasonable care to understand where the R&D takes place. HMRC cannot specify exactly how this is done, as circumstances will vary widely but businesses have a duty to keep and reserve records (see Part III of Schedule 18 Finance Act 1998). This duty applies to all aspects of R&D relief claims.

If businesses have an established relationship, the customer may already know where the contractor carries out their activities. If the parties have not done business together before, the customer may have chosen the contractor because they have particular facilities or areas of expertise available. From these, it may be clear where the activities take place. There may be arrangements to supervise or quality assure aspects of the R&D activities, which would allow the location to be understood and / or monitored.

The supply of R&D is similar to other aspects of the customer’s supply chain. Businesses need to understand their supply chain in order to operate successfully and to understand and control any risks.

The R&D reliefs claim process will not require upfront evidence of this. As with other aspects of the company’s tax affairs, the company may need to produce evidence to support overseas aspects, should HMRC request this. In this case, the evidence will need to show that the customer is complying with the overseas restriction but it might build on such existing processes and have a similar scope. This requirement would, however, 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. It would though be prudent for a company to identify and retain information such as PAYE or NIC reference numbers, contracts, confirmatory letters from subcontractors and invoices.

The same principles regarding evidence apply to EPW costs.

4. Overseas expenditure: externally provided workers

For the same accounting periods, to be qualifying expenditure (see CTA09/1129(3)(d) and CTA09/1131(2)), expenditure on payments to a staff provider or staff controller for provision of EPWs must either be

• attributable to “qualifying earnings”

or

• meet the conditions of CTA09/1138A(2). For guidance on the application of this section, see section 6.1 and on below.

4.1 Qualifying earnings

The worker’s earnings meet this condition if either the company or the staff controller is required to operate PAYE and account for Class 1 NIC in respect of them, whether wholly or in part. The PAYE/ NIC requirement therefore functions as a gateway. If it is met for a particular worker then all of the worker’s earnings are qualifying, and the appropriate part (e.g. 65% in the unconnected case) of any payment by the customer attributable to those earnings is qualifying expenditure.

A payment attributable to qualifying earnings is not simply the part of the payment from which the earnings are met. Typically an EPW payment will also cover other things such as the staff provider or staff controller’s overheads and possibly an element of profit, but it is all occasioned by the supply of the EPW, so is attributable to their earnings if those earnings are qualifying.

Note that this prevents a “double reduction” of qualifying expenditure through the application of the 65% factor to an amount that already excluded some of the payment – a possible effect of the draft legislation published in July 2023.

Example 1

A UK company engages an unconnected staff provider (and there is no election under CTA09/1130 for connected person treatment) to supply 10 specialist workers as EPWs to meet a particular need. Because their skills are in short supply, the staff provider is only able to provide 6 workers in the UK. They will work at the customer’s UK site. The staff provider is able, via its international networks, to locate 4 additional workers who are based in Mexico. They do not wish to relocate temporarily to the UK and it is agreed that they will perform their functions remotely. The workers based in the UK are subject to UK PAYE/ NIC, those based in Mexico are not. The UK customer makes a single staff provision payment to the staff provider to cover the provision of the 10 workers. Assuming that the wage levels are the same, 6/10 or 60% of the staff provision payment is qualifying earnings and therefore 65% of the payment is qualifying expenditure.

Example 2

An automotive business owns a test track in Scandinavia via a subsidiary in that territory, specifically for harsh weather conditions testing. They have a harsh weather conditioning environmental test unit in the UK but cannot test en-masse (it can only do one vehicle at a time) or do longer term durability testing in it. They plan to send vehicles to the overseas test track.

The subsidiary will supply drivers as EPWs and recharge for fuel (consumables).

There is no restriction on the cost of consumables used overseas.

The EPW costs meet CTA09/1138A because there is nowhere in the UK that has the required conditions for most of the year, or dependably in any year, and they can’t reasonably extend the one unit they have to meet demand for the testing.

5. Overseas expenditure: other qualifying cost categories

No similar restriction applies to other categories of expenditure beyond contractor payments and payments for externally provided workers. So it does not apply to staffing costs, consumables, software, data and cloud computing, or payments to clinical trial participants.

For example, if employees of a UK company need to attend a contractor’s overseas site to carry out elements of an R&D project such as assuring that the contractor’s work has been done according to specification, then those employees’ attributable staffing costs which meet the conditions in s1123 would be qualifying expenditure.

As described above, the place where expenditure in these other qualifying cost categories takes place will though be relevant in judging whether activity that is contracted out takes place in the UK.

Example 3

A construction business sends a team of UK engineers overseas for 18 months to work on a specific construction project for a client, which includes developing new construction techniques on-site. The UK engineers continue to be paid via UK payroll and also work with locally based EPWs who need to be present on-site to support the R&D activity.

The overseas restrictions do not apply to staff costs so does not affect the payment for the UK engineers.

As the EPWs need to be on-site, and the site is abroad (and clearly can’t be replicated in the UK) then the EPW costs will also satisfy CTA09/1138A although the business should be prepared to state why they need to be on site.

6. CTA09/1138A: Externally provided workers and contractors: R&D undertaken abroad

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 set out in CTA09/1138A(2).

There are 3 circumstances. They must all apply for the expenditure to qualify:

• the first circumstance (see CTA09/1138A(2)(a) is that conditions necessary for the R&D are not present in the UK
• the second (see CTA09/1138A(2)(b) is that the conditions are present in the location where the R&D is undertaken
• the third (see CTA09/1138A(2)(c)) is that it would be wholly unreasonable for the company to replicate the conditions in the UK

Necessary

Whether or not a condition is necessary for the R&D is for the company to judge. Like other business activities companies will wish to control their costs and the presumption should be that they will not be undertaking activity that is unnecessary. Project documentation may set out why/ whether an activity is necessary and what alternatives there might be.

Just because it is necessary to carry out one or more activities of the R&D project outside the UK does not mean that other activities of the project meet the conditions. Each must be judged on its own merits.

Not present in the United Kingdom/ Present in another location

While it seems as though it ought to be clear whether conditions are or are not present, in reality this may be a matter of degree with alternative ways of proceeding available. HMRC would expect that, in project planning, a company would consider alternatives and identify the best way forward and that this planning could be used to identify and justify choices made.

Wholly unreasonable

Whether it is wholly unreasonable for the company to replicate the conditions in the UK will depend upon the R&D, the circumstances of the company and the reason for undertaking the work abroad. 

In particular, time pressure may affect this. Time pressure may arise either from the demands of the R&D itself (samples may have a limited life, a particular result may be needed before the next iteration of a test run) from commercial, legal or contractual factors or from a mixture of both. There may be evidence to demonstrate this in project planning documentation, commercial documentation or less formally (communications between staff or between companies as the project evolves). Time pressure will affect different companies in different ways, depending on their size, resources and capacity.

There will be circumstances where it is obvious that time pressure is relevant, such as where unanticipated events occur which disrupt or change plans. In other cases time pressure will be apparent at an earlier stage when it becomes clear even then that some necessary condition will not be present in the UK. Each company’s circumstances need to be taken into account – what is wholly unreasonable for one may be reasonable for another.

Example 4

The company wishes to carry on destructive testing of its product, using a commercial testing lab (to which the work would be contracted).

If suitable test facilities exist both in the UK and abroad, the following apply:

If a UK test facility is available on the required timescale, the activity would not qualify if contracted outside the UK because the necessary conditions exist in the UK

If there is time pressure and UK facilities are available but are fully booked on the required timescale, the condition at (2)(c) would apply if the activity were undertaken outside the UK.

If suitable test facilities do not exist in the UK, the question is whether the company (not somebody else) can reasonably replicate them in the UK.

If the company does not have the expertise or capability to effectively own and run a testing facility, or the facility might see little use, making its creation uncommercial it would be wholly unreasonable for the company to do this. In this case and the condition at (2)(c) would apply if the activity were undertaken outside the UK.

If the company already operates similar facilities in the UK which could be easily adapted (assuming other factors do not prevent this, for example that doing so would prevent the facility being used for other necessary work) and provide the capacity required, it could be reasonable to expect it to do so. In this case, the condition at (2)(c) would not be met if the activity were undertaken outside the UK.

If there is time pressure, and the replication of a facility in the UK would take too long, the condition at (2)(c) would apply if the undertaken outside the UK.

Example 5

A disease with no prevalence in the UK requires a clinical trial to be undertaken outside the UK and the company decides to run the trial in Japan where the disease is prevalent. A contract research organisation (CRO) needs to be appointed with local knowledge and so a Japanese company is appointed.

Some of the activities it performs such as project management and data analysis do not need to be undertaken at the trial site. The Japanese CRO does not have operations in the UK and it would not be reasonable to expect the claimant to engage another party to do this because adding another would make the structure of the project more complicated, slower and prone to error. The entire cost paid to the CRO would therefore meet the conditions of CTA09/1138(2).

In contrast, had the appointed CRO been a multi-national enterprise with personnel in the UK who could undertake the project management and data analysis, the expenditure attributable to those activities would be ineligible if the activities were not undertaken in the UK.

Example 6

A pharmaceutical business engages a contractor to collect samples of newly identified plant species not native to the UK to determine their value as medicines. This requires a condition (the presence of the plants) that is not present in the UK, and one which is present in the foreign country. It would be wholly unreasonable, indeed impossible, to replicate this condition in the UK. And it is a condition that exists in places outside the UK. So this activity could qualify if undertaken in a location where the necessary conditions arise.

The question arises as to whether plant samples, gathered in a tropical country, should be analysed locally or brought back to the UK for this work. The answer to this will depend on a number of factors. It may be that the samples are unstable and need to be analysed quickly and this makes it necessary to do the work locally. Or possibly, the volume of samples from different countries means that some sort of initial screening is necessary, with only the most promising candidates brought back to the UK for follow up. Either of these could justify a claim for overseas expenditure.

Example 7

A company is conducting R&D to develop a prefabricated wall panel for an overseas market which has different regulatory standards/ building practices to the UK. Development requires the company to work closely with construction companies local to this market to evaluate the constructability of prototypes. This clearly requires conditions (the presence of alternative construction practices) that are not present in the UK. It would be wholly unreasonable to replicate these conditions in the UK and these conditions exist in places outside of the UK. Therefore, this activity would satisfy CTA09/1138A(2) if undertaken in a location where the necessary conditions arise.

Example 8

A company is conducting R&D in the development of a software service for the commercial banking market in the US. Development requires the company to have a collocated team in the US due to access regulations within the US banking sector. This requires conditions (the presence of US banking systems and regulatory requirements) which are not present in the UK, and which would be wholly unreasonable to replicate. This condition exists in the US. Therefore, this activity would satisfy CTA09/1138(2) if undertaken in the US, where the necessary conditions arise

Whether or not conditions can be replicated in the UK is not necessarily an either/ or question. It may be possible to replicate them in part, either numerically or qualitatively.

Example 9

Company A, the claimant, commissions Company B to undertake a clinical trial in the US. As this is contracted-out R&D for A, the overseas rules apply. (If A carried out the work itself directly, there would be no restrictions on its staff costs or any payments it makes to clinical trial participants as these categories are not restricted).

In this case there is no regulatory requirement for the work to be done in the US.

B is able to recruit 100% of the trial participants in the US in a reasonably efficient timeframe. Prior to submitting the claim, relevant databases indicate that it would not have been unreasonable to recruit 20% of the participants in the UK on the same timescale. A therefore limits its qualifying expenditure to 80% of the relevant cost (had it been clear that the UK recruitment could not be managed on a reasonable timescale, the full cost could qualify).

Under a different contract, Company B undertakes a clinical trial recruiting 50% of the participants in Europe and 50% in India. Although relevant databases show that 10% of the trial participants could have been sourced from the UK, this would have significantly disrupted the business plan resulting in delays and increased execution risk. In this instance the entire cost of the trial can be included as this factor means that is satisfies CTA09/1138A.

6.1 The conditions

The legislation does not include an exhaustive list of the sorts of condition necessary for the R&D that may be considered in applying CTA09/1138A(2). The term “conditions” is fairly wide, and while CTA09/1138A(3)(a) sets out some of them in two categories, (geographical, environmental and social conditions at CTA09/1138A(3)(a)(i) and legal or regulatory requirements at CTA09/1138A(3)(a)(ii)), these are not exhaustive. A valid condition may fall under either or both of CTA09/1138A(3)(a)(i) or (ii) or, possibly, neither of them. It is convenient to consider examples of valid conditions under the two headings.

Geographical, environmental and social conditions

These are features of the world (whether natural in origin, such as a disease, or the result of human activity, such as a test facility). HMRC’s view is that this includes (but is not limited to):

• medical circumstances such as incidence of a disease or availability of participants to trial a drug or other medical treatment (participants here covers both participants with particular relevant characteristics and willing participants in general, in particular note that there is a particular class of eligible costs for both reliefs that covers clinical trial participants)
• animal or plant distribution
• physical or geophysical circumstances (deep oceans or high altitudes; volcanic or seismic conditions; minerals and geology; fortuitous features such as deep mines suitable for locating particle detectors)
• centres of human expertise such as university or other research groups (but see section 6.2 for the distinction between this and availability of workers).
• the presence of machinery or facilities to which a company may require access
• cost (other than that associated with the R&D itself, see section 6.2 below).
• Environmental sustainability (for example the carbon impact of shipping materials or equipment long distances or by the choice to use green energy or be able to recycle waste)
• legal factors such as IP ownership

Other geographical, environmental and social conditions may also exist.

Legal or regulatory requirements CTA09/1138A(3)(a)(ii)

The legislation also states that legal or regulatory requirements may be relevant conditions.

HMRC’s view is that this includes:

• explicit legislative requirements (such as that activities must take place in a particular country or according to recognised regulatory principles which do not obtain in the UK) whether set out in national legislation, international agreements or treaties or elsewhere
• the requirements and decisions, formal and informal, of regulatory bodies (so for example, if testing of a drug must be done according to a method agreed by a regulatory body and that body decides that activity must take place in a particular country, or imposes requirements that make that necessary, then this is a regulatory requirement, even if it is not stated somewhere in legislation)
• guidance from regulators, local and state government and professional or accreditation bodies (e.g. specific accreditation from an industry body for a newly developed product)
• agreement by the regulator to a process that the company has proposed to ensure the trial complies with good clinical practice standards and that any proposed manufacturing facilities comply with Good Manufacturing practice standards

Example 10

Motorcycle and Motor Car Grand Prix regulators restrict their testing sessions to specific tracks, normally overseas. If a manufacturer uses such a facility for expenditure attributable to R&D that is affected by the overseas restriction (e.g. EPW costs) then would qualify.

Example 11

A SME life sciences business undertakes a range of clinical trials which include overseas EPW / subcontract activities. Some clinical trials relate to treatments for diseases more commonly present in the UK. The company uses a global CRO to identify clinical trial participants, and UK and overseas clinical trial sites are used.

The work could theoretically all happen in the UK - there are no regulatory requirements to carry out the studies overseas. However, the company is keen to utilise an ethnically diverse population sample (which is becoming increasingly important to regulators) - to achieve this diversity it requires them to undertake the trials in multiple overseas locations.

This also has the benefit of speeding up patient recruitment. Therefore a variety of circumstances are behind the decision for undertaking the work overseas.

As there is no regulatory requirement for overseas activity, CTA09/1138(3)(a)(ii) is not in point. However, the significance of other circumstances such as the increased speed of patient recruitment or other benefits that result from accessing an ethnically diverse population would need to be assessed.

Example 12

A drug company is required to run a trial in Germany to provide evidence in that territory such that the authorities will agree an appropriate price reimbursement for a drug after it is approved for use by the regulatory authorities.

In the absence of that evidence, it is unlikely that it would be economically viable to supply the product in Germany.

The payment for the cost of the trial would therefore meet CTA09/1138A(2). In this instance the relevant conditions are both economic and regulatory. However, had the primary reason been a lower cost of carrying out the trial, this would not satisfy CTA09/1138A(2).

The company might evidence this, if necessary, using a vendor selection form with a detailed description as to why a certain UK subcontractor or overseas subcontractor is chosen to conduct its R&D work. Alternatively, if there is specific correspondence from the regulatory body underlying the choice of supplier, this would also be useful evidence as might notes of meetings or calls.

6.2 Excluded conditions CTA09/1138A(3)(b)(i) and (ii)

The legislation excludes two things from being conditions, as defined in (3)(a), that would meet the test in CTA09/1138A(2). These are

• cost of the R&D activity,

and

• availability of workers to carry out the R&D activity.

These are the only conditions that are excluded. Unlike CTA09/1138A(3)(a), the list in (3)(b) is exhaustive.

Cost of the R&D will often be a factor in deciding where work is to take place. Where it is the only or main reason for activity taking place abroad, it will not justify the activity meeting the criteria, because of CTA09/1138A(b)(i). Where cost is a factor however it will often not be the only one. For example, if time pressures mean that R&D cannot wait until a new facility is developed in the UK, the fact that the staff to operate the facility are in short supply, and therefore expensive to employ, does not mean that CTA09/1138(3)(b)(i) and (ii) prevent the conditions in 1138A(2) being met. The conditions are met because another factor – the facility to carry out the R&D – would not be available.

Cost of the R&D and availability of workers will often go together, given that worker costs are a significant factor. But for the avoidance of doubt the same reasoning applies to both. If either cost or staff availability on their own, or a combination of them, is the main condition that cannot be met for the R&D to take place in the UK, then overseas expenditure will not qualify. But where other factors are significant, the mere existence of cost and/ or staff availability will not in itself disbar the overseas expenditure.

For clarity, the cost factor here is the cost of the R&D. Other costs are not excluded by (3)(b)(i). For example, the cost of constructing or adapting the facility referred to above may or may not be a cost of the R&D, depending on whether it is a cost of the R&D. This will depend on the accountancy treatment of the expenditure. However, transport costs generally will be a cost of the R&D, albeit not one that would qualify for R&D relief.

Example 13

Raw materials required to undertake the R&D are only available overseas, and the alternative to carrying out the work abroad would be to incur significant cost and carbon footprint of shipping the materials to the UK just to do the R&D testing. However, if transporting the materials to the UK is part of the cost of the R&D, it cannot be taken into account. If environmental concerns and the need for a steady supply of material were overriding factors, they might be relevant. Whether the condition in CTA09/1138A(2) is satisfied therefore depends on the wider facts.

Similarly, the second excluded condition is the availability of workers to carry out the R&D.

Example 14

A company needs AI computer scientists for an R&D project. There are many AI computer scientists in the UK, however the company has advertised open positions for a prolonged period but not enough people have applied. The company however finds several AI scientists from a well known university outside the UK and engages them on an EPW basis (under the supervision, direction and control of the core UK development team).

As availability of workers is not a condition that can be taken into account for the purposes of CTA09/1138A(2), the related EPW costs will not qualify.

Example 15

A software business designing software for use by financial services customers has teams of EPWs overseas to build software that links with the local stock exchanges. This is necessary due to the engineers needing detailed knowledge of the financial regulations in that territory in order to link with the stock exchange in a compliant manner.

There is a need for specific knowledge and it is plausible that this knowledge is more likely to be accessible by engaging individuals in the location of the stock exchange. However, this scenario relates to the availability of workers and it could be that this knowledge is readily transferable. As such, based on the facts presented, it is unlikely that overseas expenditure would qualify.

The exclusion in CTA09/1138A(3)(b)(ii) does not extend to other “people related” factors such as location close to key investors or to a leading university research group which might provide advice or guidance, unless these individuals are workers carrying out R&D. Such factors might justify activity taking place abroad, but each case will depend on its merits (for example, is there a comparable UK university research group that could provide the same quality of input?)

Example 16

A company is looking to undertake pre-clinical research on a new biologic drug candidate in a rare disease. Although there is some knowledge of this disease type in the UK the pre-eminent specialists are based in Switzerland and are able to conduct the pre-clinical research. The Company is able to provide evidence that the team in Switzerland have a level of technical capability that is not available in the UK.

However, availability of workers to carry out the R&D, as in the example, is not a condition that can satisfy CTA09/1138A(2)

As set out above, in determining whether or not it is wholly unreasonable to replicate conditions, existing abroad, in the United Kingdom, time pressure may be a consideration. Given the R&D project’s need for results within a certain timeframe it may not be reasonable for the company to replicate the conditions. Given more time, the answer might be different.

Since the availability of workers to carry out the R&D is excluded as a condition that can affect this judgement, it follows that if timeliness is an issue solely because of staff availability, it cannot be grounds for meeting the conditions in CTA09/1138A(2). If, however, there are wider timing issues, besides staff availability, the condition may still be met.

Example 17

Developing Example 2.4, the company owns a testing facility in the UK which is mothballed. It could be recommissioned quickly, but the company has no specialist staff to operate it, and training them would take too long. Apart from the availability of staff, then, it would be reasonable for the company to carry on the activity in the UK but availability of staff is not a factor that can be can be taken into account (CTA09/1138A(3)(b)(ii)). Therefore the conditions are not met.

7. Contracting out R&D: new rules

The part of the draft guidance addresses issues around activity involving two or more parties, and how to determine which party, if any, can claim the relief provided under Chapters 1A and 2 of Part 13 of CTA 2009. The simplest situation, often referred to, is one where a customer (generally referred to as Company A in this guidance) commissions some work and a contractor (Company B) undertakes it. The term used in this guidance for this is “contracting” not “subcontracting” which is reserved for cases where there are three or more parties.

7.1 Basic principle

The objective of the R&D reliefs is to increase the overall levels of R&D in the UK economy to generate productivity growth by reducing the cost of R&D, counteracting a market failure would otherwise reduce the amount of R&D taking place. This market failure arises because the value of R&D to the broader economy exceeds the immediate economic benefit of the R&D, and because of the risky and uncertain nature of R&D. To ensure that the relief is effective in this, it is important that the company making the decision to undertake R&D gets the relief for that expenditure. Allowing the decision maker to claim best incentivises decisions to undertake more R&D.

To meet this objective, where R&D is carried out under a contract, the new R&D expenditure credit, and the enhanced support for lossmaking R&D intensive SMEs from April 2024, both give the right to claim for contracted-out R&D to the customer, subject to certain exceptions. R&D is defined as contracted out where it is reasonable to assume that the customer intended or contemplated this sort of R&D would be done. Such a contract might cover an entire commercial project (including R&D and other activities), an entire R&D project or aspects of an R&D project. The rules apply equally to all three cases. The legislation also generally excludes claims for expenditure by the contractor, but with important exceptions. See below for more detail on both points.

However, if a company is contracted to do work for a customer, the company does related R&D and – having regard to all the relevant circumstances – it is not reasonable to assume that the customer intended or contemplated R&D of the sort carried out should be done, then (subject to meeting the other rules of the relief) the contractor can claim. This is not R&D contracted to the company under the new rules, because the decision to initiate R&D will have been taken by the contractor, which is important for the reasons set out in section. The contractor has been engaged to carry on specified work for the customer, not contracted to carry out R&D, so the R&D they do is initiated of its (the contractor’s) own volition.

It is worth noting that in this context, ‘contemplated’ does not indicate a minor or fleeting consideration but a more substantial intention^{[footnote 1]}. See section 7.2 below. “Intended or contemplated” goes beyond mere awareness that R&D will take place and requires a specific appreciation of what R&D will be done and therefore the ability to understand and specify that. While the exact details of who should claim the relief will depend on the specific contract and the circumstances around it, this potential for the contractor claiming is a departure from the previous rules in the R&D SME scheme.

Example 18

A company, B, is contracted to provide a product or service which is not R&D, such as constructing a building or developing a software product. From the contract, and the nature of the negotiations to agree it, it is clear to all parties that the customer, A, had no understanding or intention that any R&D should take place. If B undertakes R&D in delivering that product or service, it would be able to claim relief even though it is undertaking R&D on an activity contracted out to it.

Regardless of which party is able to claim, for a claim to succeed it will also of course need to satisfy all the other normal rules (for example, expenditure must be revenue and it must satisfy one of the qualifying categories such as staff costs).

In the amended legislation, CTA09/1133 defines when R&D is contracted out, and when it is not, for sections 1042D, 1042E, 1042F, 1052, 1053 and 1053A, which set out what expenditure a company can claim for.

In particular, there are cases where the contractor can claim even where the conditions of CTA09/1133 would not be met (for example where the customer is not a UK taxpayer, so would not be able to claim itself). These are covered at section 7.5 and on below. However, the interpretation of CTA09/1133 is generally key to who can claim in a given situation and to ensuring that there is not double claiming.

Regardless of which party is able to claim, for a claim to succeed it will also of course need to satisfy all the other normal rules (for example, expenditure must be revenue and it must satisfy one of the qualifying categories such as staff costs).

7.2 CTA09/1133

Purpose

Section 1133 CTA09 ensures that the costs of contracting out R&D by a customer to a contractor can attract relief for the customer. Where the customer is not contracting out R&D, the contractor can claim relief, if it carries out relevant R&D.

CTA09/1133(1)

This applies the section for the purposes of Part 13, that is, it applies equally for the reliefs provided by Chapter 1A (the merged expenditure credit) and Chapter 2 (the enhanced support for R&D intensive loss-making companies).

CTA09/1133(2)

Subsection (2) defines where a person (the customer) contracts out R&D, and therefore also when another person (the contractor) has R&D contracted to it. If all three parts of the definition in subsection (2) are not satisfied then the customer cannot claim for any payments it makes to the contractor – but the contractor may be able to claim, if it carries out R&D.

CTA09/1133 introduces three conditions, set out in subsection (2), all of which must be met for R&D to be considered contracted out. Together these identify who was the decision-maker for the R&D, and who may claim relief.

CTA09/1133(2)(a)

The first condition, at s1133(2)(a) is that there must be a contract. This could be a wider contract for provision of a product or services to include R&D, or it could be a more specific contract solely for R&D activities themselves. In either case any claim for relief by the customer will only be on the expenditure attributable to the R&D.

(2)(a) is not addressing whether or not R&D is specified – simply requiring that there is a contract. However, it follows that if there is no contract, then even in a situation where a company (Company A for simplicity) is funding another company (B) which performs R&D, A cannot claim R&D relief in respect of its payments. In such a scenario, unlike the previous SME scheme but like the previous RDEC scheme, company B may be able to claim for any R&D it does despite the fact that A funds it, as there is no prohibition on claiming for funded or subsidised activity.

CTA09/1133(2)(b)

The second condition, at (2)(b) is that to meet the obligations under the contract, R&D is undertaken. If for example company A and company B agree a contract for provision of software in the expectation that specified R&D will be needed but, in the event, the R&D is not carried out (for example because it was found not to be needed) then company A cannot claim for its payments. (If the R&D had been carried out, Company A might be able to claim, subject to (2)(a) and (2)(c) also being met).

CTA09/1133(2)(c)

The third condition, in subsection (2)(c), is that it is “reasonable to assume” that the customer (i.e. Company A) “intended or contemplated” that R&D would be undertaken to meet the obligations of the contract, and that this is R&D of the sort that is referred to by subsection 2(b).

The words “Intended or contemplated”, with the specification as to the sort of R&D that is envisaged, carry a greater weight than mere belief, or even knowledge, that R&D will be required^{[footnote 1]}. The nature of the R&D that is to be undertaken (such as a statement of the advance in science or technology and what uncertainties need to be addressed) would need to be articulated to show that it is intended or contemplated that R&D of a particular sort should be undertaken. This goes beyond listing project challenges and constraints, to specify specific R&D action.

This might be done in the contract itself, or in discussions leading to the contract, or in internal customer documents showing how the activity was required as part of the wider R&D. Because the activity might be a particular part of the customer’s wider R&D, or indeed commercial, project, the customer may not consider it necessary to share this with the contractor. A customer will be able to claim, under both reliefs, for activity which is in the contractor’s hands “routine” but which is R&D as part of the customer’s project. (For example, a standard test. In a case like that there is little chance of the contractor considering that this is R&D it might claim for, and it should be clear if necessary from a review of the customer’s project documentation why it meets the condition. In cases where this is less obvious, the party claiming should ensure that it can if necessary justify the claim. It may be helpful to discuss with the other party if this would help to resolve any doubt, although HMRC recognises that this may not always be possible.

Understanding and articulating the nature of the R&D means that Company A will need to have or draw on some technical capability (whether in-house or from elsewhere) though having this capacity is not in itself the condition that the legislation sets. Mere speculation or acceptance that R&D may be needed will not be sufficient to satisfy 1133(2)(c).

Therefore if the customer, Company A, is indifferent, albeit knowing that work to be taken under the contract could require R&D, then they do not intend or contemplate that it be carried out.

The legislation requires that this assessment is made “having regard to the terms of the contract and any surrounding circumstances”. The language of the contract is therefore important, as a source of evidence in assessing what Company A intended or contemplated, but so are the surrounding circumstances. HMRC would expect that where R&D is intended and contemplated, a number of commercial factors will align with that and form part of the “surrounding circumstances” referred to in the legislation. It is necessary to look at these overall circumstances in the round, to determine whether Company A’s primary objective is to have a project completed (whether construction of a building or infrastructure, or development of software) or whether Company A’s primary objective is to have some R&D performed.

These circumstances might include (but are not necessarily limited to):

• intellectual property (IP) ownership,
• financial risk in undertaking the work
• autonomy in how the activity is executed
• means by which the R&D is ultimately to be exploited
• the decision-making process (for example whether the motivation to undertake the R&D flows from the customer’s wider strategy or an immediate tactical challenge recognised by the contractor)
• the experience and seniority of decision-takers
• nature of the parties (for example whether it is evident that B specialises in providing R&D services and the contract is typical of those R&D activities).

These circumstances will not necessarily all be equally relevant or helpful in every case – for example, the question “who bears the risk” can be complex with bespoke, complex risk-sharing arrangements in some sectors such that unpicking who bears the R&D risk will not give a simple unambiguous answer (and the answer may well vary for different aspects of R&D on a single project).

Example 19

A manufacturer (Company A) contracts a third party (Company B) to provide specialist tooling and knows that R&D is likely to be required to develop this. The contract however is just for the provision of the prototype tooling.

These products form part of a wider R&D project of Company A. Although Company A understands that R&D is required and provides a detailed specification of product requirements, it does not possess the specialist expertise in this specific area of engineering.

Company B retains significant financial risk associated with the contract as it is undertaken at a loss (in the hope that Company A’s R&D project progresses through to manufacturing, which would ultimately result in large orders being made to Company B).

Although Company A understands that R&D will be required by Company B to fulfil the contract, Company B undertakes the associated economic risk. Furthermore, Company A does not specify for Company B, or set out internally, the R&D required (it is unable to as it lacks the expertise in this area) Company B would therefore (assuming it meets all other conditions) be in a position to claim the R&D relief.

Example 20

Company A (in the Chemical sector) has a product which requires an intermediate to be produced which is combined to form the final product. Company A has one source of supply for this intermediate but commercially this is a risk point, and so contracts Company B to produce the intermediate. The contract is for supply of X tonne at a cost of £Y/ tonne. Company B has a completely different process train (equipment) from that which Company A developed its process for the intermediate and different again from the current CMO supplier. Company A is aware of the difference in Company B’s process train, and understands at a high level that Company B will need to develop a process to deliver the intermediate in the quality, quantity and cost of goods required.

Company A may be aware of the requirement for R&D by Company B in order for it to fulfil the contract. Importantly however, Company A is unable to specify the R&D that would be required. Company B would be in a position to claim for the relevant expenditure.

High level wording in a contract that R&D was required would not be enough to satisfy 1133(2)(c). This could be added by a customer which wanted to reserve to itself the right to claim (and thereby deny the contractor this right) should any R&D actually be needed.

In such a case, looking at the wider circumstances, it might be that Company A could not substantiate what R&D was to be done or why it was needed. It would not therefore be reasonable to assume that A intended or contemplated that R&D of the sort that took place would be undertaken.

The condition is that it must be reasonable to assume that R&D was “intended or contemplated”, not that “the contract says X”. Just as mere formal language in the contract does not mean A has contracted out R&D, so the lack of that language should not be determinative that it has not.

Even if a contract is not explicit that R&D is needed, it may be reasonable to assume that it was intended or contemplated, for example having regard to factors such as those listed above.

Involvement by competent professionals may be relevant to this, for example, if the customer is to meet the condition that it was reasonable to assume that it intended or contemplated that R&D of the sort undertaken should be done, then it is likely to wish to draw on the expertise of its competent professionals (i.e. employed by it or brought in to advise on the issue) to inform the requirements of the contract. This may result in it specifying results that clearly required specific R&D.

While the presence of competent professionals may be relevant, Company A just having competent professionals does not mean that it is entitled to the R&D claim. What occurs in practice is key in determining the decision maker, including their role. Have they shaped the requirements of the contract, as described above? Is their role to ensure that B’s methods and outputs fit the specification (and therefore might have little to do with understanding the process of the R&D)?. Company A may sign off on the plans (and may engage competent professionals to check and approve proposals) but B may still initiate, lead and direct the R&D.

Example 21

Company A, whose trade is letting accommodation in buildings, commissions Company B, a construction firm, to supply a landmark new building. The building’s size, location, and required performance parameters (carbon neutrality, safety features, lifespan etc) mean that company B will need to conduct R&D.

While company A appreciates this, it does not, in contract negotiations or the eventual contract itself, specify this work in anything but a general sense. It does not state what it requires to be done or how this should be done (and it neither uses internal expertise nor seeks external input, for example from consultants or partners, on this). What is important to Company A is the result, ie that the building performs as required. In approaching contract negotiations with potential suppliers, Company A takes expert advice on Company B’s capability to carry out the required work, looking at their track record and general proposals. But it does not take advice on the detail of the R&D, nor does it plan or scope the R&D and it would not be able, for example, to state what advances might need to be sought or how that is to be done. It does not have an R&D project. Company A is not in a position to intend or contemplate that R&D of a particular “sort” (as referred to in section 1133(2)(c) will be undertaken. In this instance Company A does not therefore meet the definition for contracting out R&D and any claim would rest with Company B.

Example 22

Company A is a software developer which undertakes qualifying software development, and requires a bespoke building to house its development team. Company A included the input of its competent professionals into the contractual requirements of the landmark building being delivered by Company B to ensure the computer laboratory and server room met their requirements. However, this would still not necessarily be evidence that Company A was intending or contemplating R&D of the sort undertaken to execute the contractual obligations.

The competent professionals of Company A are not competent professionalss with reference to construction technology, and so in this scenario we would not expect Company A to claim any contracted out R&D to Company B, the construction company. Conversely, as outlined in Example 2a, Company B could make a claim in respect to the R&D they undertake.

Example 23

Company A is a construction company albeit one that does not have the required resource to design elements of the landmark building in Example 2a which meet certain net zero criteria, then where competent professionals of company A input into the contractual requirements for the work contracted out to Company B, this may be considered evidence that Company A was clearly intending or contemplating R&D was required (on the basis that those individuals providing input from Company A are considered to be competent professionals in the specific area of R&D that will be undertaken by Company B).

The drafting of subsection (2)(c) also ensures that it is the position at the time that the contract was entered into which is key – not assessing the work done with the clarity of hindsight. This principle extends to there being a series of contracts. At any particular moment, the position of the companies is governed by a contract or contracts and what matters for the application of s1133 is those contracts. If contracts are renegotiated or varied the answer may change for work done after that point.

Example 24

Company A and Company B enter into a contract for development of a widget. Little consideration is given to the need for R&D, as neither party considers this necessary for the widget to meet the required tolerances. Company B, the contractor, later realises that by doing some R&D, it can simplify the design and reduce the cost. The R&D was not included in the contract and is not reflected in the price and if it fails, Company B will carry the risk. Company B is therefore the decision maker in these circumstances and if it decides to proceed, it, not Company A, will potentially be able to claim relief.

Commercially it is possible that in these circumstances, before proceeding, Company B would seek to renegotiate the contract, with the R&D specified, producing a contract which then does contract out R&D to it, and for which A could claim relief – A has now entered into a contract with B that requires B to do specific R&D for A, A did not have to do this – it could have let things proceed under the previous contract with B doing the R&D or not as it wishes. Therefore it has decided that the R&D should be done (and presumably funded it).

The legislation operates to prevent the same R&D expenditure being claimed for by both Company A and Company B.

In many cases (both contracting out of routine activities that form part of the customer’s R&D project, and contracts whose goal is to have a significant and defined piece of R&D done) it should be clear that the customer, only, will claim, meeting this objective. In other cases, discussion between the parties may be helpful. Whether or not that takes place, it is incumbent on all claimants to assess all available information and to be able to justify their reasoning based on this.

Where HMRC identifies that both Company A and Company B have claimed for the same expenditure, it will address this via compliance activity. Typically this will take the form of fact finding into both claims, with a view to examining the full fact pattern to determine which of Company A or Company B satisfies s1133(2)(c).

HMRC accepts that, for contractual and other reasons, it may not have been possible for the parties to share information including about their tax position and will not reject or question claims simply because this has not been done.

It is important to recognise that there can and will be cases where both parties are claiming for different expenditure relating to the same commercial project, because R&D has arisen for the contractor of a sort that the customer did not intend or contemplate.

Example 25

Company A is a UK automotive OEM developing a new vehicle, where the activities meet the definition of R&D. It subcontracts a variety of testing requirements to Company B, an unconnected UK Test House. Company A intends to claim the expenditure paid to Company B for the subcontracted testing activities. Although in their own right these are expected to be routine in nature, these testing activities would be eligible for Company A to claim, as they are necessary as part of their R&D project, to confirm if any technological uncertainties remain.

Company B begins to execute the routine testing activities for Company A, which do not constitute R&D for Company B. In undertaking these routine tests, Company B identifies that the advances in vehicle technology evidenced by Company A indicate they will need to redevelop some of their testing methodologies to measure certain parameters to higher levels of accuracy than currently possible.

Company B decides to instigate a new R&D project to advance their own testing methodologies, and uses some of the testing cycles required to perform the testing activities for Company A to validate and test these new methodologies. It is anticipated that these new testing methodologies will have broader application and use outside the services provided to Company A.

In this scenario Company A would be able to claim on the contracted out testing, and Company B would be able to claim on the activities undertaken to develop a new testing technique. Where Company B uses testing cycles contracted out by Company A to validate some of its own R&D activities, under s1133(7) the costs of those cycles would be excluded from Company B’s claim.

In this scenario, it is possible that both Companies may disclose R&D related to the same testing criteria / application.

Example 26

In a slightly different scenario, Company A is again a UK automotive OEM developing a new vehicle, where the activities meet the definition of R&D. It subcontracts a variety of testing requirements to Company B, an unconnected UK Test House. As part of the contracting process, Company A identifies that the advances in vehicle technology will require the development of new testing methodologies to measure certain parameters to higher levels of accuracy than currently possible.

Company A prescribes that Company B will develop these testing methodologies and use the testing cycles required to perform the testing activities for Company A to validate and test these new methodologies. This is detailed in the contract and the terms of said contract reflect this.

Company A is in a position that it intends Company B to undertake R&D activities on its behalf and Company B is being compensated for this. As such, Company A is in a position to claim the costs (assuming all other conditions are met) as contracted out R&D on the development of the new testing methodology and execution of the testing itself.

7.3 Section 1133(3) - (6) CTA09: Subcontracting chains

For simplicity the discussion above has assumed that there are only two parties (Company A and Company B) involved. In reality there may be more, and the legislation allows for this.

Subsections 1133(4) and (5) set out that research and development remains contracted out (and claimable by the ultimate customer, not the contractor) if it meets the conditions of subsection s1133(2), even if the immediate contractor subcontracts it on (and so on down the chain).

A person to whom activity is contracted on is referred to in s1133(4)(b) specifically as a sub-contractor (which is why the legislation and guidance use the term “contractor” in general).

Likewise, where any parties in the chain instigate their own R&D to fulfil the contract, they can claim for the R&D instigated by them

Example 27

Company A commissions a construction firm, Company B, to supply a new landmark building. Under the terms of the contract with A, Company B is responsible for the design and build of the structure, ensuring that the programme and performance requirements have been met. Company B engages an engineering consultancy, Company C, to assist with the design and build of the new building.

Company B engages Company C to design the façade of the structure. During the design stage, Company C encounters significant technical problems with designing the façade. An R&D project is undertaken to develop an alternative design solution for the façade. Company B collaborates with Company C to fully resolve the uncertainties associated with developing the new façade design.

Company A does not have the knowledge or capability to understand how the façade will be constructed, in anything but a general sense. Its contract with Company B did not address the need for the R&D required for the façade, which was not understood or known about at that stage]. Company B’s competent professionals collaborate with Company C, reviewing design iterations and assessing the technological feasibility of the R&D design proposals. Even though Company C is the party that has identified that R&D may be required, it is reasonable to assume that Company B contemplated R&D of this sort may have been required, given its close involvement in undertaking the R&D. In this instance, Company B is entitled to claim:

• Company A has not contracted out R&D to Company B as it did not meet the condition of s1133(2)(c), Company B is entitled to claim.
• Company B has contracted out R&D to Company C as it the conditions at s1113(2) are met, Company C is not entitled to claim because Company B is the customer.

7.4 CTA09/1133(7) and (8)

Subsection 1133(7) provides that a payment that is only partly for contracted out R&D should be apportioned on a just and reasonable basis for the purposes of s1133(6). This reflects that a claim may be for the whole or part of a project, and that the conditions of s1133(2) may be met for part of a payment but not for all.

7.5 Sections 1042F and 1053A CTA09: Exception: where the customer cannot claim

The exception mentioned at section 7.1 above applies to some specific circumstances where the customer, Company A, cannot claim, even if it would otherwise satisfy s1133(2). In these specified circumstances the contractor, company B, may still be able to claim even if R&D has been contracted to it. This is intended, so far as possible, to ensure that relief is given for the R&D.

Qualifying expenditure in these circumstances is defined at sections 1042F (for the new merged reliefs) and 1053A CTA09 (for the enhanced relief for R&D intensive loss-making SMEs).

Three conditions must be met for expenditure to qualify. First (see section 1042F(2)/ section 1053A(2)) R&D must be contracted to company B, following the rules in section 1133. That is, the situation must be the sort in which, according to section 1133, Company B would not normally be able to claim. (If the R&D is not contracted to Company B, but initiated by it according to section 1133, then Company B would of course be able to claim anyway under either section 1042D or 1042E or section 1052 or 1053 as appropriate).

Secondly, Company A, the customer, must be either an ineligible company or not contracting out the R&D in the course of a trade, profession or vocation within the charge to tax. Company A might, for example, be an overseas company not within the charge to CT, or a UK Government Department. (The requirement is that every person contracting out the R&D to Company B satisfy one of these conditions – see section 7.3 and onwards for chains of subcontractors).

Finally, the expenditure claimed for must be expenditure that would qualify under section 1042D or 1042E (or 1052 or 1053) but for being contracted to the company.

7.6 CTA09/1142 - Ineligible companies

An ineligible company is defined in section 1142. It includes charities, institutions of higher education, scientific research associations, health service bodies and any other body prescribed by the Treasury as ineligible.

Example 28

A UK Contract Research Organisation (CRO) carries out clinical trials for both UK and overseas pharma companies. Trials carried out for overseas companies, which are not within the charge to CT, satisfy the conditions of section 1042F or 1053A, if they constitute R&D, and the UK CRO can therefore claim relief for its expenditure. (Where the work is contracted to the CRO by a UK pharma company, who can claim will depend on the application of s1133 – see above).

Two companies which are members of the same group (s1140A CTA09 provides that the definition of group is the same as that in Part 5 CTA2010) may jointly elect under s1142(5) that, in respect of particular R&D contracted by one (A) to the other (B), Company A is to be considered ineligible, so that Company B may be able to claim rather than A. This is a relaxation intended to enable groups in which the R&D is carried on by specified companies which have previously all claimed relief for this under RDEC to continue to do so. (An overseas member of the group will in any case be ineligible so this election would not be necessary for that company).

The election will not affect A’s ability to claim for any other R&D (ie R&D undertaken on its own behalf, or contracted to another person other than the named group members).

Alternatively, without an election, the effect of s1133 could be to consolidate the claims in the hands of A, avoiding the need to submit many claims across the group. To facilitate this, where such an election is in force, in determining whether activity is research and development for the purposes of this Part, anything done by one of those companies under the contract is treated as if done by the other to the extent that this makes a difference to what is R&D.

An election for this purpose needs to be made in writing – for example as a letter sent to a relevant officer of HMRC, such as the CRM, either before or at the same time as any claim that depends on it.

Example 29

In a large group, Company A commissions a number of R&D projects carried on by Companies B, C and D, which have all previously claimed RDEC, in some cases making use of the previous deeming which allowed A’s R&D to be R&D of B, C or D. Following introduction of the new rules in s1133, A, B, C and D jointly write to the group’s CRM, electing that A should be treated as an ineligible company in respect of any R&D commissioned by it from B, C or D. The election is made before B, C or D make their first claims under the new rules.

7.7 Interaction with CTA09/1042F and CTA09/1053 (claims by contractor where customer cannot receive relief)

As set out above in section (3) of this guidance, in some circumstances a contractor may be able to claim for R&D it carries out even where it has been contracted to do that work. Sections 1042F and 1053A both require that, for the contractor to be able to claim, all the parties contracting out the work to that company must satisfy the conditions of those sections.

Example 30

Company B is contracted to carry out a piece of R&D work directly by a UK Government Department, Department A. If the work had been contracted by another UK company, Company B would not be able to claim. However, Company B can claim R&D relief, as Department A is not carrying on a chargeable trade.

If Company B were contracted to by an intermediate contractor between it and Department A, it might not be able to claim because the intermediate contractor might not satisfy the conditions of ss1042F or 1053A (for example, because the R&D is in respect of a trade not chargeable to corporation tax). However, if Company B were working for Department A on a ‘pass through’ contract via a prime contractor, P, i.e. a contract where Company B is the sole party carrying out R&D, where the R&D programme was agreed between Company B and Department A, and P is just providing a procurement service/ route on behalf of Department A, Company B may still be able to claim R&D relief.

Section 1133(4) states that

(4) Research and development contracted out by a person is contracted out “to”—

 (a) the party to the contract who undertakes the obligations referred to in subsection (2)(b), and

(b) any sub-contractor who undertakes contractual responsibility

 for the activities needed to meet those obligations.

Depending on the terms of the contract or contracts, it may be possible that the intermediate P meets neither condition, so the R&D is not contracted out “to” P but to Company B . So P is not contracting anything (in the sense of the legislation) to Company B, so 1042F(3) is met and Company B can claim.

The following example shows, in contrast, how the condition that s1042F(3) must be met by everyone by whom R&D is contracted out to the company prevents double claiming.

Example 31

UK Automotive company A subcontracts R&D to an unconnected US company B to develop a new gearbox. The development of the gearbox is R&D in its own right but would also form part of the Company A’s R&D. The US company B then subcontracts the work on to its UK subsidiary, a connected party, Company C.

Company A can claim. It subcontracted R&D to another person, and the activity is occurring in the UK so s1138A does not apply.

The US company B can’t claim (because it is not carrying on a trade chargeable to UK CT)

The UK company doing the work, company C, cannot claim because company A is able to claim.

While Company C has been subcontracted the work by a company not within the charge to tax (the US parent) and therefore apparently meet the condition in s1042F(4)(b), s1133(4)(b) applies to the activities subcontracted to company C by the ultimate customer (Company A ) but neither s1042F(4)(a) nor (4)(b) applies to Company A itself so 1042F(3) prevents the UK subsidiary (Company C) from claiming.

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1. Collins English Dictionary, 1 ed definition: “Contemplate. 1. to think about intently and at length; consider calmly… 3. to look at thoughtfully; observe pensively…” This does not suggest a slight or passing regard, it actually means significant, focussed attention. ↩ ↩²