Overseas Expenditure & Your R&D Tax Credits Claim

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The rules relating to overseas expenditure for the purposes of R&D tax credit claims are changing. For accounting periods from 1st April 2024, the eligibility has changed, meaning fewer costs will be eligible than are currently enjoyed by companies who utilise overseas labour or resources for their R&D projects.

What’s changing?

Major changes include costs relating to EPWs – externally provided workers and subcontractors will no longer be eligible for tax relief. Currently, costs can be claimed that were partially or entirely outsourced to EPWs or subcontractors. For costs incurred from 1st April 2024, only work carried out in the UK can be claimed; EPWs being used by a company on their R&D project must be paid through the PAYE system.

There are some exemptions, in a new category HMRC defines as qualifying overseas expenditure, or ‘QOE’. 

What defines qualifying overseas expenditure?

Three criteria must be satisfied for costs to be deemed QOE:

  1. Conditions necessary for the R&D project in question are not present in the UK
  2. Conditions necessary for the R&D project in question are present in the country in which the R&D is undertaken
  3. It would be unreasonable to attempt to replicate the necessary conditions in the UK

An example

Clear as mud? Happily, HMRC provides a useful example to clear things up a bit:

If the R&D involved placing sensors on active volcanoes, this clearly requires a condition (the presence of a volcano) that is not present in the UK and one that would be wholly unreasonable to replicate. And it is a condition that exists in places outside the UK. So this activity would be Qualifying Overseas Expenditure (QOE) if undertaken in a location where the necessary conditions arise.”

Reading the example, it makes a lot of sense. As an active volcano doesn’t exist in the UK, but does overseas, it makes complete sense that work must happen overseas. It is also decidedly unreasonable to replicate the required conditions in the UK – nobody can conjure up a volcano in East Anglia!

This is a clear and obvious example, though your R&D application might not be as clear-cut. It’s important to start applying the same thought pattern and logic to your overseas R&D projects to determine if they meet the QOE criteria. 

Why are things changing?

Rather simply, the government wants to incentivise activity and development on its own shores, not overseas. The objective of the whole R&D tax relief system is to continually improve and grow the UK economy, so it makes sense from a ‘charity begins at home’ perspective, and is a sentiment many overseas jurisdictions take to their tax system.

However, the changes might cause significant headaches and anxiety for businesses that conduct large-scale, off-shore R&D activity. The ONS estimates that overseas expenditure within UK-based R&D claims can be as much as £20 billion, so the potential impact is large indeed.

Changes were originally intended to be introduced in April 2023, however, it was announced in the Spring Budget 2023 that it would be delayed until April 2024, mercifully providing affected firms another year to consider the impact on their R&D operations.

Improve your chances of claiming QOE

It is best to assume that the proposed changes will commence on 1st April 2024. A great way to prepare and give your business maximum chances of claiming QOE is to compile a dossier of evidence aligned with the three-step test listed above. Providing evidence to show that conditions unambiguously do not exist in the UK to conduct your R&D activity – but do overseas – will help substantially.

For example, communication from bodies or businesses concerned with regulatory guidance or compliance, or the foreign government if legislation dictates certain activities must occur in a particular country.

As with much of the R&D tax credit schemes, much is open to interpretation. Yuzu Group’s tax consultants can help you navigate the murky waters and help to submit a claim that stands the maximum chance of success with HMRC.

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