Understanding the New Contracting Rules for UK R&D Tax Credits

The UK’s R&D tax credit system has undergone significant reform, with changes to contracting rules taking effect from April 1, 2024. These updates aim to streamline the system, reduce abuse, and ensure that R&D incentives align more closely with innovation-driven activities in the UK.

Key Changes to Contracted-Out R&D Rules

• Clarifying the Decision Maker: The new rules focus on identifying the “R&D decision maker” within a contracting arrangement. This is the entity that dictates the scope and purpose of the R&D activity and bears the associated risk.

In simple terms:

1. If a company (Company A) directly hires another (Company B) for R&D, Company A can include those costs in its claim.

2. However, if Company B identifies R&D needs while fulfilling a contract unrelated to R&D, it may claim the tax relief, as it drives the research process.

• Overseas Subcontracting Restrictions: To prioritise UK-based innovation, claims for overseas subcontracted R&D activities are generally disallowed unless conducting the work domestically would be "wholly unreasonable" (e.g., due to unique geographic or environmental requirements). These stricter guidelines aim to ensure that tax reliefs support UK economic and technological development.

• Proportional Claim Adjustments: For unconnected subcontractors, claimable costs remain capped at 65% of payments made. Claims involving connected subcontractors must comply with additional criteria, though they may allow up to 100% of costs depending on the circumstances.

  
  

Implications for Businesses

• For Companies: Companies must carefully structure contracts to reflect who controls the R&D process. Clear records of decision-making authority and R&D intentions will be critical for compliance.

• For Subcontractors: They must assess their eligibility independently, particularly in cases where they undertake R&D not explicitly demanded by the company who contracted them.

• Administrative Burden: robust documentation is important to support claims, from initial contracts to detailed records of who drove the R&D decisions.

  
  

Practical Advice

To navigate these changes effectively:

• Draft Clear Contracts: Ensure agreements specify roles, risks, and expectations regarding R&D activities.

• Document Early and Thoroughly: Track decision-making processes and justifications for subcontracting arrangements.

The government’s intent is to foster innovation at the core of the UK economy by directing reliefs to those actively pursuing technological advancements. By understanding and adhering to these new contracting rules, businesses can maximise their claims while maintaining compliance​.