How do the new contracted-out R&D rules affect you?

The move from the SME and RDEC regimes to the new merged research & development (R&D) scheme has introduced important changes for businesses that contract out R&D or are contracted out to undertake it.

Contracted out status and whether R&D is regarded as “customer-led” have always been key considerations when preparing a compliant claim. However, under the new rules, which apply to accounting periods beginning on or after 1 April 2024, identifying who initiated and controlled the R&D has become even more important.

What has changed under the merged R&D scheme?

Broadly, the new rules are designed to ensure that the company that decides to undertake or initiate the R&D is the one entitled to claim relief.

Two changes are particularly significant:

1. Large companies and contracted-out R&D costs

Under the previous regime, large companies could not generally include R&D contracted-out R&D costs (where the contractor was a company) within their claim.

Under the merged scheme, large companies may now be able to claim for qualifying contracted-out R&D costs, subject to meeting the revised rules.

2. When contractors can (and cannot) claim R&D relief

Under the merged regime, a company contracted out to undertake R&D can only claim relief in more limited circumstances than before.

In broad terms, a contractor may still be able to claim where:

• The work is contracted out by an “irrelievable” client (broadly, an entity not within the UK Corporation Tax regime), or
• The customer is unaware of or indifferent to how the R&D is carried out, focusing only on the end result

This represents a subtle but important shift, meaning it is now more important than ever to determine whether your activities are treated as contracted-out R&D.

When is R&D considered to be ‘contracted out’?

HMRC guidance states that R&D is ‘contracted out’ where all of the following apply:

• A company enters into a contract for activities to be carried out on its behalf
• Those activities include R&D
• Taking into account the contract and surrounding circumstances, it is reasonable to assume the company intended that R&D of that type would be undertaken

Intention is more than awareness

HMRC makes clear that:

• Mere awareness that R&D may be required is not enough for it to be treated as contracted out.
• Even if the company has detailed knowledge of exactly the kind of work to be carried out, it does not necessarily mean the customer intended R&D to be undertaken.
• A business may still not be regarded as contracting out R&D if it is ultimately indifferent to how the work is delivered.

What evidence does HMRC consider?

The contract wording will usually be the starting point, but HMRC also considers wider circumstances, including:

• Ownership of intellectual property
• Which party bears the financial risk
• Autonomy over how the R&D is carried out
• How the results of the R&D are exploited
• Who drove the decision to undertake the R&D
• Whether the R&D formed part of the customer’s wider strategy
• The experience and seniority of decision-makers
• Whether the contractor is a specialist R&D provider

Where intention is unclear, the customer and contractor can make a separate agreement as to which party can claim. HMRC has confirmed that they will regard such agreements as persuasive, unless it appears unreasonable.

Practical examples

HMRC’s guidance includes a number of examples. Two of the most relevant include:

Specialist tooling

A manufacturer contracts a specialist supplier to provide prototype tooling, knowing R&D will likely be required. However, the manufacturer cannot specify what R&D is needed and bears limited financial risk. The contractor determines how the R&D is carried out and undertakes that risk. In this case, the R&D is not treated as contracted out, and the contractor may be able to claim.

Construction project

A property company commissions a construction firm to deliver a landmark building that requires innovative solutions. While R&D is anticipated, the customer does not define or manage the R&D. Here, the customer is not considered to have intended or contemplated R&D of a specific sort, meaning the claim may rest with the contractor.

Why evidence matters

Being able to evidence the commercial reality is critical. In addition to contracts, useful evidence may include:

• Pre-contract correspondence
• Proposals, quotes and tender submissions
• Project plans and scopes
• Statement of Works and Master Services Agreements
• Meeting notes and internal decision records (such as risk registers)

Given the increased subjectivity under the new rules, reviewing contracts and commercial arrangements is now essential.

Next steps

We recommend businesses start:

• Reviewing how contracted work is structured
• Assessing whether contracts reflect the intended R&D position’
• Documenting decision-making and commercial intent
• Seeking professional advice where the position is unclear

We’re here to help

Azets’ specialist R&D team can help you understand how the new contracted out R&D rules affect your business and support you in reviewing contracts, evidencing intention and preparing compliant claims. To discuss your position, please contact your usual Azets adviser or a member of our Innovation and R&D Tax team.