Changes to overseas R&D: What do they mean for my R&D tax claim?

Restrictions on some overseas R&D expenditures take effect for accounting periods starting on or after 1 April 2024. Learn more about these changes, why they’re being implemented, and how to prepare for them.

These changes have been introduced for accounting periods beginning on or after 1 April 2024 and will apply to the merged scheme R&D expenditure credit (RDEC) and enhanced R&D intensive support (ERIS). Companies eligible for R&D tax relief between 1 April 2024 and 31 March 2025 will feel the impact of the reform post their accounting period, ending after 31 March 2025. Despite this, it is important for companies engaged in overseas R&D to prepare for the forthcoming changes. 

With the recent changes to the R&D tax credit scheme, including restrictions on overseas R&D, accurately estimating your claim size is crucial. Use our R&D Tax Credit Calculator to get an updated estimate and see how these changes might impact your potential benefits.

Before 1 April 2024, overseas R&D costs incurred by a UK claimant company qualified for R&D tax incentives in the UK. However, for accounting periods starting on or after 1 April 2024, subcontracted R&D work and the cost of externally provided workers (EPWs) is limited to work done in the UK. That said, some exemptions will be classified as qualifying overseas expenditure. 

What makes qualifying overseas expenditure?

To be deemed Qualifying Overseas Expenditure (QOE), expenditure on R&D conducted outside the UK must meet three criteria. All conditions need to be met for the expense to qualify.

• The first factor is that conditions necessary for R&D are not present in the UK.
• The second is that the conditions are present in the location where the R&D is undertaken.
• The third factor is that it would be wholly unreasonable to replicate the conditions in the UK.

You can find extra clarification on ‘conditions’ and ‘wholly unreasonable’ scenarios in the draft guidance, but here’s a helpful example of qualifying overseas expenditure offered by HMRC:

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.

If you conduct R&D activities outside of the UK, the current proposal is for these changes to come into play for any accounting periods that begin on or after 1 April 2024. So, if your current accounting period ends on 31 March 2024, this change will come into play when you prepare your R&D claim for the 12 months ending 31 March 2025.

The government’s decision to exclude overseas R&D expenditures as a qualifying cost is an attempt to concentrate R&D tax relief on developing innovation in the UK. 

This makes sense on the surface; the inclusion of international R&D expenditure as a qualifying expense runs counter to the scheme’s main goals of promoting and retaining innovation in the UK.

In addition, where R&D work takes place outside of the UK, less of the spillover benefits will arise in and benefit the UK. It’s also a common approach shared by many other worldwide tax jurisdictions and a number of OECD countries.

However, it can’t be denied that the proposed changes will have a significant impact on a lot of UK companies. Estimates from the Office for National Statistics suggest that the proportion of such overseas expenditure within UK R&D claims may be as much as £21.6 billion. This equates to just over 45% of the total £47.5 billion R&D expenditure used to claim tax credits in 2019-20. So the proposed reforms would have a major financial impact on many UK businesses. 

The decision to exclude overseas R&D costs represents a significant refocusing of the UK scheme. Whilst we acknowledge the UK has previously been an outlier in allowing overseas costs to be included, and this decision is bringing the UK R&D scheme in line with most OECD countries, we did not think that 1 April 2023 was the right time to be making changes to such a dramatic scale. 

EmpowerRD called for delaying the restriction of relief for overseas R&D expenditure by at least a year until April 2024 in our submission to the House of Lords last year –  and we are delighted to see the government take action on this.

Innovative UK businesses undertaking R&D work overseas will need time to adapt supply chains and restructure to accommodate these proposals. As can be seen from the size of the ONS estimates, the potential impact of this significant and valuable R&D funding ceasing overnight could dramatically and detrimentally impact the UK business economy. It’s, therefore, great to see that the government has delayed the timing by a year.    

If you’d like to learn more about the upcoming changes, please contact one of our experts today.