Are you prepared for the new rules on ‘contracting out R&D’?

Are you prepared for the new rules on ‘contracting out R&D’?

The government has announced the merger of the R&D Expenditure Credit and R&D SME tax relief schemes.  The most significant difference between these R&D schemes is the treatment of activity involving two or more parties, and which party, if any, can claim the relief. 

HMRC has recently published draft guidance on new ‘contracting out’ rules, intended to reconcile these differences and how they should be applied in the merged scheme.

Here, we explain the new rules, and how companies can identify the commercial and practical implications of the changes and prepare for what could have a significant impact on their R&D benefits.


In the Autumn Statement, the Chancellor confirmed the merger of the R&D Expenditure Credit (RDEC) scheme for large companies with the enhanced R&D tax relief for small and medium-sized enterprises (SME). Effective from 1 April 2024 for all companies and accounting periods, this provides a gross 20% ‘above the line’ credit, net 16.2% for those seeking a payable tax credit.

However, the SME and RDEC schemes incentivise R&D activities differently, depending on how projects were funded and undertaken.  In general, the SME scheme favours the ‘decision-maker’ commissioning R&D projects, even if a third-party supplier performs the R&D. The RDEC regime, conversely, benefits those performing R&D, even if funded by a third party/customer. Where SMEs and large companies work together on a project, there are provisions for which can claim relief.

In principle, the merged scheme is closer to the SME regime in that it incentivises the company deciding to undertake R&D (the customer) even if a third party undertakes the R&D. However, the new rules also consider where a company (the contractor) is contracted to provide a service for a customer and, in the course of that engagement, it becomes apparent that R&D is required. Under these circumstances, the merged scheme rewards the contractor.

In summary, if the customer ‘intended or contemplated’ that R&D should be done, then in the merged scheme the customer can claim the relief. If the customer had no understanding or intention that R&D should take place and the contractor initiates R&D, then the contractor can claim the relief.

While seemingly innocuous, depending on how loosely ‘intended or contemplated’ is interpreted, the R&D benefits of large companies undertaking R&D in projects ultimately funded by customers, for example, in work undertaken by consultancies or by companies in supply chains, is severely reduced.

The new rules in essence

The key clarification in the recent guidance is that: “‘contemplated’ does not indicate a minor or fleeting consideration but a more substantial intention. “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.”[i]

This higher threshold for ‘intended or contemplated’ thus swings the pendulum away from the characteristics of the SME scheme and, in effect, becomes closer to how the RDEC scheme operates.

The new rules require that the customer’s ‘intention/contemplation’ must involve an appreciation of the technological characteristics of the R&D performed.  Support of the intention to contract out R&D will often need to be identified in advance (for example, in contractual terms) with detail on the R&D’s characteristics (a statement of the advance in science or technology and what uncertainties need to be addressed). This, in turn may rely on the customer to have their own technical capability (whether in-house or external) to articulate the predetermined nature of R&D.

As well as contractual terms, HMRC identifies other commercial factors that might help demonstrate awareness by the customer of what R&D was intended, or technically why it is needed. These include:

  • 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 (e.g., 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; and
  • nature of the parties (e.g., whether it is evident that the contractor specialises in providing R&D services and the contract is typical of those R&D activities).

The above sets out the treatment in the most common circumstances. There are provisions for elections amongst group companies, or where a party cannot claim, whether the customer (e.g., a government department without a trade) or the contractor (e.g., a charity or higher education institution). There are further provisions to ensure benefits are preserved where there are more than two parties involved (e.g., subcontractors in a supply chain) or parties in the chain instigate R&D.


This change in emphasis preserves many of the RDEC regime’s characteristics. To continue receiving R&D benefits, many SMEs that previously claimed contracted-out activities may have to be more directly involved in planning and specifying the underlying R&D.

For many companies, the changes won’t impact immediately, perhaps even into the 2025 period. However, companies should review their contractual arrangements with customers and/or suppliers now. They should consider the extent to which any work with third parties may be deemed contracted out R&D, i.e. with R&D intended/contemplated beforehand, or a contract for services during which R&D is instigated and model the impact of these changes on their projected R&D benefits.

Where there is scope and commercial rationale to consider contractual changes, introducing statements to reflect whether the contract would be regarded as ‘contracted out R&D’ (i.e the decision-maker foresees potential R&D and the nature of it) or a ‘contract for services’ (during which the subcontractor may initiate R&D and claim the R&D benefit) would remove ambiguity and provide clarity in who receives what remains a generous R&D benefit. 

Need help?

For advice or support with these changes, contact David Byrne, Director, R&D. More information on our R&D services and team is available here. We’re here to guide you through the transition effectively.

[1] HMRC Open consultation: Research and development tax reliefs: new contracting out rules and overseas restrictions – draft guidance, pub. 9 February 2024.

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