Overseas contractors and R&D tax relief: what can still qualify?

The rules for overseas R&D costs have changed. For accounting periods beginning on or after 1 April 2024, spending on overseas contractors and externally provided workers is generally excluded from qualifying R&D expenditure unless a specific exception applies. HMRC’s guidance says the restriction applies under both the merged RDEC scheme and enhanced R&D intensive support, commonly known as ERIS.

This does not mean every overseas cost is automatically out of scope. Some R&D genuinely has to happen outside the UK because the conditions needed for the work do not exist here. The key is being able to explain why the R&D had to be carried out abroad, why those conditions were present in the overseas location, and why replicating them in the UK would have been wholly unreasonable.

For companies using international contractors, clinical research organisations, specialist testing sites, field teams or overseas development partners, this is now an important area to review before making an R&D tax relief claim.

What counts as overseas R&D expenditure?

For these rules, overseas means outside the UK: England, Scotland, Wales and Northern Ireland. The restriction mainly affects two types of R&D cost: payments to contractors for R&D activity undertaken overseas, and externally provided workers (EPW) where the worker’s earnings are not subject to UK PAYE and National Insurance. HMRC guidance confirms that contractor payments are tested by the location of the R&D activity, while EPW costs are tested through the PAYE and National Insurance position.

That distinction matters. A UK company may contract with a supplier based overseas, but the key question for contractor costs is where the R&D activity is actually carried out. For EPWs, the focus is different: whether the worker’s earnings are subject to UK PAYE and Class 1 National Insurance contributions.

The new rules apply to accounting periods beginning on or after 1 April 2024 and affect claims under the merged RDEC scheme and ERIS.

The general rule: overseas contractors and EPWs are excluded

The starting point is simple: spending on overseas contractors and overseas EPWs is generally excluded from qualifying R&D expenditure.

This is a significant change for many businesses. Under earlier R&D tax relief rules, overseas subcontractor and EPW costs were often more widely included, subject to the relevant scheme rules. Under the reformed rules, the starting point is now more restrictive. If the work is carried out overseas, or the EPW position does not meet the UK PAYE and National Insurance test, the cost will usually be excluded unless the overseas exception applies.

This does not affect every category of R&D cost in the same way. The overseas restriction is specifically focused on contractor and EPW costs. Other areas of the R&D claim still need to be reviewed under the normal qualifying expenditure rules.

The key exception: R&D necessarily carried on abroad

Overseas spend may still qualify where the R&D necessarily has to be carried on outside the UK. HMRC guidance describes a specific exception where three conditions are met. Broadly, the necessary conditions for the R&D are not present in the UK, those conditions are present in the overseas location, and it would be wholly unreasonable to replicate those conditions in the UK.

In practice, this exception is not about preference or convenience. It is about necessity.

A company needs to show that the overseas location was needed for the R&D itself. The reason cannot simply be that a supplier was cheaper, easier to access, or already known to the business. It also cannot be justified only by saying the necessary expertise was available abroad. HMRC’s draft guidance and professional commentary on the rules make clear that cost and worker availability are not acceptable reasons on their own.

What counts as a necessary condition?

A necessary condition may be geographical, environmental, social, legal or regulatory. The list is not exhaustive, so other conditions may be relevant if they are genuinely necessary for the R&D and cannot reasonably be replicated in the UK.

Examples could include a climate or natural environment that does not exist in the UK, access to a specific patient population, local regulatory requirements, construction practices in a target market, or access rules that require work to be performed in a particular country.

Regulatory reasons can be especially important. A formal legal requirement may support the case, but informal regulator guidance, clinical practice standards or accreditation requirements may also be relevant where they shape where the R&D must happen. The important point is that the company should be able to show how the condition affected the R&D, not just the commercial decision to use an overseas supplier.

What does not count?

Cost and the availability of workers are specifically excluded as qualifying reasons.

This means overseas spend will not qualify simply because the overseas contractor was cheaper. It also will not qualify simply because the company could not find the right workers in the UK, or because a trusted development team was already based abroad.

Those points may explain a commercial decision, but they do not meet the test for qualifying overseas R&D expenditure. The question is whether a necessary condition for the R&D existed overseas, did not exist in the UK, and could not reasonably be replicated here.

What does “wholly unreasonable” mean?

“Wholly unreasonable” does not mean impossible in every case. The test is more practical than that. HMRC considers whether it would be wholly unreasonable for the company to replicate the necessary overseas condition in the UK, taking into account the facts and circumstances.

Time pressure can be a significant factor. For example, biological samples may have a limited life, clinical recruitment windows may be tight, or project disruption may make delay impractical. A UK option might exist in theory, but if it cannot meet the required timescale and the delay would materially undermine the R&D, the overseas activity may still have a stronger case.

The company’s size, resources and practical circumstances can also matter. A large multinational may be expected to replicate or adapt facilities that a small company could not reasonably build, operate or fund. If a company already has similar UK facilities that could be adapted within the project timescale, it may be harder to justify using an overseas contractor. If adaptation would take too long or would materially disrupt the R&D, the analysis may be different.

This is why planning evidence is so important. A clear record of the options considered, timing constraints, UK alternatives reviewed and reasons for using the overseas route will usually be stronger than a retrospective justification prepared after the year end.

Example: overseas testing facilities

A company wants to contract out destructive testing of a product to a commercial testing lab. There are suitable facilities in both the UK and overseas, and the UK facility can perform the work within the required timescale. In that case, the overseas spend is unlikely to qualify because the necessary conditions exist in the UK.

If the UK facility exists but is fully booked on the required timescale, the answer may be different. The overseas spend may qualify if the delay would make it wholly unreasonable to wait for the UK facility. The evidence would need to show why the timing mattered and how the delay would affect the R&D.

If no UK facility exists at all, and the company does not have the expertise or commercial justification to build and run one, overseas testing may qualify. However, if the company already operates similar UK facilities that could be reasonably adapted, HMRC may expect the company to use or adapt them. If even that adaptation would take too long given the project’s time pressure, the overseas cost may still have a case.

Example: prefabricated wall panels for an overseas market

A company is developing a prefabricated wall panel for an overseas construction market. The market has different building regulations and construction practices from the UK, and the R&D requires the company to work closely and iteratively with local construction firms to test whether prototypes are buildable under those local conditions.

If the relevant construction practices and regulatory standards do not exist in the UK, and it would be wholly unreasonable to replicate them here, the overseas development and testing activity may qualify. The company should document why the local interaction was necessary, what technical uncertainties were being tested, and why UK-based testing would not have provided the required evidence.

What evidence should you keep?

The strongest evidence is usually created before and during the project. It should show why the R&D needed to happen abroad and why the company could not reasonably replicate the necessary conditions in the UK.

Useful records may include project planning documents, supplier selection notes, technical risk assessments, facility searches, trial recruitment data, regulator correspondence, clinical practice requirements, accreditation standards, access rules, testing windows, sample stability evidence and internal decision logs.

The evidence should also connect the overseas work to the qualifying R&D. It is not enough to show that a supplier was overseas. You need to show what R&D activity they performed, where it was performed, why that location mattered, and how the cost links to the project.

This fits the wider compliance direction for R&D claims. HMRC now expects clearer technical narratives, cost linking and supporting information, and many claims require an Additional Information Form before submission.

How to approach your next R&D claim

Now overseas contractor and EPW costs need closer review before they are included in an R&D tax relief claim.

A practical review should answer four questions:

• What overseas contractor or EPW costs were incurred?
• Where was the R&D activity actually carried out?
• What condition made the overseas location necessary?
• What evidence shows it would have been wholly unreasonable to replicate that condition in the UK?

If the answer is unclear, it is better to resolve it before the claim is prepared. A well-documented position is easier to support, easier to explain and more likely to stand up to scrutiny.

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