Subcontractors, EPWs and Overseas R&D: What Still Qualifies After the April 2024 Reforms
A practical guide to understanding entitlement, location rules, and evidence requirements
The Reality Check
There's a misconception currently circulating among founders that subcontractors and agencies have become "unusable" for R&D tax relief. This is incorrect. The reforms introduced in April 2024 were not designed to stop you from outsourcing; they were designed to tighten the rules on entitlement and location.
The real change isn't "you cannot claim." It is "you can still claim, but the entitlement and location rules now matter more, and the cost restrictions can materially reduce what qualifies."
Historically, companies could be somewhat loose with subcontractor language and still get claims approved. Post-April 2024, the risk profile has shifted. It is now less about finding the "right scheme" and more about showing:
- Who is entitled to claim when work is contracted out (the "decision maker")
- Where the R&D activity physically took place(the territorial restriction)
- Whether a cost restriction applies(typically the 65% rule)
The good news is that the rules reward clean governance. If you run your projects with discipline, and your contracts and records align with how you actually work, there is nothing exotic here. This topic is now evidence-driven, so getting your record keeping right is essential.
Understanding the Language
Before applying rules, we need shared language. A common failure point arises when founders use the word "subcontractor" to mean "anyone not on payroll." HMRC uses specific definitions, and mixing them up can make a claim fragile.
Important: The label on your invoice is not decisive—the nature of the engagement is.
| Term | Practical Meaning | Why It Matters for Claims |
|---|---|---|
| Employee | On payroll | Typically no 65% restriction, but apportionment still matters |
| EPW | Worker supplied via a staff provider, earnings subject to PAYE and NIC | Often restricted, specific evidence required |
| Contractor | Supplier delivering services under contract | Often restricted (65%), and entitlement depends on decision making |
| Contracted out R&D | R&D undertaken under a contract where R&D was intended or contemplated | Drives who can claim, especially where customers are involved |
| Overseas R&D | Activity physically undertaken outside the UK | Generally restricted post-April 2024 unless a narrow exception applies |
The Two Gating Tests
To understand your position, you must pass two "gating tests" before you even calculate the numbers. You must solve the "who can claim" question and the "where was it done" question first.
Test 1: Who Can Claim (The Decision Maker Concept)
Post-reform, HMRC's logic is aimed at stopping duplicate or misdirected claims where one party pays another to do work. The general principle is that only the company that decided the R&D was needed, and initiated it for its own purposes, should be able to claim.
Decision Maker Flow
Indicators of entitlement include: who initiated the work, who owned the baseline and technological uncertainty, who controlled the technical direction, who bore the financial/delivery risk, and who owned the outputs and IP.
| Scenario | Likely Claimant | What Evidence Makes It Defendable |
|---|---|---|
| You are building your own product, you hire a dev shop to help deliver | You | Roadmap, uncertainty log, internal technical oversight, contract scope, IP clauses |
| A customer pays you to build a bespoke solution to their specification | Customer (usually) | Customer initiation, contract terms, ownership and risk, decision records |
| Joint development with a partner | Fact dependent | Governance notes, who initiated, who controlled direction, output ownership |
| You outsource a defined R&D work package you initiated | You | Why the work was needed, how you directed it, iteration evidence |
Test 2: Where the Work Took Place (UK First Rule)
The second test is territorial. The post-reform position is that contractor and EPW activity generally needs to be physically carried out in the UK to qualify. This territorial restriction mainly bites on subcontracted R&D and EPW type costs.
There is an exception, but it is a "conditions" exception, not a commercial convenience exception. Saying "the best developers were in Poland" or "it was cheaper to hire in India" are not qualifying reasons.
The Three-Point Exception Test
In practice, "conditions" refers to things like specialist facilities, regulated testing environments (e.g., deep water testing), access to location-specific data, or environmental constraints.
Cost Categories and Restrictions
Even if you pass the entitlement and location tests, you must apply the cost category rules. The famous "65% restriction" is not a punishment or a fine; it is simply how the legislation defines the proportion of third-party payments that are treated as qualifying expenditure.
Visual Comparison: £100,000 Spend Scenarios
Key Takeaway: This highlights why you cannot treat contractor invoices like payroll. It also underscores the importance of structuring engagements correctly early in the year—once costs are incurred, you cannot rewrite history to make them tax-efficient.
Overseas Delivery: Worked Examples
This section is critical for avoiding expensive mistakes. Many founders accidentally claim overseas delivery because it was "part of the project," unaware that the location rules are strict.
| Example | UK Activity | Overseas Activity | Does Overseas Qualify? | Qualifying Amount |
|---|---|---|---|---|
| Split delivery, no exception | £60,000 | £60,000 | No | UK only, then apply restriction: £60,000 × 65% = £39,000 |
| Split delivery, exception evidenced | £60,000 | £60,000 | Potentially yes | Total, then apply restriction: £120,000 × 65% = £78,000 |
Assumption: £120,000 contractor spend genuinely related to qualifying R&D activity.
Evidence Required: If you assert the exception, you must document it in prose. A simple "we needed to test in the arctic circle" is a start, but you need to detail the specific environmental conditions, why they were necessary for the R&D, and why replicating them in the UK (e.g., in a cold chamber) was unreasonable or impossible.
Evidence and Documentation Framework
This is not about creating a burden; it is about creating a coherent file. Most disputes arise from mismatches: the contract says one thing, working practices say another, and invoices lack detail.
| Evidence Item | What It Proves | What to Keep |
|---|---|---|
| Contract pack | Scope, direction, ownership, risk, R&D intent | Signed contract, SOWs, change requests |
| Decision trail | You initiated the R&D and directed it | Decision logs, emails, steering notes, technical reviews |
| Location proof | Where activity physically took place | Timesheets by location, project records, supplier confirmations |
| PAYE evidence (EPWs) | Worker earnings subject to PAYE and NIC | Agency invoices, worker schedules, confirmations |
| Technical evidence | Baseline, uncertainties, iterations, outcomes | Uncertainty log, failed tests, benchmarks, repo or ticket extracts |
| Cost mapping | Numbers tie to the story | Cost coding, invoice mapping, apportionment working papers |
Red Flags and How to Fix Them
Here are the common issues that frequently trigger inquiries. If your claim looks like this, fix it before you file.
| Red Flag | Why It Hurts | Better Approach |
|---|---|---|
| ⚠ RED FLAG Generic "development services" contract | No evidence of intent or decision making | Add scope, uncertainty context, ownership, risk, deliverables |
| ⚠ RED FLAG All work overseas, no exception file | Default restriction applies | Document exception properly or restructure delivery |
| ⚠ RED FLAG Treating contractor invoices like payroll | Overstates claim | Apply restrictions and keep mapping |
| ⚠ RED FLAG No internal technical ownership | Weak entitlement narrative | Keep evidence of direction and review |
| ⚠ RED FLAG Claim narrative contradicts project reality | Looks unreliable | Align narrative with actual working practices and records |
Frequently Asked Questions
Look at the control and payment method. An EPW is usually a worker supplied by an agency who works under your supervision and whose earnings are subject to PAYE/NIC. A subcontractor is a third party contracted to deliver a specific service or output, working more independently.
Often, no. If a customer contracted you specifically to do R&D, or the R&D was "intended or contemplated" in the contract, the customer is likely the claimant. However, if the R&D was your own initiative to enable you to deliver a fixed-price contract, you may still be the decision maker.
You must apportion the costs. Work physically done in the UK can qualify (subject to restrictions), while work done overseas is generally excluded unless you meet the narrow specific conditions exception.
You need documentation proving three things: the necessary conditions (e.g., geography, environment) were not present in the UK, they were present where the work was done, and replicating them in the UK would be unreasonable. Cost or availability of staff is not a valid condition.
Likely, yes. Ensure your contracts clearly state the scope, who owns the IP, and who bears the technical and commercial risk. Vague contracts are a major cause of claim enquiries.
Summary
To successfully claim for subcontractors and EPWs post-reform, you must pass the two gating tests:
- Entitlement: Are you the decision maker?
- Location: Is the work in the UK or covered by a specific exception?
Once those are established, you must apply the correct cost restrictions—typically 65% for unconnected parties—to ensure your claim value is accurate. This is not about gaming the system; it is about good filing discipline.
Sanity Check Your Position
Most readers will not want a full engagement just to confirm whether their offshore dev team creates an issue. We offer a low-friction "Sanity Check" for this exact purpose.
Send us a small pack of documents (your contract pack, a summary of supplier invoices, and a short description of the work), and we will provide a written view on likely treatment, exclusions, and evidence gaps before you file.
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