Restricting R&D relief for expenditure incurred overseas – the impact for life sciences

25 April 2022

In the second of our series on R&D tax relief changes, we consider the upcoming impact of one of the most significant policy changes to the UK R&D regimes since their introduction.

‘Buy British’ – a significant policy change ahead for life sciences businesses

In a consultation paper released in Autumn 2021, HM Treasury announced its intention to refocus R&D relief towards innovation in the UK. It would do this by restricting relief for expenditure incurred overseas, whether that be on subcontracted R&D, or payments to workers based outside the UK. While payments to clinical trial volunteers would be kept outside this restriction, the proposed change would still have a significant impact on life sciences businesses claiming R&D tax relief.

Take the example of a UK company that subcontracts some of its testing to an overseas laboratory or has scientists carrying out trials outside the UK. From April 2023 these costs, despite being necessary to the UK’s R&D activity, will no longer benefit from R&D tax relief under either the RDEC (large company) or SME schemes.

We and other stakeholders strongly opposed these changes in our responses to the consultation, seeking to highlight situations where UK businesses make these choices out of necessity rather than choice in many instances. In the Chancellor’s Spring Statement, it did appear that this had been listened to. Mr Sunak announced that expenditure on overseas activities can still qualify where the R&D cannot take place in the UK due to:

Geographical, environmental, population or other conditions not present in the UK (eg deep ocean research); or
Regulatory or other legal requirements (eg clinical trials that must take place outside the UK).

In subsequent discussions with HMRC’s policy team in recent weeks, we understand that these exemptions are intended to be narrowly drafted, and ‘focussed on necessity, rather than convenience or preference.’ Although these policy changes are not yet on the statute book and definitions are yet to be finalised, we can be reasonably confident of what the R&D tax relief regimes will look like from 1 April 2023.

SMEs that currently outsource R&D activities to overseas subcontractors, and companies of all sizes that use overseas Externally Provided Workers (EPWs), should seek to quantify the expected impact on their tax position and consider whether the loss of R&D tax relief provides sufficient incentive to bring these activities onshore. Those entering into new EPW or subcontractor arrangements should consider the tax implications when choosing between UK and overseas providers.

For example, where there is flexibility over where to source expertise (in the form of external workers, or subcontractors) from overseas or the UK, companies will need to factor in the availability of R&D tax relief when costing the options. As with other changes discussed in this series of articles, the commercial requirements of how contracts and research is structured will dominate, but this will need to be considered in the round.