The government has proposed changes to the research and development (‘R&D’) tax relief for companies that subcontract R&D to a third party or engage with external labour resource (externally provided workers or ‘EPWs’), effective from April 2023. R&D relief for subcontracted activity will only be available where that third party performs the work in the UK and, in the case of EPWs, R&D relief will only be available where these workers are paid via a UK payroll.

The aim is to encourage innovation within the UK, to ‘buy British’ and to avoid incentivising any perceived loss of skills to other countries. The reality, however, is that these changes are likely to negatively impact many businesses that choose to access a global knowledge base, leading to a reduction in the value of R&D tax relief claimed.

The proposed changes also assume that businesses have the commercial flexibility to change the way they engage with external suppliers and move towards UK-based resources. For many, this won’t be the case.

Key barriers faced by businesses include:

• Lack of UK resources - as a result of skills shortages, particularly in R&D intensive sectors such as engineering, software and manufacturing, businesses may not have the choice to either buy British or buy overseas. Instead they have to access the resource wherever they can find it.
• Brexit/migration - Brexit has led to many workers returning to the EU, simultaneously deterring migration into the UK from the EU. This further exacerbates the skills shortage.
• The ultimate impact of such a policy change may be that some innovative companies choose to relocate overseas, which would have a detrimental impact on ‘UK plc’.

We recommend that the government considers the following options to mitigate the impact on UK businesses:

• Recognise that we are part of a global economy. Businesses will inevitably continue to use overseas resources for many reasons so, instead of a blanket exclusion, a restriction or cap could be introduced. This cap could be based on a percentage of either overall or UK-based spend.
• Introduce an ‘allowable purpose’ test, where work is required to be undertaken overseas for specific commercial or regulatory reasons.
• Recognise that many businesses are global, so allowing relief for costs incurred with connected parties overseas.
• Recognise that the intended start date of April 2023 does not give businesses enough time to reconsider existing contractual terms and negotiate new ones, especially as these rules are still not finalised.

Although this is still a draft proposal subject to ongoing consultation, it is clear that the government is committed to focusing R&D tax relief towards UK-based activities. While we have sympathy with the policy intent, we encourage the government to consider all options when introducing changes so that the new regime is as fair as possible to UK business. If adequate care is not taken there is a real risk that, instead of boosting R&D in the UK, the new policy will become an own goal for UK innovation.