Overseas R&D Expenditure

What Can Still Qualify Under the New Rules?

Summary

For accounting periods beginning on or after 1 April 2024, restrictions apply to two specific categories of overseas expenditure: externally provided workers (EPWs) and contractor payments. As a result, a company may find that less of its expenditure qualifies for R&D relief. Where EPW or contractor costs are excluded, a loss-making SME may also be less likely to meet the R&D intensity threshold for ERIS.

What Has Changed?

The restriction applies specifically to payments for EPWs and contracted-out R&D. It does not directly restrict qualifying costs for the claimant company’s own employees, consumables, software, data or cloud computing, although the normal qualifying conditions still apply.

The key question depends on how the overseas work is arranged:

EPWs - Payments generally qualify only if the worker’s earnings are subject wholly or partly to UK PAYE and NICs, unless the overseas exception applies. This is a payroll test, not simply a test of where the worker is based.
Contractors - The focus is where the relevant R&D activity is physically undertaken. If the R&D is undertaken abroad, the relevant part of the contractor payment is normally excluded unless the overseas exception applies.

What is the Overseas Exception?

The exception can apply where the R&D genuinely needs to be carried out abroad and all three of the following conditions are met:

Conditions necessary for the R&D are not present in the UK
Those conditions are present in the overseas location where the R&D is undertaken
It would be wholly unreasonable for the claimant company to replicate those conditions in the UK

Relevant conditions may include geographical, environmental or social conditions, legal or regulatory requirements, and access to particular facilities or machinery. The test is activity-specific; one necessary overseas element does not make an entire invoice eligible.

When applying the exception, the cost of carrying out the R&D and the availability of workers must be disregarded. An established offshore team or convenient time-zone coverage, without more, is unlikely to satisfy the statutory test on its own.

Potential Financial Impacts

Excluded overseas expenditure can have a double effect: it reduces the qualifying expenditure in the claim and may lower the company’s R&D intensity percentage. A loss-making SME needs relevant R&D expenditure of at least 30% of total relevant expenditure to access enhanced R&D intensive support (ERIS). Excluded EPW or contractor costs may leave the company able to claim only under the merged scheme for its remaining qualifying expenditure, although the one-year grace period may apply.

Worked Example: How Overseas Costs Can Affect ERIS

Assume a loss-making SME has £1 million of total relevant expenditure, including £290,000 of qualifying UK R&D expenditure and £50,000 for overseas EPWs or contracted-out R&D that does not meet the exception.

Measure	Overseas Cost Excluded	Equivalent Qualifying Activity in the UK
Qualifying R&D expenditure	£290,000	£340,000
R&D intensity	29%	34%
Likely scheme	Merged scheme, unless the grace period applies	ERIS, if all conditions are met
Potential benefit rate	Approx. 16.2%	Approx. 27%
Illustrative benefit	About £46,980	About £91,700

In this simplified example, moving above the 30% intensity threshold increases the illustrative benefit rate from 16.2% to about 27%, before considering the additional £50,000 brought into the claim.

This simplified example assumes sufficient surrenderable losses, no connected companies and no restriction under the PAYE cap. Actual results depend on the company’s wider tax position.

Planning Ahead

The best time to consider the overseas rules is before signing or renewing a development contract, rather than waiting until the R&D claim is prepared.

Before committing to overseas R&D expenditure, consider:

Does the arrangement involve the company’s own employees, EPWs or contracted-out R&D? For EPWs, are earnings subject to UK PAYE and NICs?
Where was the relevant R&D activity performed, and can mixed costs be split between UK and overseas activity and between qualifying R&D and routine delivery?
If relying on the narrow exception, what required the activity to take place overseas, why was that condition unavailable in the UK and why would UK replication have been wholly unreasonable?

Onside can help you address these issues early, model the impact on your claim value and ERIS eligibility, and strengthen the evidence supporting your claim.

To discuss how the rules could affect your business and how we can help, please contact our Managing Director Ryan Snape at ryan.snape@onsidetax.com or complete the contact form below.

Key Takeaways

The new overseas restriction applies specifically to externally provided workers (EPWs) and contractor payments.
It does not directly restrict qualifying costs for the claimant company’s own employees, consumables, software, data or cloud computing
For EPWs, the key question is generally whether their earnings are subject wholly or partly to UK PAYE and NICs
For contractors, the key question is where the relevant R&D activity was carried out
An exception may apply where necessary conditions for the R&D are absent from the UK, present where the R&D is undertaken and wholly unreasonable to replicate here
The cost of carrying out the R&D and the availability of workers must be disregarded when applying the exception
The same qualifying expenditure rules generally apply under the merged scheme and ERIS, although the relief is calculated differently and special rules apply to companies registered in Northern Ireland that claim ERIS
The restrictions may reduce qualifying expenditure and, for loss-making SMEs, may also lower R&D intensity and affect eligibility for ERIS.

Published: August 2026

Last Technical Review: August 2026

Author: Luke Gott, R&D Tax Associate, Onside Tax

FAQs

Can we still claim for overseas software developers?

It depends on how they are engaged. If the developer is the company’s own employee, the overseas restriction does not directly apply to staffing costs, although the normal qualifying conditions still apply. EPW costs may qualify where the worker’s earnings are subject to UK PAYE and NICs. Payments for contracted-out R&D undertaken overseas will usually be excluded unless the exception applies.

Does using a cheaper overseas team meet the exception?

No. The cost of carrying out the R&D and the availability of workers must be disregarded when applying the exception. Better time-zone coverage, by itself, is also unlikely to satisfy the statutory test.

Can part of an overseas contractor’s cost qualify if they worked in the UK?

Yes. It is the location of the R&D activity that matters, rather than where the contractor is based. If some qualifying R&D is carried out in the UK, the relevant UK part of the payment may qualify, subject to the normal rules, including the usual 65% restriction for payments to unconnected contractors. The cost should be reasonably apportioned and supported by records showing where the work took place.