First question: whose claim is it?
Before any percentage matters, the merged scheme asks who is entitled to claim contracted-out R&D at all. The general rule in HMRC’s manual: only the party who takes the decision to undertake or initiate the R&D can claim. That is judged from the terms of the contract and the surrounding circumstances, including who bears the financial risk. If a customer commissions work contemplating that R&D of that sort would be needed, the R&D is generally the customer’s to claim, not the contractor’s.
Get this wrong and the percentages below are academic. If your R&D sits inside somebody else’s contract, or you commission technical work from others, settle entitlement first; the fuller treatment is on the merged scheme explained.
Externally provided workers: the 65% rule
An EPW is an individual, not a company, who is not your director or employee. They personally provide services to you through a staff provider, and work subject to your supervision, direction or control as to how the services are provided. Think agency contractor embedded in your team.
For unconnected staff providers, 65% of the payment attributable to qualifying earnings is treated as qualifying expenditure. The workers must themselves be directly and actively engaged in the R&D, and partly engaged workers are apportioned exactly like employees.
Contracted-out R&D: the other 65%
A contractor payment is a payment for contracted-out R&D to the person it is contracted out to. Where you and the contractor are not connected and no election is made, 65% of the relevant portion of the payment is claimable.
The “relevant portion” matters: the payment qualifies to the extent it relates to the qualifying R&D, so a contract mixing development with routine delivery needs splitting before the 65% is applied, not after.
Connected parties, and the election
Where provider and claimant are connected, group companies being the common case, the 65% shortcut is replaced by a lower-of test. Broadly, you claim the lower of what you paid and what the work actually cost the connected party. Unconnected parties can jointly elect into the same treatment, and the election is irrevocable for that contract.
Whether actual-cost beats 65% depends entirely on the margin structure, which is why this is a decision to model before year end, not a box to tick at claim time.
The honest boundary notes
- Same work, two claimants, one enquiry. Where customer and contractor both claim the same project, at least one is wrong. If your contracts are silent on who contemplated the R&D, fix the contracts.
- Overseas kills most of it. Contractor payments for R&D undertaken overseas, and EPWs outside UK PAYE, are generally excluded now; see overseas costs before assuming anything survives.
- Labels do not decide the category. An invoice saying “consultancy” can be an EPW arrangement in substance, and vice versa. HMRC looks at supervision, direction and control, and so should the claim.
- Personal service companies complicate it. An individual billing through their own company is not straightforwardly an EPW (the worker must be an individual supplied through a staff provider) and needs case-by-case analysis rather than assumption.
- HMRC, CIRD137000 and CIRD137100 (externally provided workers), Corporate Intangibles Research and Development Manual, gov.uk
- HMRC, CIRD138000 (contractor payments), Corporate Intangibles Research and Development Manual, gov.uk
- HMRC, CIRD161000 (contracted out R&D: overview), Corporate Intangibles Research and Development Manual, gov.uk
- HMRC, Check what Research and Development (R&D) costs you can claim, gov.uk
Frequently asked questions
Why do we only get 65% of what we actually paid?
Because statute says so for unconnected providers, as a rough-and-ready allowance for the provider's margin. It is not negotiable and not a target to argue up; the alternative basis only exists for connected parties or where both sides make an irrevocable joint election.
Our contractor does the R&D. Can they claim instead of us?
Under the merged scheme the claim generally belongs to whoever decided to undertake the R&D, judged from the contract and circumstances. A contractor can claim for R&D it initiates itself, but not usually for work contracted out to it. Both sides claiming the same work is how enquiries start.
Do overseas subcontractors qualify?
Mostly no. Contractor payments for R&D undertaken overseas, and agency workers whose earnings are not subject to UK PAYE, are excluded unless a narrow exception applies. The detail is on the overseas costs page.
What is the difference between an EPW and a subcontractor?
Control. An externally provided worker is an individual supplied through a staff provider working under your supervision, direction or control, like a temp on your team. A subcontractor takes on work to deliver: you buy an outcome, they control how. The two categories have different tests and paperwork, so classify before you calculate.