Software R&D Projects: Do Overseas Subcontractor Costs Still Qualify?

For many years, businesses carrying out research and development (R&D) overseas subcontractors were often able to include subcontractor costs within their UK R&D tax relief claims. However, for accounting periods beginning on or after 1 April 2024, the rules changed significantly.

The overseas expenditure restrictions introduced under the merged R&D scheme mean that overseas subcontractor costs will generally no longer qualify for R&D tax relief unless a specific legislative exception applies.

If your business uses overseas developers, engineers or consultants, it is important to understand how these changes may affect your next claim.

The General Rule

The key consideration is where the R&D activity is physically undertaken.

This is different from:

• Where the subcontractor is incorporated.
• Where invoices are issued from.
• Where the contract is entered into.

For example, appointing a UK subcontractor does not automatically make the expenditure eligible if the underlying R&D activity takes place overseas. Equally, using an overseas subcontractor does not automatically prevent relief if the R&D activity is physically carried out in the UK.

Are There Any Exceptions?

Yes—but only in limited circumstances.

HMRC recognises that certain R&D activities genuinely need to take place outside the UK. In these situations, overseas subcontractor costs may still qualify where all of the following conditions are met:

• A qualifying condition required for the R&D activity is not present in the UK.
• That condition exists in the overseas location where the R&D activity is undertaken.
• It would be wholly unreasonable to replicate that condition in the UK.

HMRC identifies four categories of qualifying conditions:

• Geographical conditions.
• Environmental conditions.
• Social conditions.
• Legal or regulatory conditions.

These exceptions apply only where the location itself is fundamental to carrying out the R&D activity.

Overseas Software Development

One of the most common questions software businesses ask is whether overseas software development still qualifies.

In most cases, the answer is no.

Commercial reasons such as lower labour costs, access to overseas developers, existing offshore teams or faster delivery are not qualifying conditions.

However, overseas software development may still qualify where the work must genuinely be undertaken overseas because of a qualifying geographical, environmental or legal/regulatory condition.

Examples may include software that must be developed or tested using location-specific infrastructure, regulated overseas systems or physical assets that cannot reasonably be replicated in the UK.

The determining factor is not who performs the work, but why the activity must be carried out in that location.

What Doesn't Qualify?

Businesses should not assume overseas expenditure qualifies simply because it is commercially beneficial.

The following factors, on their own, will not justify claiming overseas subcontractor costs:

• Lower labour costs.
• Commercial preference.
• Existing overseas teams or group companies.
• Convenience.
• Availability of overseas expertise.
• Recruitment challenges in the UK.
• Faster delivery times.

HMRC expects R&D activities to be undertaken in the UK wherever it is reasonably possible to do so.

Evidence Is Essential

Where overseas expenditure is included within an R&D claim, businesses should retain clear evidence demonstrating either:

• That the R&D activity was physically carried out in the UK; or
• Why the overseas legislative exception applies.

Useful evidence may include contracts, statements of work, technical documentation, project records and evidence explaining why the qualifying condition could not reasonably be replicated in the UK.

Questions to Ask Before Claiming Overseas Costs

Before including overseas subcontractor costs within an R&D claim, businesses should consider:

• Where was the R&D activity physically undertaken?
• If overseas, which qualifying condition applies?
• Why could that condition not reasonably be replicated in the UK?
• What evidence supports that conclusion?

If these questions cannot be answered clearly, the expenditure is unlikely to qualify under the post-April 2024 rules.

How We Can Help

The overseas expenditure restrictions represent one of the most significant changes introduced under the merged R&D scheme. Businesses that have historically claimed overseas subcontractor costs should not assume those costs continue to qualify.

At Greenuna Tax Ltd, we can help you:

• Review overseas subcontractor arrangements.
• Assess whether an overseas exception may apply.
• Identify qualifying and non-qualifying expenditure.
• Strengthen supporting evidence.
• Reduce the risk of HMRC challenge.

If your business uses overseas developers, engineers, consultants, we recommend reviewing these arrangements before submitting your next R&D claim.