This year, the landscape for claiming R&D tax credits has shifted significantly, particularly in relation to offshore and nearshore tech teams. Previously, businesses could include any expenditure on these teams in their R&D tax credit claims, but recent R&D Tax rules changes have altered the playing field. What are the new requirements, and how do they impact CTOs and their outsourcing choices moving forward? Let’s break it down.
Understanding the New R&D Tax Credit Rules:
-
Previous Requirements:
- Under the old R&D tax credit regulations, companies could claim tax relief for research and development work regardless of where in the world it was carried out.
- This included costs related to nearshore and offshore consultants, externally provided workers (EPWs) and development teams.
- The goal was to encourage innovation irrespective of the team’s location.
-
Current Regulations:
- As of April 2024, the rules have tightened, restricting claims for R&D tax credits to activities and expenditures occurring within the UK.
- This means that any R&D activities carried out by offshore or nearshore teams are no longer eligible for these tax credits unless they meet specific criteria.
- For payments to EPWs to be eligible for tax relief, the workers’ earnings must be subject to UK PAYE and National Insurance Contributions (NIC). This effectively excludes most overseas workers from qualifying unless they are paid through UK payroll.
Why the change?
The UK Government has introduced this shift in regulation with an aim to boost local talent, create jobs, and drive economic growth by ensuring that investments in research and development directly benefit the UK economy.
Exceptions to the Rule:
There are exceptions where overseas R&D expenditures may still qualify, but these are tightly defined. All three of the following conditions must be met:
- Necessary conditions not present in the UK
- Conditions present overseas
- Replication in the UK is unreasonable
To summarise simply, overseas R&D costs can be claimed if the R&D involves conditions found abroad that are unavailable in the UK, and replicating those conditions in the UK would be completely impractical (could be due to geographical considerations, time pressures, environmental issues etc.).
HMRC brings to life these conditions with several examples, including the following:
A company is conducting R&D in the development of a software service for the commercial banking market in the US. Development requires the company to have a collocated team in the US due to access regulations within the US banking sector. This requires conditions (the presence of US banking systems and regulatory requirements) which are not present in the UK, and which would be wholly unreasonable to replicate. This condition exists in the US. Therefore, this activity would satisfy CTA09/1138(2) if undertaken in the US, where the necessary conditions arise.
Implications for Outsourcing Strategies
The inability to claim tax credits for offshore tech teams can significantly impact a company’s financial planning. Previously, the tax relief provided a financial cushion, making offshore outsourcing more attractive despite higher logistical and management costs. Now, companies must absorb these costs without the offsetting benefit of tax credits, potentially making offshore solutions less financially viable.
Reevaluating Cost-Effectiveness:
The new regulations ask for a fresh look at the cost-effectiveness of outsourcing strategies. While offshore teams might offer lower hourly rates, the inability to claim tax credits diminishes these savings. In contrast, onshore teams, although typically more expensive upfront, become more attractive when considering the potential tax savings as well as the other benefits offered by onshore. Businesses should weigh up the long-term financial benefits of onshore partners more heavily in their decision-making processes and consider that investing onshore doesn’t always need to be at a high cost. Onshore organisations that have a non-traditional approach to consultancy, like Counter, are highly capable and cost-efficient, plus they bring with them the opportunity for in-person collaboration.
Considering the Implications for Offshore and Nearshore Teams
For businesses currently utilising offshore or nearshore tech teams to support their internal tech capabilities, the new R&D tax credit regulations present several considerations. While offshore teams have traditionally provided cost savings through lower labour costs, these savings may be counterbalanced by potential miscommunication, misalignment and different time zones, not to mention the inability to claim tax credits under the updated rules. This shift could lead to a reassessment of the true cost benefits of maintaining offshore operations.
How Much Could You Claim Through R&D Tax Relief?
Maybe you’re a regular claimant of R&D tax credits, or perhaps you’ve only ever considered it but the unknowns of the process have put you off. To help businesses understand the potential savings and benefits of working with onshore teams, we recommend using our R&D tax credit estimator (please note: you will need a Google account, and be asked to make a copy!). This tool can provide a clear picture of the financial advantages and help inform your outsourcing strategy moving forward. You can see how much you could claim through R&D tax relief, making the decision to invest in UK-based teams more transparent and financially sound.
To highlight the financial impact of claiming R&D tax relief, consider this: the average cost of a six-month Counter team, consisting of four Associate Consultants led by one Tech Lead, is approximately £235,000. By choosing our UK onshore teams over nearshore or offshore options, you could save an additional £32,250.
Strategic Considerations for Tech Teams
While offshore and nearshore tech teams have their advantages, the new R&D tax credit regulations prompt a reevaluation of their cost-effectiveness. Onshore teams not only provide opportunities for better communication, cultural alignment, and quality control but also ensure that businesses can fully leverage available tax credits. As CTOs and CFOs consider these changes, partnering with cost-efficient onshore teams may emerge as a strategic move that aligns both financial and operational goals.
If you’d like to learn more about working with our onshore technologists and saving via the R&D tax relief scheme, please get in touch today.
