Externally Provided Workers for R&D Tax Credits

What HMRC Accepts

An externally provided worker is defined in Chapter 9 of Part 13 of the Corporation Tax Act 2009. The defining features are:

1. The worker is an individual.
2. The worker is not a director or employee of the claimant company.
3. The worker personally provides, or is under an obligation personally to provide, services to the claimant.
4. The services are not provided under a contract directly between the worker and the claimant (there is an intermediary).
5. The services are subject to (or to the right of) supervision, direction, or control of the claimant.

Agency contractors placed at the claimant on a day-rate basis are the classic EPW example. So are workers placed via an umbrella company, or through a staffing company that routes workers through PSCs. The consistent thread is that there is a staff provider between the worker and the claimant, and the claimant directs the work.

The claimable amount is 65% of the staff provider payment that relates to qualifying R&D activity. The 65% figure is a statutory simplification reflecting that part of the payment represents the provider's margin rather than worker remuneration.

Apportionment

Apportionment applies on two dimensions. First, the fraction of the staff provider payment that relates to individuals performing qualifying activity; second, the fraction of each individual's time spent on qualifying activity.

For a contractor engaged full-time on an R&D project, the first fraction is 100% and the second is typically 70-90% after allowing for holidays, training, general meetings, and administrative time. For a contractor splitting time between R&D and production support, the second fraction reflects the split.

Evidence for EPW apportionment typically includes: the staff provider invoices showing hours and rates, timesheets or Jira tagging by the EPW against R&D projects, and a written apportionment schedule reconciling the staff provider payment to the claim.

What Is Included

• Payments to the staff provider for EPWs engaged on qualifying R&D activity (at the 65% rate for unconnected parties).
• VAT where irrecoverable is included in the base figure before the 65% cap is applied.
• Agency fees charged to the claimant that form part of the staff provider's invoice.
• Expenses recharged by the staff provider that relate to the EPW's R&D work, where they form part of the invoice.

What Is NOT Included

• Direct engagements of individuals without a staff provider intermediary — these are either employees or subcontractors depending on the facts.
• Payments to a staff provider for non-R&D work.
• The 35% residual of each payment that is outside the 65% cap.
• Payments to overseas staff providers for EPWs not subject to UK PAYE, for periods beginning on or after 1 April 2024 (outside the narrow exception).
• Recharges from a connected group company where the connected-party rules apply — these follow a different calculation.

Merged Scheme Changes

The 65% cap is unchanged by the merger. The connected-party rules are unchanged. The primary change is the UK provision requirement, which has moved significant spend on offshore contractors outside the scheme for many companies.

For companies with accounting periods straddling 1 April 2024, a split calculation is required. EPWs before the split date follow the pre-merger rules; EPWs after the split date follow the new rules. For context on straddling periods, see our merged scheme guide.

Common Enquiry Risks

• Mischaracterising subcontractors as EPWs or vice versa. The wrong label leads to wrong cost. HMRC checks the contractual and practical relationship.
• Claiming 100% of the staff provider payment instead of 65%. Simple but common error.
• Including overseas EPWs without applying the UK provision test. The largest recent quantum adjustment area.
• Treating personal-service-company contractors engaged directly as EPWs. Without an intermediary staff provider, they are not EPWs.
• Failing to gather contract evidence. HMRC often asks for the staff provider agreement to verify the relationship.
• Double-counting. Where a contractor moves between direct engagement and staff-provider placement mid-year, the split has to be tracked accurately.

Worked Example (Indicative)

A fintech company engages three senior contractors through a UK staffing agency for the year to 31 March 2026. Gross staff provider payments total £360,000 across the three. The contractors are UK-based, placed under PAYE by the agency, and work under the company technical lead. Their time split across the year shows 85% on qualifying R&D projects and 15% on production support.

Qualifying staff provider payment: £360,000 x 85% = £306,000.

Claimable EPW cost after 65% cap: £306,000 x 65% = £198,900.

At the 20% merged scheme credit rate, this generates £39,780 of gross credit. After corporation tax at 25%, the net benefit to the profitable company is approximately £29,835. Under ERIS at 27%, the gross credit would be £53,703. Figures are indicative and will vary with actual facts.

Contract Structure and the Direction-of-Control Test

The practical question underpinning every EPW classification is who directs the work. The answer decides whether a cost sits in the EPW category, the subcontractor category, or (rarely) the staffing category. HMRC looks at the facts rather than the label on the contract.

Four factors carry most weight in the direction-of-control analysis:

• Who sets the daily priorities. If the claimant's technical lead assigns tickets and sets daily priorities, direction sits with the claimant; this points to EPW.
• Who determines how the work is done. If the claimant specifies the methods, toolchain, and quality checks, that also points to EPW. If the third party decides the approach and warrants the outcome, that points to subcontractor.
• How the worker is supervised. Reporting to the claimant's line management, attending its stand-ups, using its issue tracker: points to EPW. Delivering milestones and progress reports independently: points to subcontractor.
• How the work is priced. Time-based rates with invoicing for hours worked: typical EPW pattern. Fixed-price deliverables with stage payments: typical subcontractor pattern.

The four factors do not need to be unanimous; HMRC weighs the overall picture. Contracts that straddle the two treatments (time-based rates but outcome-based deliverables, or vice versa) require specialist review. A written contract that accurately reflects the working arrangement is the cleanest starting position.

Umbrella Company Contractors

UK umbrella company arrangements have been a common way to engage contractors for R&D work. The typical structure has the claimant engaging an agency, the agency paying an umbrella company, and the umbrella company employing the worker and processing PAYE.

Under the old SME scheme, these arrangements were usually claimable as EPWs. Under the merged scheme, the UK provision rule applies: the worker needs to be subject to UK PAYE, which is normally the case for a UK umbrella employer. The 65% cap applies to the claimant's gross payment to the agency.

Complications arise where the umbrella is based offshore, where the worker is technically employed outside the UK but physically present in the UK, or where the arrangement is layered through multiple intermediaries. Each variant needs specialist review. The simplest compliant structure is a UK-registered staffing agency engaging a UK-based umbrella company employing a UK-tax-resident worker.

Evidence Portfolio for EPW Claims

A strong EPW claim is backed by a consistent evidence portfolio. Specialists typically assemble:

• The signed staff-provider agreement covering the period of the claim.
• Monthly or weekly invoices from the staff provider showing hours worked, day rates, and identified R&D projects where possible.
• Timesheet extracts or Jira tags from the EPWs showing time spent on qualifying R&D activity.
• Written confirmation from the claimant that the EPWs worked under the direction of its technical leads.
• For post-April 2024 periods, evidence that the staff provider operated UK PAYE on the workers (a letter from the staff provider or sample payslips).
• Reconciliation between the cumulative staff-provider invoices and the claimed EPW cost.

Connected-Party EPW Arrangements

Where the claimant and the staff provider are connected within the meaning of sections 1122 and 1123 of the Corporation Tax Act 2010, the 65% cap is replaced by a different rule. The claim is limited to the lower of:

• The payment made by the claimant to the staff provider; or
• The staff provider's relevant expenditure on the individual worker (roughly, the staff provider's cost of employing or engaging the worker, attributable to the R&D activity).

The rule prevents groups from inflating the claim by routing labour through a connected staff provider at a marked-up rate. In practice, most connected-party EPW claims end up at a figure close to the underlying staff cost of the worker, which can be lower than the 65% of the intercompany charge.

The mechanics require the staff provider to share cost data with the claimant. Where the staff provider is a group subsidiary, this is usually manageable. Where the connected party is offshore, there may be additional tax and transfer pricing considerations that a specialist adviser needs to address.

Interaction with ERIS and the R&D Intensity Test

For loss-making companies claiming under ERIS (Enhanced R&D Intensive Support), the R&D intensity test uses total qualifying R&D expenditure divided by total expenditure. EPW cost sits inside the qualifying numerator after the 65% cap has been applied.

This creates a modest quirk: gross EPW spend that is above the 65% cap reduces the intensity ratio. A company spending heavily on agency contractors may find its intensity percentage pushed just below the 30% ERIS threshold even though its R&D activity remains intense. A specialist adviser will model the interaction and advise on any restructuring options where the company is close to the threshold.

For a fuller treatment of ERIS, see our merged scheme guide.

Sector Patterns: How EPWs Appear in Claims

EPW usage varies significantly by sector, and so does the claim profile. Four recurring patterns are worth noting.

Software and SaaS. Agency contractors engaged on day rates to supplement the in-house engineering team. Typical EPW share of the claim is 5-15%. The working arrangement almost always meets the direction-of-control test for EPW status. Post-April 2024, the UK provision rule has pushed a significant share of historic offshore contractor spend outside the scheme.

Engineering and manufacturing. Specialist contractors brought in for specific technical skills (mechanical engineering, electronics design, firmware). EPW share is usually smaller than in software (3-10%) because staff costs dominate. Direction-of-control is typically clear.

Life sciences. Contract research organisations blur the line between EPW and subcontractor. Where the claimant's scientific lead directs the day-to-day activity of individual CRO staff embedded in the research, an EPW treatment may be appropriate. Where the CRO runs an independent research package against a statement of work, subcontractor treatment applies.

Construction and built environment. Freelance engineers, architects, and specialist consultants. The outcome-versus-time test is often decisive. Where the output is a discrete piece of analysis or design delivered under the consultant's own direction, subcontractor treatment applies. Where the consultant is embedded for a period and directed by the claimant's project manager, EPW treatment fits better.

Related Cost Categories

• Staffing costs — for in-house employees.
• Subcontractors — for third parties delivering outcome-based work.
• Eligible Expenses pillar guide — full category framework.