Who Claims R&D Tax Relief? Contracted-Out Decision Tree (Merged Scheme)

How the contracted-out rules work under the merged scheme

The merged scheme replaced the separate SME R&D scheme and RDEC from 1 April 2024. One of the most debated areas in the transition was how contracted-out R&D would be treated. Under the old SME scheme, a contractor could sometimes claim on R&D it carried out even if a customer paid for it, provided certain conditions were met. The merged scheme closed that route. The rules now closely follow the old RDEC position.

The financial risk test

The company that bears the financial risk of the R&D activity is the one that can claim. HMRC defines "bearing the financial risk" as being in a position where the company would suffer a loss if the R&D failed to produce a usable result. If a customer pays a fixed fee and the contractor has to deliver regardless of outcome, the customer bears the risk. If a contractor takes on open-ended exploratory work with no guarantee of payment on failure, the contractor bears the risk.

This matters because the same piece of work cannot be claimed by both parties. HMRC is explicit about this at CIRD81900. Double-claiming is an error that will be corrected on enquiry.

Who initiated the R&D

Initiation is evidence of who directed and bore the risk of the work. If a customer approaches a contractor with a specific technical problem and contracts for a solution, the customer is the initiating party. If a contractor develops a new product or process speculatively and then sells it, the contractor is the initiating party. Initiation alone is not decisive, but it is strongly correlated with where the financial risk sits.

The role of a written contract

A written contract specifying who bears cost overruns and the risk of technical failure is strong evidence. HMRC officers will read the contract as part of any enquiry. However, the contract must reflect commercial reality. If the paperwork says the customer bears the risk but in practice the contractor absorbs all overruns, HMRC will look at economic substance. Contracts should be drafted to match the actual commercial arrangement, not to engineer a particular tax outcome.

Overseas customers

If the customer is based overseas and not subject to UK Corporation Tax, the customer cannot make a UK R&D tax relief claim. In that situation, the UK contractor may be able to claim provided it independently bears the financial risk and meets all other qualifying conditions. The contractor must be a UK company subject to UK Corporation Tax.

Subsidised expenditure

Expenditure is subsidised when a third party (including the customer) has met or agreed to meet the cost. Under the merged scheme, subsidised R&D cannot be claimed by the contractor. If a customer pays a contractor to carry out R&D, that expenditure is subsidised from the contractor's perspective. The contractor has received a payment that covers the cost. The customer is the one out of pocket if the work fails, so the customer is the risk-bearer and the claimant.

Partial subsidies are treated proportionally. If a grant covers 40% of costs and the contractor bears the other 60% at risk, the contractor can claim on the 60%. The grant-funded portion is excluded. HMRC sets out the grant interaction rules at CIRD82500.

Qualifying bodies

A qualifying body is an organisation that is not subject to Corporation Tax: universities, charities, scientific research organisations, health service bodies (including NHS trusts), and certain government bodies. When a qualifying body commissions R&D, it cannot itself make an R&D tax relief claim. In that scenario, provided the contractor bears the financial risk independently, the contractor can claim. This exception exists because otherwise work commissioned by universities would generate no tax relief anywhere in the system.

The list of qualifying bodies is set out at CIRD81900. Local authorities, public bodies, and most foreign universities do not qualify. Verify the body's status before relying on this exception.

Worked example: software contractor

A software company (Company A) is commissioned by a UK manufacturer (Company B) to build a proprietary machine-learning model for defect detection. Company B defines the requirements, pays a fixed project fee, and owns the intellectual property. Company A bears no risk if the model underperforms. In this scenario, Company B bears the financial risk and would claim R&D relief on the fee paid to Company A (as a subcontractor cost in its own claim). Company A cannot claim, because its expenditure was subsidised by the fee received.

If the arrangement were reversed and Company A developed the model speculatively without a guaranteed fee, Company A would bear the risk and could claim on its own development costs.

What to do with the result

This tool returns a verdict based on the six questions. The verdict is an indicator, not legal advice. Contracted-out R&D disputes feature in several First-tier Tribunal cases and HMRC enquiries go into contract terms in detail. If the verdict indicates you can claim, the next step is a free assessment with a qualified specialist who will review the contracts and the commercial substance. If the verdict indicates your customer claims, you may want to notify your customer so they can include the expenditure in their own claim.

For more on qualifying costs, see the qualifying expenditure guide. For a recovery estimate, use the R&D eligibility checker.