Usually yes. Under the merged scheme, R&D a customer contracts out belongs to the customer rather than the company doing the work — unless the customer sits outside the UK tax net. Where the person contracting the work out is not acting in the course of a trade within the charge to UK tax, the claim stays with the company that did the R&D. An overseas parent with no UK trade sits inside that exception: the subsidiary claims on its own qualifying costs — and the cost-plus recharge neither creates the claim nor limits it.
Why does an overseas parent change the answer?
Contracted-out R&D is claimed by the customer where it intended or contemplated the specific R&D when the contract was made. Had a UK parent commissioned this work, the parent would hold the claim and the subsidiary none. The exception exists so relief is not lost where the customer could never have claimed it: a charity, a university or a health service body, or any person not trading within the charge to UK tax. HMRC calls them irrelievable clients.
Two things about persons not trading within the charge to UK tax catch groups out. The test is the parent’s tax position, not its address. And “within the charge to tax” is wider than corporation tax: a UK sole-trader customer falls inside it, and so, on the face of the legislation, may an overseas parent that trades here through a UK permanent establishment, where it contracts the work out in the course of that UK trade. HMRC’s contracted-out guidance does not address permanent establishments, so this is a reading of the statute rather than a settled position — and it is a question to answer before the return goes in, not a reason to assume the claim is lost.
Where the parent is within the charge through a UK establishment, the relief does not disappear; it moves to the company that contracted the work out, as who can claim R&D tax relief sets out. And a group has one option unrelated parties do not: the two companies can jointly elect that the one contracting the work out is treated as ineligible, which puts the claim back with the company doing the work. Groups and connected companies sets out how that election is made and when.
A simpler route reaches the same place. Where the parent funds the subsidiary without contracting for activities to be carried out for it, nothing has been contracted out and the subsidiary is doing in-house R&D. Funding is not commissioning, and the paperwork behind a transfer decides which it is. The irrelievable-client condition is the same under ERIS, though a captive’s claim normally runs through the merged scheme.
Does cost-plus pricing reduce the claim?
No. The claim is built from what the subsidiary spent, not what it invoiced. Take a £4m cost base recharged at cost plus 8%. The claim is worked out on the qualifying costs inside that £4m — staff, externally provided workers, consumables, software, data and cloud computing — and the £320,000 mark-up changes none of it.
The instinct that a recharge must shrink the claim comes from the old subsidised-expenditure rule, abolished for accounting periods beginning on or after 1 April 2024. It still decides the answer for earlier periods: what subsidised expenditure means sets out how it worked.
Pricing the recharge at arm’s length does not rewrite the connected-party rules. HMRC’s manual is direct about it: transfer pricing rules do not displace the limits on expenditure for subcontracted R&D between connected persons. Where the subsidiary pays a connected company for part of the work, that cost is capped at the lower of the payment and the other company’s relevant expenditure, as the group rules set out.
One point deserves a decision rather than a default. The credit is a receipt of the subsidiary’s trade, so it increases the same trading profit the cost-plus arrangement was designed to produce. Whether the group’s intercompany pricing policy treats the credit as reducing the cost base the mark-up is struck on, or leaves it in the subsidiary’s profit, is a transfer pricing question for the group to settle — and it decides which company ends up holding the benefit.
When can the UK subsidiary still not claim?
The most common failure is a chain. Every person who contracted the R&D out to the subsidiary has to satisfy the exception, including the customer at the top — not just the party that signed the immediate contract. HMRC’s own example: a UK company contracts development to a US company, which passes the work to its own UK subsidiary. The UK customer can claim. The US company cannot, having no UK trade. Nor can the UK subsidiary, because the customer above it is within the charge to UK tax. A captive that also serves external customers needs to know what sits above it.
The subsidiary must also carry on a trade of its own and deduct the costs in computing its profits, and the R&D must relate to that trade. A company that is a cost centre in substance rather than a trader has nothing to claim. A service agreement priced at cost plus a margin is usually evidence of a trade; the case to worry about is a subsidiary carrying costs with no agreement and no margin. Where the work happens matters: payments to subcontractors and externally provided workers qualify only on the UK terms set out in overseas R&D costs. A subsidiary claiming for the first time must file a claim notification within six months of the end of its period of account; the parent’s claim history counts for nothing.
Who owns the intellectual property is not the test. HMRC treats IP ownership as one of the surrounding circumstances that show what the customer intended, alongside financial risk and autonomy over the work — evidence of intention, not the rule itself. A group that treats the parent’s ownership of the results as settling the question — in either direction — has assumed something the legislation does not say.
What should the intercompany arrangement show?
Four things, on paper: the parent’s UK tax position, whether the parent is fulfilling somebody else’s contract, what work is done where, and what the subsidiary spent. A transfer pricing report and a monthly journal record the price and nothing else; the claim turns on the arrangement behind it.
If a UK company in your group does R&D for an overseas parent and nobody has tested where the claim sits, talk it through with a chartered adviser.
Sources
- CTA 2009 s1042F — qualifying expenditure on activity as contractor for an irrelievable client: condition B requires that each person by whom the R&D is contracted out to the company either is an ineligible company or “is not, in relation to the contracting out of the research and development by that person, acting in the course of a trade, profession or vocation within the charge to tax”.
- CTA 2009 s1053A — the identical condition for ERIS.
- CTA 2009 s1133 — contracted-out R&D: the intended-or-contemplated test at subsection (2)(c), and subsection (4), under which R&D is contracted out to a sub-contractor as well as to the immediate contracting party.
- CTA 2009 s1142 and CIRD163000 — ineligible companies: a charity, an institution of higher education, a scientific research association and a health service body; subsections (5) and (6) let two companies in the same group jointly elect that the one contracting R&D out to the other is treated as ineligible, by written notice, revocable, and ending once they are no longer in the same group.
- CTA 2009 s1042B — entitlement requires the company to carry on a trade in the period and the expenditure to be allowable as a deduction in calculating the profits of that trade.
- CTA 2009 s5 — subsections (2)(b) and (3): a non-UK resident company carrying on a trade in the UK through a permanent establishment is within the charge to corporation tax on the profits attributable to it.
- CTA 2009 s1042D — the in-house route, available where the R&D is not contracted out to the company; s1042 — “relevant research and development” means R&D related to a trade carried on by the company, or from which it is intended that a trade to be carried on by the company will be derived.
- CTA 2009 s1042H — the credit is brought into account as a receipt in calculating the profits of the trade.
- CIRD161000 — irrelievable clients under s1042F and s1053A; the general rule that only the party taking the decision to undertake or initiate R&D can claim; IP ownership, financial risk and autonomy listed among the surrounding circumstances rather than as the test.
- CIRD162000, example 5 — a UK customer contracting to a US company which passes the work to its UK subsidiary: the subsidiary cannot claim, because the condition is not met by the customer at the top of the chain.
- CIRD162100, example 10 — a UK contract research organisation running trials for overseas pharmaceutical companies not within the charge to corporation tax satisfies s1042F or s1053A and can claim for its expenditure.
- CIRD164000 — the group election is made by notice in writing before or at the same time as any claim that depends on it, there is no limit on the number, and “An overseas member of the group will in any case be ineligible so this election would not be necessary for a claim to be possible in principle”.
- CIRD81200 — relief is available only to companies within the charge to corporation tax in respect of profits charged to it, and the permanent-establishment principle “extends (with necessary modifications) to UK permanent establishments of foreign companies”.
- CIRD192000 — connection takes its meaning from CTA 2010 s1122, and “transfer pricing rules do not displace the limits on expenditure for subcontracted R&D between connected persons”.
- CTA 2009 s1134 — where the parties are connected, the qualifying element of a contractor payment is the lower of the payment and the contractor’s own relevant expenditure.
This page describes the rules as they stood at the review date above, as general information rather than advice on your circumstances. For how that distinction works, see our terms; for an answer on your own facts, talk to us.