Quick answer: Contracted-out R&D is where one company pays another to carry out R&D and takes the results. Under the merged scheme (accounting periods beginning on or after 1 April 2024), the funder, not the performer, claims the relief, at 65% of the payment made, regardless of whether the subcontractor is connected or unconnected. This replaced the legacy SME-scheme overlap rules.
What is contracted-out R&D under the merged scheme?
Contracted-out R&D occurs where a company (the claimant) pays another entity to carry out R&D activity. The claimant funds the work and takes the results. The subcontractor provides resource, facilities, or know-how and delivers work product in return for payment. Under the merged scheme, the funder is the claimant because it bears the financial risk and takes the benefit of the R&D. The subcontractor's costs are qualifying expenditure for the funder, subject to a 65% uplift cap on externally contracted R&D.
HMRC's guidance at CIRD90300 sets out the merged-scheme rules for contracted-out R&D. The contracted-out costs qualify as subcontractor expenditure for the funder at 65% of the payment made. The performer cannot claim on the same activity unless it is also undertaking its own independent R&D beyond what it was contracted to do.
How did contracted-out R&D change from the legacy SME scheme?
Under the legacy SME scheme, a subcontractor that was not connected to the claimant could sometimes claim RDEC on its own costs while the claimant claimed SME uplift on the payment made to the subcontractor. The merged scheme eliminates this overlap. The funder-gets-the-claim rule applies regardless of whether the subcontractor is connected or unconnected. If you are doing R&D work under a contract, you need to establish clearly whether you are the funder or the performer to determine where the claim sits.
What does contracted-out R&D look like in practice?
A manufacturing company commissions a specialist engineering consultancy to develop a novel coating process. The manufacturer pays £200,000 for the work and retains all rights to the resulting process. Under the merged scheme, the manufacturer claims on £130,000 (65% of £200,000) as contracted-out R&D. The consultancy cannot also claim on its costs for that project. If the consultancy incidentally extends the research beyond the contracted brief, it may be able to claim on that incremental activity, but not on the costs recovered from the manufacturer.
What common mistakes arise with contracted-out R&D claims?
A frequent mistake is the performer claiming on its own costs when those costs were entirely funded by a third party. This creates a double-count and is one of the categories HMRC's compliance activity specifically looks for. The subsidised expenditure rules reinforce this: costs met by another party are not qualifying in the performer's hands.
A second mistake is mischaracterising an employment arrangement as a subcontract. A developer placed through an agency and working under the client's supervision is typically providing labour rather than subcontracting R&D. The distinction matters because labour costs fall under the externally provided workers rules rather than contracted-out R&D rules, and the qualifying percentage (65%) is the same in both cases under the merged scheme.
If you are unsure whether you are the funder or the performer in a specific arrangement, the free assessment can help clarify the position.
Related terms
- Subcontractor: R&D UK Rule
- Externally Provided Workers
- Subsidised Expenditure
- Merged R&D Scheme
- Qualifying Expenditure
Frequently asked questions
Contracted-out R&D is where a claimant company pays another entity to carry out R&D activity, funding the work and taking the results. The subcontractor provides resource, facilities, or know-how in return for payment.
Under the merged scheme, the funder claims because it bears the financial risk and takes the benefit of the R&D. The subcontractor's costs are qualifying expenditure for the funder at 65% of the payment made, and the performer cannot also claim on the same activity unless it undertakes independent R&D beyond what it was contracted to do.
Under the legacy SME scheme, an unconnected subcontractor could sometimes claim RDEC on its own costs while the claimant claimed SME uplift on the same payment. The merged scheme eliminates this overlap: the funder-gets-the-claim rule now applies regardless of whether the subcontractor is connected or unconnected.
A frequent mistake is the performer claiming on costs entirely funded by a third party, creating a double-count that HMRC's compliance activity specifically looks for. A second mistake is mischaracterising an employment arrangement, such as an agency-placed developer under client supervision, as a subcontract rather than externally provided worker labour. If you are unsure how a specific arrangement would be treated, the eligibility calculator can give an indicative view before you seek a full assessment.