Can You Claim R&D Tax Credits on Subcontractor Costs?

Yes, you can claim R&D tax credits on subcontractor costs. But since the merged R&D scheme took effect for accounting periods beginning on or after 1 April 2024, the first question HMRC asks is no longer just "how much did you pay?" It is "who decided this R&D should happen?" The company that intended or contemplated the R&D gets the claim. The company that merely performed it, however skilled, generally does not.

That decision-maker test is the biggest change to subcontracted R&D in a decade, and it catches businesses on both sides of the contract: customers who assume they cannot claim for outsourced work, and subcontractors who assume they can claim for work a client commissioned. This page sets out who claims, the 65% rule, the connected party mechanics, what the credit is actually worth at each corporation tax rate, and the two forms that now gate every claim.

What Counts as a Subcontractor for an HMRC R&D Claim

Contracted-out R&D means your company engages another party to carry out R&D activities as part of a project you are running. You are seeking to resolve the scientific or technological uncertainty; the subcontractor performs some or all of the work. The subcontractor does not have to be a company. A freelancer or sole trader billing your company directly can be a contractor for R&D purposes.

Common examples:

• A software consultancy in Newcastle building a prototype matching algorithm for your logistics platform
• A specialist test lab in Sheffield running materials analysis for a composite your engineering firm is developing
• A freelance data scientist in Cardiff building a machine learning model your product team has specified
• A design engineering practice in Glasgow developing a manufacturing process your factory will run

One boundary matters before anything else: a contractor is not the same as an externally provided worker (EPW). If the individual works under your direction, supervision and control, like a temporary member of your team supplied through a staffing arrangement, they are an EPW, which carries its own 65% rule but different mechanics. A genuine contractor delivers an outcome under their own control. The contract and the working reality decide, not the label on the invoice.

Who Claims: the Decision-Maker Test Under the Merged Scheme

For accounting periods beginning on or after 1 April 2024, the merged scheme replaced both the old SME scheme and old RDEC. With it came a single rule for contracted-out R&D, in CTA 2009 s.1133 as rewritten: the party that intended or contemplated the R&D claims the relief.

"Intended or contemplated" goes beyond knowing that some R&D will probably happen. HMRC's guidance (CIRD161000) requires a specific appreciation of what R&D will be done. In practice HMRC looks at the surrounding circumstances:

• Who owns the resulting intellectual property
• Who bears the financial risk if the work fails
• Who has autonomy over how the uncertainty is tackled
• Whether the contractor is an R&D specialist selling that capability

The subcontractor can claim instead of the customer in limited situations: where the customer did not intend or contemplate the specific R&D (the contractor took the initiative to do R&D to deliver a conventional contract), where the customer is an ineligible client (an overseas company outside UK corporation tax, a charity, a government body), or for the contractor's own at-risk R&D outside any client contract. Only one party can claim for the same work, so it is worth stating in the subcontract who will.

How This Differs From the Old Rules: a Date-Fenced Comparison

The scheme that applies is fixed by when your accounting period begins, so companies are still filing claims under both sets of rules. The differences for subcontracted work are substantial:

Question	Old rules (APs beginning before 1 Apr 2024)	Merged scheme (APs beginning on or after 1 Apr 2024)
Can a customer claim for subcontracted R&D?	SME scheme: yes, at 65% for unconnected parties. Old RDEC: generally no, except payments to qualifying bodies, individuals and partnerships	Yes, all companies, where the customer intended or contemplated the R&D. 65% rule for unconnected parties
Can the subcontractor claim on client work?	SME scheme: no, subcontracted-to work was excluded. Could sometimes claim old RDEC instead	Only where the customer did not intend the R&D or is an ineligible client
Subsidised expenditure	SME relief restricted where the cost was subsidised, including by grants or client payment (heavily litigated)	Restriction removed entirely. Grant-funded and client-funded R&D no longer loses relief on that ground
Overseas subcontractors	Location of the work did not generally restrict the claim	UK activity required, unless the narrow s.1138A exception applies

The removal of the subsidised expenditure restriction is easy to miss and works in claimants' favour: under the merged scheme, receiving a grant or being paid by a client no longer disqualifies expenditure by itself. The decision-maker test does the policing instead.

The 65% Rule for Unconnected Subcontractors

If your subcontractor is unconnected (an independent third party, no common control), 65% of the qualifying element of the payment counts as qualifying expenditure (CTA 2009 s.1136). The remaining 35% cannot be claimed. The qualifying element is the part of the payment attributable to R&D activity taking place in the UK (plus any overseas activity within the s.1138A exception).

The 65% figure is a rough-and-ready allowance for the subcontractor's overheads and profit margin. It applies mechanically: however precisely the invoice itemises staff time, you still take 65%. You do not need the subcontractor's internal cost breakdown, which is exactly why the rule exists.

Connected Subcontractors: the Lower-Of Rule

A subcontractor is connected where your company controls them, they control you, or both sit under common control, typically more than 50% of shares or voting rights, and control by the same person or group counts. A director's own personal service company doing R&D for the company they control is a classic connected case.

For connected subcontractor spend the 65% cap does not apply. Instead you claim the lower of the payment and the subcontractor's relevant expenditure on the work (CTA 2009 s.1134): their non-capital spend on staffing, software, data and cloud, consumables, clinical trial payments and EPWs, accounted for under GAAP within 12 months of the end of your accounting period. Two consequences:

• Any profit margin the connected subcontractor charges drops out. A subsidiary that bills its parent £60,000 for work that cost it £42,000 supports a claim of £42,000, not £60,000.
• Payments the subcontractor makes to its own subcontractors do not count as its relevant expenditure (s.1134(3)(c)), so relief cannot be layered down a chain.

An unconnected customer and subcontractor can jointly elect to use the connected-party basis instead of the 65% rule. That only pays where the subcontractor's relevant expenditure exceeds 65% of the price, and it needs their cost data, so in practice it is rare.

What the Credit Is Actually Worth: a Worked Example at Both CT Rates

The merged scheme pays a 20% expenditure credit, and the credit is itself taxable income. So the net benefit depends on your corporation tax rate.

Say a software company in Nottingham pays an unconnected AI developer £80,000 to build a recommendation engine, all work done in the UK, and the company intended the R&D from the outset.

• Qualifying expenditure: 65% of £80,000 = £52,000
• Expenditure credit: 20% of £52,000 = £10,400
• Net benefit at the 25% main rate: £10,400 less £2,600 tax = £7,800 (15% of qualifying spend)
• Net benefit at the 19% small profits rate: £10,400 less £1,976 tax = £8,424 (16.2% of qualifying spend)

Now a mixed example. A structural engineering company in Bristol develops a lightweight composite for bridge construction. It subcontracts testing to an unconnected lab for £45,000 and design work to a connected subsidiary for £60,000; the subsidiary's relevant expenditure on the work is £42,000.

• Unconnected lab: 65% of £45,000 = £29,250
• Connected subsidiary: lower of £60,000 and £42,000 = £42,000
• Total qualifying subcontractor spend: £71,250
• Expenditure credit: 20% = £14,250; net £10,687.50 at 25%, or £11,542.50 at 19%

These subcontractor figures then sit alongside the company's in-house qualifying costs (staff, consumables, software, data and cloud) in the same claim.

ERIS: Loss-Making R&D-Intensive Companies

Loss-making SMEs whose relevant R&D expenditure is at least 30% of total expenditure (counting connected companies' spend in both sides of the ratio) can use Enhanced R&D Intensive Support (ERIS) instead of the merged scheme credit. ERIS gives an 86% additional deduction (so 186% total) and a payable credit of up to 14.5% of the surrenderable loss, which can be worth up to around 27p per £1 of qualifying spend, tax-free, against the merged scheme's 15p to 16.2p.

Subcontractor costs count toward ERIS on the same basis as above: the 65% rule for unconnected parties, the lower-of rule for connected ones, and the decision-maker test deciding whose claim it is. The payable credit is capped by the PAYE cap (£20,000 plus 300% of the company's relevant PAYE and NIC liabilities, unless the exemption applies), which bites hardest on companies whose R&D spend is mostly subcontracted rather than payroll, precisely the profile this page describes. A company that qualifies for ERIS should model both routes before electing.

Deadlines: the Two Forms That Gate Every Claim

Two administrative steps now decide whether a technically valid claim survives:

• Claim notification form. Required if you are claiming for the first time, or your last claim was made more than 3 years before the end of the claim notification period. The window runs from the first day of the period of account to 6 months after the end of the period of account. Miss it and the claim is invalid, with no discretion.
• Additional information form (AIF). Required for every claim since 8 August 2023, submitted before or on the same day as the CT600. HMRC rejects claims where the return arrives first. The AIF breaks costs down by category, so subcontracted R&D must be identified as its own line, and for each connected subcontractor you should be able to evidence the control relationship and the relevant-expenditure figure.

The claim itself goes in the company tax return (or an amended return) within 2 years of the end of the accounting period.

Common Mistakes With Subcontracted R&D Claims

Claiming as the contractor on work the client commissioned. Under the merged scheme, if your client intended or contemplated the R&D, the claim is theirs. Agencies and consultancies claiming on client projects without checking this are a growing enquiry target.

Claiming 100% of unconnected subcontractor costs. The 65% rule applies however detailed the invoice is.

Taking the full invoice from a connected subcontractor. The claim is the lower of the payment and their relevant expenditure. If you cannot produce the subsidiary's cost figure, you cannot support the claim.

Ignoring the UK activity condition. Work performed overseas by a subcontractor is excluded unless the s.1138A conditions are genuinely met, and cost saving is never a qualifying reason.

Missing the claim notification window. Six months after the period of account ends, for first-time claimants. This is the single most unforgiving deadline in the regime, because it can expire before the company has even thought about claiming.

Mislabelling EPWs as subcontractors or vice versa. Both carry a 65% figure but the mechanics, and the AIF disclosures, differ.

Records That Survive an Enquiry

HMRC has run a much higher enquiry rate on R&D claims since 2023, and subcontractor costs are a frequent focus. Keep:

• The subcontract or engagement letter, ideally stating which party intends the R&D and will claim
• Evidence of who bears the risk and owns the IP (these prove the decision-maker test, not just the relationship)
• Invoices, and for connected parties the subcontractor's GAAP-accounted cost breakdown
• Evidence of where the work was physically performed, for the UK activity condition
• Technical documentation of the uncertainty: designs, test results, iteration records

If a claim fails, HMRC can recover the relief with interest and penalties. The defensible position is not a bigger claim narrative; it is contemporaneous records that answer the three questions above: who decided, who is connected, and where the work happened.

Whether your project qualifies at all is a separate question, covered in our R&D tax credit eligibility checklist. For the claim process end to end, see our R&D tax credits guide.

Related articles in R&D Tax Credits

• How to Claim R&D Tax Credits
• R&D Tax Credit Specialist For A Manufacturing Company Doing Incremental Improvement
• R&D Tax Credits Explained For A Construction Company Developing New Materials