This article is part of our Biotech Review of the Year - Issue 12 publication.
After years of plans by the UK Government to overhaul the UK’s tax relief rules for R&D, the new R&D tax relief regime officially came into force in April 2024. We consider the implications for companies contracting out research and also those conducting it, along with some practical tips for drafting and negotiating contract research organisation (CRO) agreements.
R&D relief – legal landscape
From 1 April 2024, several key changes were made to the UK R&D tax regime, including:
- the consolidation of SME R&D tax relief and the Research and Development Expenditure Credit (RDEC) schemes into a single scheme;
- the introduction of an enhanced regime for ‘R&D-intensive’ loss-making SMEs; and
- the imposition of restrictions on relief for contracted-out R&D and overseas expenditure – the focus of this piece.
Who can claim relief for contracted out R&D?
Before 1 April 2024, the CRO would typically be the party able to claim tax relief for any qualifying R&D expenditure as the contractor. However, under the new rules, if the commissioning customer had reasonably “intended or contemplated” the R&D work as part of their overall innovation strategy, then it is the customer who has the primary right to claim any R&D relief. This means that, for R&D tax purposes, a customer who commissions research from a contractor (for example a CRO) has ‘contracted-out’.
According to HMRC, “intended or contemplated” means more than just being aware that R&D will occur; the customer needs to have a specific appreciation of what R&D will be done. This does not necessarily entail knowing or describing the work to be carried out in every detail. Rather, it means that work which falls substantially outside of a customer’s intention or expectation cannot be R&D contracted out by that customer.
This shift raises important considerations for CRO agreements, and, given the value of R&D relief, has the potential to substantially alter the cost and expected returns for each contracting party. Customers engaging with CROs should have a clear paper trail setting out the intended scope of the research to be undertaken in order to maximise the upside from the new rules. CROs, on the other hand, should be wary of customers attempting to include overly broad R&D clauses that extend beyond the agreed project scope: this could restrict the CRO’s ability to make a claim for relief in respect of expenditure on its own innovation.
Territoriality restriction
The UK’s new R&D tax relief regime includes a territorial restriction in respect of payments for externally provided workers and payments to contractors. Tax relief for R&D activity is now limited to expenditure incurred in the UK and “qualifying” overseas expenditure.
This change is designed to encourage R&D activity within the UK by only allowing overseas expenditure to qualify for tax relief where it would be wholly unreasonable for the company to replicate those conditions in the UK.
This is a difficult and fact specific test to apply but HMRC guidance provides a list of conditions that it considers would result in overseas expenditure qualifying for relief, including:
- a geographical, environmental or social condition that only exists outside of the UK, for example a physical or geophysical feature, the presence of specific machinery or facilities, or access to centres of human expertise (universities and research groups rather than specific individuals); or
- legal or regulatory requirements that necessitate conducting R&D in a particular foreign jurisdiction (this helpfully includes instances where a regulatory body determines that clinical trial activity must take place in a particular country).
Notably, two conditions are expressly excluded as a basis for claiming overseas expenditure:
- the cost of R&D activity; and
- the availability of workers to carry out the activity.
In order to maximise R&D relief, companies now need to ensure that any CRO they engage conducts as much work as possible in the UK and should consider adding into their contracts a requirement that their permission is obtained before work is conducted overseas.
Where research activity is undertaken outside the UK, an entity claiming R&D relief must be prepared to justify this decision by reference to clear, documented evidence such as correspondence with a regulatory body imposing a jurisdictional study requirement or reports showing the lack of availability of relevant patient populations in the UK.
When is R&D “wholly and reasonably” conducted outside the UK?
The table on the next page considers some common scenarios that result in clinical trials being conducted outside of the UK and sets out our views on whether R&D spend could constitute “qualifying” overseas expenditure.
| Scenario | Example | Is expenditure “qualifying”? |
|---|---|---|
| Access to one eminent key opinion leader (KOL) Some projects hinge on the expertise of a world renowned KOL based outside the UK. | A pharmaceutical company developing a cutting-edge immunotherapy treatment needs to collaborate with a leading immunologist based in the US. | As a minimum, we would expect HMRC to require the company to show that the KOL’s involvement is essential and that there is no equivalent expertise available in the UK. This goes beyond a mere preference for the particular investigator. This fact pattern is challenging because ‘availability of workers’ does not justify overseas expenditure. A focus on the KOL’s association with a particular research institution or University may be helpful. |
| Access to a specific patient population R&D may need to be conducted where a particular patient population is located, especially when a disease is prevalent in specific geographic areas. | A biotech company developing a therapy for podoconiosis, a disease linked to volcanic soil needs to conduct clinical trials in regions where specific environmental conditions are present. | The company will need to show that the patient population needed for the trials cannot be sourced within the UK. This should be supported by documentation such as clinical studies and trial design protocols. Companies must ensure that the decision to conduct trials abroad is based solely on the necessity of accessing the patient population, and not for reasons related to lower costs. HMRC will not accept cost savings as a justification for overseas R&D. |
| Overseas regulators requiring local trials In some cases, local R&D is mandated by foreign regulatory bodies, particularly when approvals require trials involving local patient populations. | A company is seeking approval from the Japanese Pharmaceuticals and Medical Devices Agency, PDMA. The PDMA insists on additional data from clinical trials performed on Japanese patients due to the homogeneity of the population. | The company must retain evidence of regulatory correspondence and ensure that contracts with CROs specify these requirements. The scope of the overseas R&D would need to align directly with regulatory demands and not extend beyond what is required (for example, if there is a requirement to perform clinical trials on patients of a certain ethnicity, could the clinical trials be performed on patients of that ethnicity within the UK?). |
| Differing approaches in the provision of healthcare services The deployment strategy for a medicine or medical device may depend on the processes and structure of a particular country’s national healthcare system. | A company is seeking to initially test a medical device for pregnant women in France due the lower deployment risks associated with the advanced prenatal diagnosis program in France. | The company would need to demonstrate how the specific country’s national healthcare system or infrastructure scientifically justifies the decision to conduct studies in that country. For example, the company would need to demonstrate how the higher uptake and superior quality of prenatal screening in France reduces the risks of deployment compared to the UK. |
Some top tips to optimise your CRO agreements for the new R&D rules
| CRO position | Example | Customer position |
|---|---|---|
| Resist broad clauses that grant your customer exclusive rights to claim all R&D tax relief in respect of any and all work undertaken in connection with the contract. Ensure that any internal process improvements are excluded from the scope of the agreement, allowing you to claim relief for your own | R&D tax relief clauses | Ensure the agreement explicitly describes the work conducted by the CRO as R&D undertaken for your benefit. Include clauses asserting your right to claim R&D tax relief in respect of all research within the scope of work. If the contract is silent on R&D relief or the scope of work is vague, this could limit your ability to claim relief in respect of payments under the agreement. |
| Accept obligations to maintain records, but ensure they are not unduly onerous. Retain documentary evidence of any innovation that falls outside the scope of the original contract and relates to your own business innovation to support your own R&D filing position. | Record keeping | Put obligations on the CRO to keep and supply written records of: i. what research activities have been completed (so that this can be mapped against the original scope of work to demonstrate it was ‘intended or contemplated’); ii. where the R&D is taking place; and iii. why it is taking place there (if R&D is taking place outside the UK). |
| Be aware of the impact that the research location will have on your UK customer’s R&D tax relief position. Balance the customer’s potential tax saving in respect of UK based activity against the practical realities of the particular project. If you have unique overseas capabilities and facilities that are not available in the UK, be aware of the potential benefits this could bring to your customer’s R&D relief position. Properly articulating and documenting this capability could add material economic value to your customer. Leverage this awareness during negotiations. | Overseas activity | Secure a commitment that R&D activity will be performed in the UK whenever possible. Any overseas work should require your approval and the provision of clear evidence as to why it must be conducted abroad. |
| If pricing terms under pre-April 2024 agreements were agreed on the assumption that you would be entitled to R&D tax reliefs, you will need to revisit your net margin for the project and consider negotiating for amendments given that your customer may now be enjoying an unexpected R&D tax upside. | Ongoing CRO agreements negotiated before the R&D relief changes | Provided the scope of research under pre-April 2024 agreements is clear, you could now enjoy an R&D tax upside in respect of post-April 2024 expenditure pursuant to those agreements. Ensure your internal tax and finance function are provided with agreements so that the spend can be properly evaluated to maximise claim entitlement. Leverage your awareness of the shift in allocation of R&D reliefs as part of any broader contract amendment negotiations. |
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