Should I outsource my R&D activity or keep it in-house?
Updated: Oct 17
A topic that comes up a lot when we deliver R&D claims is subcontracting or outsourcing R&D activity to a third party. It’s a difficult decision for businesses to weigh up. Either way, we want to share everything we know to help determine if R&D project activity is better kept in-house or outsourced.
So, let’s kick off with a bit about what exactly subcontracting is, weigh up the pros and cons, and get some examples too!
Subcontracting R&D Project Work
So, subcontracted work is defined as when a company engages someone else to carry out R&D project activity on their behalf in exchange for payment. And there are two key situations you to be aware of when subcontracting, here’s why:
If business A sub-contracts R&D work to business B, business A might not be able to claim R&D tax relief, or only a limited claim is available under the RDEC scheme – reducing the claim to 10.53% of the qualifying expenditure
If business A sub-contracts R&D work to a third party (unconnected to their company) – they can still claim for qualifying costs but the relief available is only 65% of those costs.
What? Only 65% of costs can be claimed….
Yes, that’s correct.
If a business is undertaking an R&D project for their own business, and you have sub-contracted part of the R&D project to a third party, you can only claim for 65% of the costs.
And the R&D work must be for a specific part of the project.
Here’s an example of what this might look like for a business:
A UK company has an R&D project and they are considering whether to subcontract the design stage of the project, expected to take 6 months, or use an in-house employee.
The annual salary of an adequately skilled employee is estimated at £60K.
Cost Employee Outsourced
6-month salary £30,000
Estimated additional fringe costs
(pension, NIC, etc) £5,000
Payment for project work
to outsourcer £35,000
Initial cash cost to company £35,000 £35,000
R&D allocation* 90% 100%
Subcontractor restriction Nil 65%
R&D expenditure claimable £31,500 £22,750
* It’s typical for outsourcers to have a slightly higher R&D allocation due to other responsibilities of employees.
Here’s how the potential benefit breaks down:
A) For a Profitable Company
Corporation tax saving due to R&D £7,780.50 £5,619.25
B) For a Loss-Making Company
Tax credit claim £10,505.25 £7,587.125
If the business is the subcontractor they may not be able to claim under the SME R&D Scheme, but if they qualified under the RDEC scheme at 10.53% of qualifying expenditure:
Cash refund £3,316.950
So when it comes to the numbers, it’s clear to see that the tax saving is more attractive if a business chooses to go down the in-house route. However, taking on a new employee is a big call to make, as it comes with its own challenges. There’s the cost and time involved in finding the right person, with the right skillset that will fit into the business. Then there is the ongoing time of managing that person. It’s a significant commitment.
Let’s take a look at the pros and cons….
When a business is faced with the possibility of outsourcing, there are some important pros and cons to consider
NO IN-HOUSE EXPERTISE: Sometimes a business just doesn’t have a choice! For example they may be looking to develop a new app but with no expertise, subcontracting to a company with the expertise is the only option.
ACCESS TO MORE TALENT: By subcontracting, a business has access to a greater pool of talent, global even!
CHEAPER & FASTER: When it comes to R&D projects that are completely different to anything that has been done in the past, it can be much cheaper and faster to look at subcontracting rather than setting everything up in-house from scratch.
SYSTEMS & PROCESSES: A quality subcontractor will already have the robust systems and processes in place to ensure the R&D work is tracked and expectations are managed – potentially a huge weight lifted.
STAY FOCUSED: Outsourcing to a subcontractor helps to keep the business and its resources focused on what it is already doing.
THEY DON’T KNOW YOUR BUSINESS: It can be difficult for sub-contractors to have the same level of understanding of a business as the employees. However, this doesn’t always have to be a negative, sometimes a different perspective is what is needed for innovation.
CONFLICT IN EXPECTATONS: It’s super important expectations are managed, as differences of opinion can arise when it comes to the brief, objectives or quality of the work taken place. This is particularly tricky if the requirements of the R&D work change after the project has started.
CONTROL & TIMING: Letting go of control, and the day-to-day running of the project work can be difficult. But the best way to address this is to discuss requirements and agree milestones or check points to ensure the timely delivery of the project. The subcontractor should have processes in place ready to tackle this.
IP & CONFIDENTIALITY: Management of intellectual property, and the potential leaking of information is a risk when you take R&D activity outside of a business. It’s easier to manage, and less likely to happen when all R&D activity stays in-house.
So, there you have it. Unfortunately, there isn’t a black and white answer. We’re sorry! Whether a business outsources aspects of their R&D project has to be right for the business. Our advice? Make sure your clients start with the calculations. Can they afford to lose 35% of their R&D claim money coming back into then business? Then, it is a case of being honest and looking at the business case of bringing in a new employee – how do the pros and cons stack up?
Share this information with your R&D clients and help them work through their outsourcing conundrum logically.
Radish Tax, Your R&D Tax Relief Service
For DTX’ers with a potential R&D Tax Relief client you’d like to discuss please book a scoping call here.
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Please note, as this blog was published prior to 1st April 2023, there is no reference to the changes which have been brought into place for the R&D tax relief schemes.
For expenditure on or after the 1st of April 2023, the following changes in rates of relief apply:
SME – the Enhanced Expenditure uplift rate has fallen from 130% to 86%; and the tax credit rate has fallen from 14.5% to 10% (exc. R&D intensive loss-making SMEs).
RDEC – the credit rate has increased from 13% to 20%.
Further, data and cloud computing costs can now be included within the claim qualifying expenditure calculation. Pure mathematics now falls within the scope of the relief.
For submissions on or after the 8th of August 2023, it is now required for an Additional Information Form to be submitted prior to submission of the R&D claim. For reference, please see our blog here.