Blog: Tax Talk – Subcontractors and Externally Provided Workers

Date: September 24, 2018

By Nigel Holmes, Senior Tax Specialist at Catax

As you will be aware these are two of the categories of qualifying expenditure for Research & Development (R&D) tax relief claims. On the face of it, they sound very similar. The article below considers the differences, why it matters, the impact of the claim being an RDEC claim and the connected party rules.

Subcontractors and Externally Provided Workers


Although HMRC uses this terminology it can confuse clients. Some clients, aware of the term “subcontractors” in the manufacturing and building trades, may think this relates to HMRC’s subcontractor tax scheme where some payments have tax withheld and there are onerous filing conditions to be met. For R&D purposes, subcontractor means a third party service and could perhaps be better described as consultancy services.

Subcontracted R&D services are services provided by others that are required as part of the R&D project. For example, it could be testing carried out by a third party laboratory. The services do not have to be R&D on the part of the subcontractor, but must be for the contractor, i.e. the claimant company. As an aside, if it is R&D in the eyes of the subcontractor then there is a risk that both parties could claim R&D tax relief. HMRC has tried to address this double claiming in the past and gave up so, for now, this situation is entirely possible.

The SME Scheme

If the subcontractor is unconnected then the claimant company claims 65% of the qualifying costs for its R&D if the claim is within the SME scheme. This is because HMRC is trying to ensure the actual cost of the R&D attracts the additional relief and, therefore, strips out a notional 35% profit element. Of course, 100% of the cost already obtains normal tax relief, it is only the R&D uplift element that is restricted to 65%.

If the subcontractor is connected (by this it will usually be in relation to the subcontractor or the owner of the subcontracting business being related to the shareholders of the claimant company) then the amount that qualifies for the relief is the lower of the actual cost to the subcontractor within their accounts and the amount invoiced. This, once again, is to remove the profit element. However, care must be taken as the actual cost to the subcontractor is only on certain items being staffing costs, consumable items, externally provided workers and payments to clinical trial volunteers.

Even if the subcontractor is unconnected, the claimant company can elect for the connected subcontractor rules to apply.


Subcontracted costs are usually not allowed under RDEC unless it is to an individual, partnership or qualifying body (predominantly universities).

Externally Provided Workers (EPW)

An EPW is an individual who is contracted to a third party staff provider. Unlike a subcontractor who is contracted to supply a particular service, an EPW would appear to the outside world as an employee of the claimant company and is controlled by that company, but is paid via invoice to the staff provider as opposed to being on the payroll. In other words, there always has to be a third party staff provider in existence alongside the individual in order for an EPW position to exist.

Unlike subcontractors, there are no separate rules for the SME Scheme and RDEC, the same rule applies to both.

As with subcontractors, the R&D element of an EPW is included at 65% of the qualifying cost if the EPW is unconnected with the claimant company.

If the staff supplier and the claimant company are connected then, as with subcontractors, the lower of the recharge and actual cost through the staff provider’s accounts is the relevant amount for R&D.

The individual will be paid through PAYE by the staff provider in order to meet the definition of an EPW. However, he or she cannot also be a director or employee of the claimant company. In this case if an individual is an employee of both the claimant company and the staff provider, only their wages through the claimant company will qualify.

As a staff provider must exist, a payment to a self-employed consultant can never be an EPW payment and will only qualify if the relationship is one of contractor:subcontractor as opposed to merely more akin to an employer:employee relationship.

For more information on R&D Tax Credits feel free to get in touch with us on 0370 218 8094 or send us a message here.

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