Employees or EPWs
When the research and development relief (R&D) legislation was introduced in April 2000, relief was only available for the qualifying costs of the claimant’s own employees who carried out in-house R&D projects. This was fine in a lot of cases but many claimants soon discovered that they didn’t have as much eligible expenditure as they had anticipated, as the individuals undertaking the R&D activity were third party workers. They were working side by side with the company’s own staff on the R&D but they were not actually employees of the company.
The government recognised that this was not particularly satisfactory and FA 2003 introduced legislation to permit the costs of “externally provided workers” (EPWs) to be included in the claim. EPWs are essentially individuals who are not employees of the claimant company and are provided to that company via a third party. The classic example would be agency workers supplied on an as-needs basis.
The explanatory notes to the 2003 Finance Bill indicated that the intention of the new EPW rules was to ensure that:
“credit is given for staff working alongside one another on an essentially similar basis, regardless of how they are paid.”
You may think this should be a fairly straightforward outcome to achieve. What we actually ended up with was six sections of legislation that, unfortunately, failed to deliver the policy objective. It also took several years of lobbying to finally get the amendments that were needed to rectify that situation.
The operation of the legislation as originally enacted can be summarised (very broadly) as follows: a claimant company makes a payment (defined by the legislation as a “staff provision payment”) to a third party (defined as the “staff provider”) in respect of the supply to the company of the services of the individual worker (the EPW). One of several conditions was that the services of the individual had to be provided to the claimant under the terms of a contract between the individual and the staff provider. Thus, we had what came to be referred to as the ‘tripartite arrangement’.
The practical problem with the legislation as originally enacted is best highlighted with a couple of examples.
Example 1: Group contracting company
Company A, which is undertaking R&D, is a member of a group. The group has a group contracting company (B), which enters into all contracts with external suppliers to the group. A needs specialist contractors to help with its R&D project, so it approaches B and asks it to source the contractors from a third party agency. B enters into the supply agreement with the agency, pays the fees and then recharges the cost to A.
The claimant company (A) makes a payment to B (the recharged costs) for the provision of the workers; B is, therefore, defined as the staff provider by the legislation. However, the services of the individual worker are being provided to A under the terms of a contract between that individual and the agency, not the staff provider (B in this example) as required by the legislation. There are four parties to the arrangement, not the required three and the claimant will not be able to include the cost of the EPWs in its claim for R&D relief.
Example 2: Personal service companies (PSC)
The claimant company (X) makes a payment to an agency (Y) for the provision of the services of an individual worker (Z). Z engages with the agency through a PSC (Z Ltd). In this case the individual’s services are supplied to the claimant (X) under the terms of a contract between the PSC and the staff provider (or, possibly, between the individual and the PSC). Either way, the requirement, that the contract be between the individual and the staff provider, is not met.
In my experience, examples 1 or 2 are not unusual. Indeed, I believe that it is quite common for agencies to insist that workers operate through PSCs (or an umbrella company). Many potential claimants who thought that they would be able to benefit from the EPW legislation found that their claims were being restricted because they did not have a tripartite arrangement. They could not include the costs of many of the people “working alongside [their own staff] on an essentially similar basis”. This was, in my opinion, a significant failing of the legislation.
In FA 2012, changes were made that corrected this defect for expenditure incurred on or after 1 April 2012.
The key change is that the requirement that the services of the individual worker be provided to the claimant under the terms of a contract between the worker and the staff provider has been removed. The legislation now requires that the services are provided under the terms of a contract between “the worker and a person other than [the claimant]” (CTA 2009 s 1128 (7) as amended). This other person is then defined by that same subsection as a “staff controller”.
If we look at the changes in the context of the previous examples, we can see how they have significantly improved the effectiveness of the EPW rules.
The facts are as in example 1. The group contracting company will still be the staff provider as it is the one to whom A makes the payment for the provision of the workers, however, under the amended CTA 2009 s 1128 (7) the agency will be defined as the staff controller. The services of the worker will be provided to A under the terms of a contract between the worker and the staff controller (which is a person other than the claimant). Thus, subject to the other requirements being met, A will now be able to include the relevant cost of the workers in its R&D claim.
The facts are as in example 2 . In this example, Z Ltd will be the staff controller and the services of Z will be provided to X under the terms of a contract between Z and Z Ltd. Again, subject to the other requirements of the legislation being met, X will be able to include the relevant cost of the worker in its R&D claim.
It is important to note that these changes have not simply added another party to the equation; we haven’t gone from needing a tripartite arrangement to needing a quadripartite one. The staff provider and the staff controller could be the same person. Indeed, there could even be multiple staff controllers (although there can only be one staff provider in any arrangement).
Let’s now assume that the worker in example 3 decides to start operating through a personal service company (still using the agency). We now have five parties in the arrangement, with the new personal service company being the staff controller. Subject to the other conditions of the legislation being met, A will still be able to include the relevant cost of using the worker in its R&D claim.
Limits on EPW costs
How much qualifying expenditure in respect of EPWs can the claimant include in its R&D claim?
The rule in CTA 2009 s 1129 applies if the claimant, the staff provider and (if different) the staff controller (or controllers) are all connected and all of the staff provision payment and all of the relevant expenditure of the staff controller(s) have been brought into account (in accordance with GAAP) in determining the profits of the appropriate company. In such a case, the claimant’s qualifying expenditure on EPWs is given by CTA 2009 s 1129 (2) as the lower of:
• the entire staff provision payment; and
• the aggregate of the relevant expenditure of each staff controller.
The “relevant expenditure” in this context is defined by CTA 2009 s 1129 (3) and is essentially the staff costs or agency workers’ remuneration incurred by the appropriate company in providing the EPWs.
Where the staff provider and (if different) the staff controller (or controllers) are not all connected, CTA 2009 s 1130 provides that the companies may jointly elect for the provisions of CTA 2009 s 1129 to apply. However, beware as such an election is irrevocable and means that the claimant will be dependent upon the other parties providing details of their relevant expenditure for the duration of the arrangement.
In all other cases, CTA 2009 s 1131 provides that the qualifying expenditure on EPWs is 65% of the staff provision payment.
At least three
In terms of numbers, it is important to remember that, even with the FA 2012 changes, there must still be at least three parties in any EPW arrangement: the claimant, the staff provider and the individual worker. There can now be more than three (with the addition of one or more staff controllers), but there cannot be fewer than three. If you have a scenario with only a claimant company and a self employed individual contractor, then you do not have an EPW arrangement. At best you might (subject to the facts) have a subcontract arrangement, at worst you have expenditure that cannot be included in the R&D claim.
The changes in FA 2012 are extremely welcome and, from 1 April 2012, will make it much easier to include the relevant costs of using EPWs in an R&D claim. Given the preference of so many businesses to balance resource needs with external workers, rather than increasing/decreasing its own headcount, this is a very important change.
Finally, it is worth noting that HMRC have not yet amended the relevant pages of the Corporate Intangibles Research and Development manual dealing with EPWs to reflect the FA 2012 changes.
This article was first published in Tolley’s Practical Tax Newsletter on 1July 2013
NOTE: HMRC has now updated CIRD 84000, 84050 and 84100.