Externally Provided Workers

Externally Provided Workers and Subcontractors. What’s the Difference?

Externally provided workers and Subcontracted R&D might seem the same. But when it comes to R&D Tax Relief, they’re very different in the eyes of HMRC. Here’s our guide to help you spot the difference and ensure you’re filing costs under the correct category.

HMRC lists several costs that qualify for R&D Tax Relief.

Two of the expenses sound pretty similar. ‘Externally provided workers’ and ‘Subcontracted R&D’.

So what’s the difference?

Externally provided workers

Externally provided workers – EPWs for short – are temporary workers sourced from an external agency. They work like regular employees, but their contract is with the agency, not with your company.

The external agency is the key here. The cost you’re claiming for is the fee paid to the agency, not the member of staff. If you’re paying a temporary member of staff directly, the cost could be classified under Subcontracted R&D.

R&D Tax Relief relief is usually given on 65% of the payments to the external agency, regardless of the size of your company. The ‘other’ 35% is meant to reflect the external provider’s profit margin and is fixed by HMRC.

However, you might be able to claim 100% of the costs back if you and the external agency are ‘connected’.

Subcontracted R&D

Subcontracted R&D means you’ve paid to outsource a piece of your R&D project to another company. 

For example, if you hired an external firm to develop a certain software module on your behalf, that would count as Subcontracted R&D.

Usually, only SMEs can claim for Subcontracted R&D expenses. If you’re an SME, you can claim up to 65% of subcontractor costs. 

Large companies, however, usually aren’t able to claim for Subcontracted R&D unless it’s undertaken by “a charity, higher education institute, scientific research organisation or health service body — or by an individual or a partnership of individuals.”

When claiming for subcontracted R&D, it’s important to identify whether the subcontractor has already claimed R&D Tax Credits for the project. If they have, you can’t claim tax relief for it. HMRC would view this as ‘double-dipping’ on the project.

Who claims for subcontracted R&D?

Determining who claims for R&D Tax Relief between you and your subcontractor isn’t an exact science. It usually depends on who takes on the project’s financial burden and who holds the intellectual property of the subcontracted work.

Here are two examples:

Example 1

Company A commissions Company B to develop a new machine-learning system that has been deemed to qualify for R&D Tax Credits. 

A has agreed to pay a fixed £50,000 for the work. B will be overseeing the development and will own the IP. It is also more likely to shoulder the financial burden because the project could go over budget. 

B is, therefore, more likely to be able to claim R&D Tax Credits.

Example 2

Company A commissions Company B to develop a new mutating algorithm that qualifies for R&D Tax Credits. 

Company B estimates it’ll be delivered in two months. A agrees to pay B £1,000 per day to develop the algorithm. A will oversee the development, but B will hold the IP. 

The financial burden is now shouldered by A – it’ll cost them more if the project takes longer to complete. While B retains the IP, A has control of the project and holds the financial burden. 

In this case, it’s more likely A will claim R&D Tax Relief.

When can you claim for externally provided workers?

Unlike the fairly flexible guidelines for claiming subcontractor costs, there are only certain situations where you can include EPWs costs as a qualifying expense. You must meet the following criteria:

  1. The externally provided worker isn’t an employee or director of your company. They are self-employed or otherwise outside your company.

  2. The staff member must be under your control. This means you must define the scope of the R&D, actively supervise the work, and ensure it’s completed to the determined specification.

  3. The individual’s services must be supplied by an external agency. So, at least three parties will be involved in the staff member’s contract – you, the external agency, and the staff member. Be sure to look at this contract carefully. If the staff member is being paid a fixed fee, it might suggest a subcontractor relationship.

  4. The individual must be under a contractual obligation to provide services to you under the agreement between the staff provider and the individual.

How to calculate subcontractor and EPW expenses

Now that we know which costs qualify for the different categories, let’s look at how we calculate our claim.


EPWs should be initially treated just like internal members of staff, with the exception of the 65% cost ceiling.

So let’s say you paid an external agency £20,000 for an EPW programmer. The programmer spent 50% of their time on doing R&D and 50% on doing production support. 

That means 50% of their time is eligible for R&D Tax Credits. That’s £10,000 worth of costs. 

Then you have to factor in the 65% cost ceiling. 65% of £10,000 is £6,500. This is the qualifying R&D expenditure.

2. Subcontractors

Calculating subcontractor costs is also relatively straightforward, assuming your contract has been split into clearly defined projects.

Example 1

Example 1) You subcontract company B to develop module X as part of a project that qualifies for R&D Tax Credits. You pay them £5,000. So, you can claim 65% of £5,000. That’s £3,250.

Example 2

Example 2) Now, let’s say the contract involves both building module X and doing some UI mockups for another unrelated project. Out of the £5000 fee, 75% is apportioned for developing the module, and 25% is allocated to the UI mockups. Now, 75% of the £5,000 is eligible for R&D Tax Credits – £3,750. Then we apply the 65% cost ceiling. So, £2,437.50 will qualify for R&D Tax Credits.

HMRC says that if a project qualifies for R&D Tax Credits, then sub-projects related to that project also qualify for tax credits relief, even if they involve routine work. So, if a contractor is taking on a sub-project involving routine work, but that sub-project is part of a larger project that qualifies for R&D Tax Credits, then the subcontractor’s costs do qualify for tax relief.

You can read more about claiming R&D Tax Relief on subcontractor costs here

A warning on directors and subcontractors

We often see arrangements where directors are registered as their own companies. Rather than paying a salary or dividends to the director, businesses pay a fee to the director’s company. In effect, the director becomes a subcontractor.

It’s a pretty common practice, but HMRC doesn’t like it. Smaller companies usually get away with it – they’re too small for HMRC to take notice. But that changes if they draw attention to themselves by filing for R&D Tax Credits and attempting to claim the director’s pay as a subcontractor cost.

If you’re using this sort of arrangement, our advice is not to claim for the director costs in your R&D Tax Credits application. If you’re claiming directors’ fees, they should be paid a salary.


So now you know all there is to know about the relationship between externally provided workers and Subcontracted R&D.

If you have any questions about claiming, or want to save time and money by claiming with a professional, please get in touch!

Request a Call Back

Just fill out the contact form below, and one of our team will be right with you.