For accounting periods beginning on or after 1 April 2024, a UK company generally gets no R&D tax relief for overseas contractors: that covers contractor payments for R&D done overseas, and externally provided workers whose earnings aren't subject to UK PAYE. HMRC's manual page on the overseas restrictions applies this to both the merged RDEC scheme and enhanced R&D intensive support (ERIS), unless a narrow statutory exception applies. A nearshore team in the EU usually falls outside that exception, so the lost credit is a real cost on the nearshore side of your comparison. This is general information, not tax advice. (Northern Ireland ERIS claimants are treated differently; see the FAQ.)
Short answer: does a UK company get R&D relief on EU nearshore engineers?
Usually not, for the contractor or externally provided worker (EPW) cost. Two things decide it: where the R&D is carried out, and, for EPWs, whether their earnings are subject to UK PAYE in whole or in part.
Employees on your own UK payroll are a different case, covered below. The legal setup around an EU hire is mapped in our guide to the legal requirements for hiring developers in Europe. This page covers one line that guide doesn't: the tax credit.
What the rule says
Contractors: where the R&D is carried out
HMRC's manual says contractor payments for R&D undertaken overseas only are excluded from qualifying expenditure, unless the statutory exception applies. The test is geographic. It doesn't matter whether the contractor is a freelancer, a company or a nearshore vendor.
Externally provided workers: the UK PAYE test
An EPW is a worker supplied by a staff provider and paid through that provider. The manual excludes spend on EPWs whose earnings aren't subject, in whole or in part, to UK PAYE. The manual page on connected-party EPW costs frames it the same way: earnings qualify only if subject to UK PAYE and National Insurance contributions, or attributable to overseas R&D that meets the exception.
An EU-resident engineer paid under their home country's payroll fails that test. It isn't the same question as IR35, which asks whether a contractor is really an employee; our piece on off-payroll rules for a contractor based in the EU covers that. The R&D test asks whether UK payroll tax is being deducted.
The narrow exception, and why cost and hiring pool don't count
Section 1138A of the Corporation Tax Act 2009 lets overseas R&D count in the circumstances in subsection (2), where three things hold (there is also a separate Northern Ireland route for ERIS). The conditions necessary for the R&D must be absent in the UK, present where the work is done, and wholly unreasonable to replicate in the UK. Subsection (3) counts geographical, environmental or social conditions, and legal or regulatory requirements. It excludes conditions relating to the cost of the R&D or the availability of workers.
That last clause is the one that matters for nearshore. In HMRC's trial example in CIRD151000, the manual says that "had the primary reason been a lower cost of carrying out the trial, this would not satisfy CTA09/S1138A(2)." The manual's own cost example is a drug trial, but it also has a software case. In HMRC's US banking software example, overseas R&D qualified where US banking access regulations made UK replication wholly unreasonable. That's regulatory grounds, not cost or hiring pool.
Our reading: a preference for EU senior engineers, a better time-zone fit or a lower day rate doesn't appear in the statutory list, so we would not expect the exception to apply on those grounds. Cost and worker availability cannot count as the qualifying condition on their own, and any claim under the exception is something you'd need to evidence and defend.
How much relief is at stake?
The number is a share of the engagement cost. Everything below is illustration with stated assumptions, as of 12 October 2026. Rates can change at a Budget.
The merged RDEC credit
The rate under the merged scheme is 20%, and gov.uk's merged scheme guidance says the credit is liable to Corporation Tax as trading income. For an unconnected contractor, HMRC's contractor payments page says 65% of the relevant portion is claimable, and overseas R&D counts only where section 1138A applies. The same 65% applies to payments to an unconnected staff provider for EPWs, but only on the part attributable to qualifying earnings (CIRD137000). For connected parties, different rules apply.
Take £100,000 of nearshore invoices for R&D work that would qualify if the contractor were in the UK. Assumptions: the company pays Corporation Tax at the main rate and can use the credit; profits are above £250,000, so the 25% main rate applies; the contractor is unconnected; the invoice is deductible either way (our reading).
- Claimable portion: £100,000 × 65% = £65,000.
- Gross RDEC credit: £65,000 × 20% = £13,000.
- Tax on the credit at 25%: £13,000 × 25% = £3,250.
- Net benefit: £13,000 - £3,250 = £9,750.
So roughly £9,750 of benefit disappears on £100,000 of spend, 9.75%. Gov.uk's Corporation Tax rates page shows 19% for profits of £50,000 or less, with marginal relief up to £250,000. At 19%, the net is 13% × 0.81 = 10.53% (£10,530). Those thresholds are reduced for associated companies and short accounting periods. Loss-making and ERIS companies compute differently.
ERIS for loss-making R&D-intensive SMEs
If you're a loss-making SME with R&D spend of at least 30% of total expenditure (counting connected companies), ERIS gives an extra 86% deduction on top of the normal 100%, so 186% in total. The payable credit is worth up to 14.5% of the surrenderable loss, capped at £20,000 plus 300% of relevant PAYE and National Insurance liabilities. The overseas restrictions apply to ERIS too, so moving R&D work to an EU contractor loses that enhanced deduction on the spend.
Three routes for a UK company
Route 1: UK-based staff, or a UK staff provider on UK PAYE
The relief is available subject to the normal rules. The trade-off is a UK salary or provider rate against an EU rate. Nobody has to argue about the exception.
Route 2: your own employees on UK payroll, working abroad
R&D Community's guidance, an adviser site, says staffing costs are not subject to the overseas restriction, which applies to payments for EPWs and contractors. HMRC's manual restricts contractor payments for overseas R&D and EPW spend not subject to UK PAYE, and says nothing restrictive about employee costs, which implies they sit outside it. That's our reading, not a stated HMRC position.
Putting an EU-resident engineer on UK payroll raises employment-law, social-security and permanent-establishment questions this article doesn't settle. We're not recommending it. It's a decision for tax and employment specialists.
Route 3: nearshore contractor or EOR in the EU
For a typical nearshore partner or EU B2B contractor, the cost sits outside qualifying expenditure unless section 1138A applies, which for the reasons above it usually won't. The relief simply goes. Setting up the engagement is covered in how a UK company sets up an EU hire.
How to add lost R&D relief to a nearshore cost comparison
1. Check whether you claim R&D relief at all
If you don't claim, there's nothing to lose. If you do, note whether you're under the merged scheme or ERIS, and whether you pay Corporation Tax or are loss-making. That decides the rate in step 4.
2. Split the engineering spend into R&D and non-R&D activity
Only hours spent on qualifying R&D carry relief. Maintenance, support and routine feature work usually don't.
3. Mark each person: UK PAYE employee, UK-provided EPW, or overseas contractor or EPW
The first two keep relief under the normal rules. The third loses it unless section 1138A applies.
4. Work out the credit you would lose
Multiply the R&D share of each overseas contractor's cost by 65% × 20% = 13% gross, then tax it at your rate. At the 25% main rate that's 9.75%, as in the £100,000 example above.
5. Net it against the rate gap
Take the employer-side numbers from our comparison of the employer-side cost of an in-house developer against a nearshore rate, and subtract the lost credit from the nearshore saving.
Illustration using HighCircl's published senior range of €45-105/hr: at 160 hours a month, that's €7,200-16,800. If all of it would otherwise have qualified for an unconnected contractor under the merged scheme, the net loss at the 25% main rate is 9.75%, so €702-1,638 a month. The credit is in the currency of the invoice, with no exchange rate applied.
6. Take the number to your adviser before you decide
Check with your R&D adviser how the 65%, the connected-party rules and your tax rate apply to your company. The figure in your comparison should be theirs, not ours.
What this means for your nearshore budget
If your nearshore comparison has no line for lost R&D credit, it overstates the saving for any role doing qualifying work. Make it a line item, owned by whoever signs off the budget, usually the CFO or COO.
Model it per person, not per team, and split R&D hours from the rest. Where a role mostly does qualifying R&D, the lost credit is larger, so it deserves a line in the comparison; the roughly 10% net figure in our example is the kind of gap that can change the answer. Where a role does mostly non-R&D work, the saving can stand as is. That's judgment, not a recommendation on which route to pick.
For the wider set of compliance questions beside this one, see EU engineering hiring compliance: contracts, IP and GDPR.
Hiring European engineers through HighCircl
HighCircl matches engineers from seven European countries at €45-105/hr for seniors, with a 20% margin that's capped and applied on top of what the engineer earns, so the cost line in your comparison is visible.
FAQ
Can I claim R&D tax relief on EU developers?
Usually not on contractor or EPW costs, for accounting periods beginning on or after 1 April 2024. The R&D is carried out outside the UK, and unless the section 1138A exception applies, the spend is excluded. Cost and worker availability can't qualify.
Does the overseas restriction apply to employees as well as contractors?
HMRC's manual restricts contractor payments and EPWs not on UK PAYE. Employee costs aren't mentioned as restricted, which is why we read them as outside it. Confirm with your adviser, particularly if the employee lives abroad.
Does the 65% rule apply to UK contractors too?
Yes. For an unconnected contractor, 65% of the relevant portion of the payment is claimable under the manual, wherever the contractor sits. The overseas restriction is a separate test that can remove the payment altogether.
Do Northern Ireland companies get different treatment?
Partly. Under gov.uk's description, ERIS claimants who are Northern Ireland SMEs aren't subject to the restrictions on payments to overseas contractors or overseas EPWs. The restrictions remain for RDEC.
Does IR35 decide R&D eligibility?
No. IR35 is a status test for UK tax. The R&D rule turns on where the work is done and, for EPWs, whether earnings are subject to UK PAYE. The two overlap only because both involve UK payroll tax.