Introduction: Section 174A and the UK Founder With a US Subsidiary
Section 174A is the new provision that lets a US company deduct its domestic research and development spending in full again, and it changes the numbers for every British founder who runs engineering through an American subsidiary. For three years, the US arm of a UK group had to capitalise its developer salaries and spread them over five years. Consequently, many profitable-on-paper US subsidiaries paid federal tax on cash they had already spent on product. The One Big Beautiful Bill Act, signed on 4 July 2025, ended that for domestic research. However, it left foreign research exactly where it was, and that distinction is where UK-parented groups lose money.
At TaxYork, we prepare the US corporate and personal returns for founders, investors and dual national US UK families whose businesses straddle London and the United States. In our experience, the British founder is the person most likely to be caught by the domestic-versus-foreign line. Specifically, their best engineers often sit in London, on the UK parent's payroll, while the US subsidiary pays for the work. Therefore, this guide explains what Section 174A allows, what it does not, which elections have closed and which remain open, and how to structure the group so that the deduction lands where it is worth most.
What Section 174A Changed for Tax Years From 2025
Section 174A applies to domestic research or experimental expenditure paid or incurred in tax years beginning after 31 December 2024. A US company may now deduct those costs in the year it pays them. Alternatively, it may elect to capitalise them and amortise them over at least 60 months, starting with the month in which it first benefits from the work. You can read the statutory text of section 174A alongside the IRS summary of One Big Beautiful Bill provisions for the official framing.
Importantly, the definition of research did not narrow. Software development still counts as research or experimental expenditure. As a result, the salaries of a US subsidiary's developers, the cloud costs of its test environments and the fees of its American contractors all fall within the regime. The change is to timing, not to scope. Nevertheless, timing is everything for a growth company, because a deduction in year one is worth far more than the same deduction spread over five years.
Why the 2022 to 2024 Years Hurt UK-Parented Groups
Between 2022 and 2024, the old section 174 forced every US taxpayer to capitalise research costs. Domestic costs were amortised over five years and foreign costs over fifteen, both using a mid-year convention. Consequently, a subsidiary spending two million dollars on US engineers deducted only two hundred thousand dollars in the first year.
For a British founder, this landed awkwardly. The US subsidiary frequently earned a healthy margin on sales to American customers, yet its engineering costs were mostly disallowed in the short term. Meanwhile, the UK parent was claiming generous relief on its own development spending in London. Therefore, the group often paid American tax at 21% on profits it had reinvested in full, while the UK side looked lightly taxed. Section 174A ends that mismatch for domestic work, provided the work is genuinely domestic.
Domestic Versus Foreign Research Under Section 174A
The single most important question under Section 174A is where the research is physically performed. Domestic research means research conducted inside the United States. Foreign research means everything else, and it remains under the amended section 174, which still requires capitalisation over fifteen years from the midpoint of the year the cost is incurred.
The Fifteen-Year Rule That Survived
The fifteen-year rule is harsh in practice. A foreign research cost of 900,000 dollars produces a first-year deduction of only 30,000 dollars, because one-fifteenth of the cost is halved under the mid-year convention. Furthermore, section 174 denies any write-off of the unrecovered balance if the project is abandoned or the underlying property is sold. The amortisation simply continues on its original schedule.
Additionally, foreign research does not qualify for the federal research credit at all, because the credit excludes research conducted outside the United States. Accordingly, the London engineer who costs the US subsidiary 150,000 dollars a year produces roughly 5,000 dollars of first-year deduction and no credit. The same engineer relocated to Austin produces a 150,000 dollar deduction and potentially a credit as well.
When Your US Subsidiary Pays the UK Parent for Research
This is the pattern we see most often. The UK parent employs the engineering team, and the US subsidiary pays the parent a cost-plus fee for development work, often because the subsidiary owns the US rights to the product. In that case, the subsidiary has incurred research expenditure, but the research was performed in Britain. Consequently, that intercompany charge is foreign research expenditure in the subsidiary's hands and falls under the fifteen-year rule, not under Section 174A.
The IRS approach to contract research, set out in IRS Notice 2023-63, looks at who bears the financial risk of failure and who holds the right to use the resulting product. Therefore, the wording of your intercompany agreement matters as much as the location of your staff. A poorly drafted agreement can leave the US subsidiary with capitalised foreign costs it never intended to own. Equally, the pricing must satisfy the arm's length standard described in the IRS transfer pricing guidance.
Remote Workers and Split Locations
Remote work blurs the line further. In our view, the location test follows where the activity is carried out, not where the employer is registered. Accordingly, a US-employed developer who spends four months a year working from Edinburgh generates a proportion of foreign research cost. Similarly, a British contractor who travels to New York for a two-week sprint generates a small slice of domestic cost.
We recommend that groups keep simple time records by location for every engineer whose cost reaches the US subsidiary. Without those records, the domestic share cannot be supported on examination. Moreover, the same records support the federal research credit claim on Form 6765, which now asks for more granular project information than it did before 2024.
The Transition Elections and Which Windows Have Closed
Section 174A came with two transition elections for the domestic costs capitalised between 2022 and 2024. Both are explained in Rev. Proc. 2025-28, the IRS procedural guidance released on 28 August 2025. One of them has already expired, and the other depends on your subsidiary's year end.
The Small Business Retroactive Election Closed on 6 July 2026
The first election allowed an eligible small business to apply Section 174A retroactively to 2022, 2023 and 2024, filing amended returns to claim refunds. Eligibility required meeting the gross receipts test in section 448(c), which for a tax year beginning in 2025 means average annual gross receipts of 31 million dollars or less over the three prior years. Tax shelters were excluded.
That election had to be made by Monday, 6 July 2026, or earlier where the refund limitation period expired first. It is now closed. Furthermore, many UK-parented subsidiaries never qualified, because the gross receipts test aggregates commonly controlled businesses. A US subsidiary with modest sales of its own can fail the test because of its UK parent's turnover. Therefore, if your adviser assumed the subsidiary was small without testing the whole group, the analysis was incomplete.
The Catch-Up Election for Unamortised 2022 to 2024 Costs
The second election is available to every taxpayer, regardless of size. It lets the subsidiary deduct the remaining unamortised balance of its 2022 to 2024 domestic research costs in full in its first tax year beginning after 31 December 2024. Alternatively, it may spread that balance evenly across that year and the next. If neither election is made, the old five-year schedules simply continue.
Importantly, this election applies only to domestic costs. Unamortised foreign research balances stay on their fifteen-year schedules permanently. Additionally, the election is treated as a change in accounting method on a cut-off basis, so no section 481 adjustment arises. It is made with the return for the first tax year beginning after 2024, using the statement procedure in Rev. Proc. 2025-28.
Fiscal-Year Subsidiaries Still Have a Live Window
Here is the gap most commentary misses. Many UK groups align their US subsidiary's year end with the parent's, often 31 March. For such a subsidiary, the year beginning 1 April 2024 is still governed by the old rules. Consequently, its first year under Section 174A is the year beginning 1 April 2025 and ending 31 March 2026.
A corporation with a 31 March year end files Form 1120 by the 15th day of the fourth month, which was 15 July 2026, and an extension carries that to 15 January 2027. Therefore, a March year-end subsidiary that extended its return can still choose between the full catch-up, the two-year spread and the old schedule. Calendar-year subsidiaries, by contrast, had to decide by 15 October 2026 at the latest. If your calendar-year return has already gone in without the election, speak to a specialist promptly about what, if anything, remains correctable.
Choosing Between Full Catch-Up, Two-Year Spread and Amortisation
Once you know which costs qualify for Section 174A, the next decision is how fast to take them. Faster is not always better. The right answer depends on the subsidiary's profit profile, its state tax position, its use of the research credit and its dividend plans.
Net Operating Losses and the 80% Limit
A full catch-up in a year with modest profits can create a net operating loss. Post-2017 losses carry forward indefinitely, but they can only offset 80% of taxable income in any later year. Consequently, a subsidiary that turns a profit into a loss through the catch-up may pay some tax in the following year that a two-year spread would have avoided. We model both paths before recommending one.
Equally, some subsidiaries should consider the 60-month amortisation election for current-year costs under Section 174A. That is unusual, but it can make sense where the deduction would otherwise be wasted, for example where the company has large accumulated losses that are about to be used up anyway.
The Research Credit and the Section 280C Choice
The federal research credit interacts directly with the deduction. Under the amended section 280C(c), the domestic deduction must be reduced by the full amount of the credit claimed. Alternatively, the company may elect a reduced credit, equal to the credit multiplied by one minus the 21% corporate rate, and keep its full deduction. That election must be made on a timely filed original return, including extensions.
Furthermore, an early-stage subsidiary may be able to set up to 500,000 dollars of research credit against its employer payroll taxes. That option is limited to qualified small businesses with gross receipts under 5 million dollars and no gross receipts before the five-year window, as explained on the IRS page on the payroll tax credit for increasing research activities. Consequently, a young US subsidiary of a UK group can turn research spending into cash even before it is profitable.
State Conformity Is Not Automatic
States do not all follow the federal rules. Some states adopted the federal capitalisation regime, others never did, and others have yet to decide whether to follow Section 174A. Therefore, a California or New York nexus can produce a different answer at state level from the federal one. We prepare the state computations alongside the federal return so that the elections are coordinated rather than accidental.
The UK Side of the Same Research Pound
A British founder has to look at both countries at once, because the UK and US rules now push in opposite directions. The UK merged research and development scheme, which applies to accounting periods beginning on or after 1 April 2024, generally restricts relief for contracted-out work and externally provided workers outside the United Kingdom. You can read the current rules in HMRC's guidance on Corporation Tax research and development relief.
Where Should the Engineers Sit?
The result is a genuine placement decision. Research performed in London by the UK parent's own staff can qualify for UK relief, but if the US subsidiary pays for it, the subsidiary amortises it over fifteen years. Conversely, research performed in the United States by the subsidiary's own staff gets immediate deduction under Section 174A, but it generally earns no UK relief for the parent.
Neither answer is automatically right. Instead, the group should decide who owns which intellectual property, who directs the research and where the team physically works, and then document it consistently in both countries. Our earlier analysis of research and development relief for American owners of UK companies covers the reverse structure, where Americans own the UK company.
Dividends Back to the UK Parent
Once the subsidiary's taxable profit falls, more cash is available to send home. Under Article 10 of the US-UK income tax treaty, dividends from a US subsidiary to a UK company that has owned at least 80% of the voting power for twelve months can carry zero US withholding, provided the parent satisfies the limitation on benefits article. Otherwise, the rate is 5% for holdings of at least 10%. HMRC publishes the US-UK double taxation convention in full, and our tax treaty optimisation service tests the limitation on benefits conditions before any distribution is paid.
Reporting Obligations That Travel With Section 174A
Claiming Section 174A relief puts the subsidiary's return under closer review, and closer review exposes the information returns that foreign-owned groups most often miss. In our experience, the penalties on those returns frequently exceed the tax at stake on the research deduction itself.
Form 5472 for Foreign-Owned US Companies
Every US corporation that is at least 25% foreign-owned must file Form 5472 for each related party with which it has reportable transactions. The research fee paid to the UK parent is exactly such a transaction. The penalty for failing to file is 25,000 dollars per form per year. Accordingly, a subsidiary that has paid intercompany research fees for three years without filing can face a six-figure exposure before any tax is considered.
Founders Who Are US Persons
The position becomes more complex when the founder is an American citizen, a green card holder or an accidental American born in the United States. A US person who controls the UK parent may need to file Form 5471 every year, and the UK parent's own London research is foreign research in that computation. Consequently, the fifteen-year rule can inflate the controlled foreign corporation income that the founder reports personally.
Furthermore, a dual national founder with signature authority over the UK parent's bank accounts may have FBAR obligations under the rules published by FinCEN on reporting foreign bank and financial accounts. Our FBAR and FATCA reporting service handles those filings, and where years have been missed our IRS Streamlined Filing team restores the founder's personal compliance.
Case Study: A London SaaS Founder and Her Delaware Subsidiary
The following illustrative case shows how Section 174A works in practice. Eleanor is a dual US-UK national living in London. She owns 70% of a UK software company with group turnover of around 38 million pounds. The UK company owns 100% of a Delaware subsidiary that sells to American customers, and the subsidiary's year end is 31 March to match the parent.
The Unamortised Balance Eleanor Inherited
The subsidiary employed US engineers throughout the capitalisation years. Its domestic research costs were 1.5 million dollars for the year to March 2023, 1.8 million dollars for the year to March 2024 and 2.0 million dollars for the year to March 2025. Under the five-year schedules with the mid-year convention, it had deducted 750,000 dollars, 540,000 dollars and 200,000 dollars of those amounts respectively. Therefore, the unamortised domestic balance at 1 April 2025 was 3.81 million dollars.
The group's turnover meant the subsidiary failed the aggregated gross receipts test, so the retroactive small business election was never available. However, because its first Section 174A year ran from 1 April 2025 to 31 March 2026, and its return was on extension to January 2027, the catch-up election was still open when Eleanor came to us.
The Three Paths We Modelled
For the year to March 2026, the subsidiary had profit before research costs of 5.5 million dollars. It spent 2.4 million dollars on US engineers, which is fully deductible under Section 174A. Additionally, it paid the UK parent 900,000 dollars for development work performed in London, which is foreign research and yields only 30,000 dollars of deduction this year.
Without any election, the old schedules would add 1.06 million dollars of amortisation, leaving taxable income of 2.01 million dollars and federal tax of 422,100 dollars at 21%. With the two-year spread, the deduction this year is 1.905 million dollars, taxable income falls to 1.165 million dollars and federal tax falls to 244,650 dollars. With the full catch-up, the subsidiary deducts all 3.81 million dollars, records a loss of 740,000 dollars and pays no federal tax for the year.
What We Recommended and Why
We recommended the two-year spread. The full catch-up wasted part of the deduction into a loss restricted by the 80% rule, and the subsidiary's 2027 profits were forecast to be higher, so the second half of the spread would shelter income at the same 21% rate without any limitation. Furthermore, we showed Eleanor what the London fee was costing. Had the full 900,000 dollars of work been performed in the United States, the first-year deduction would have been 870,000 dollars higher, worth 182,700 dollars of federal tax timing at 21%. Consequently, the group moved three engineers who were relocating to Boston onto the subsidiary's own payroll for the following year, so their costs fall into immediate deduction.
Finally, we found that the subsidiary had never filed Form 5472 for the research fees, and that Eleanor had not filed Form 5471 for the UK parent. We prepared the delinquent forms with reasonable cause statements, alongside her personal US tax return preparation for expats, so that the improved corporate position was not undermined by missed reporting.
How TaxYork Can Help
Our team prepares the full set of US returns that a UK-parented group needs to benefit from Section 174A safely. That includes the Form 1120 with the domestic and foreign research computations, the catch-up election statement where it remains available, the Form 6765 research credit claim and the section 280C choice. Additionally, we prepare the Form 5472 filings, review the intercompany research agreement against the contract research rules, and coordinate with the UK parent's own research relief position.
For founders who are US persons, we prepare the personal Form 1040, the Forms 5471 for the UK parent, the FBAR and Form 8938. Moreover, where the founder is a dual national or accidental American who has fallen behind, we bring the personal filings up to date before the corporate structure attracts attention. Our cross-border planning team works across both sides, and our related analysis of video games tax relief for American studio owners shows the same foreign research rule from the other direction.
Conclusion
Section 174A restored the immediate deduction that US subsidiaries of British groups lost in 2022, but only for research physically performed in the United States. Foreign research, including the London work that a US subsidiary pays its UK parent to perform, remains on a fifteen-year schedule with no credit and no write-off on abandonment. The small business retroactive election closed on 6 July 2026. Nevertheless, the catch-up election for unamortised domestic costs is still open for many fiscal-year subsidiaries whose first Section 174A year ended in 2026.
Therefore, now is the moment to check where your engineers sit, which entity bears the research risk, which elections your returns contain and whether the information returns that accompany them have been filed. Professional bodies such as the ICAEW tax faculty publish ongoing commentary as the IRS releases further guidance, and we monitor it for every client file.
Contact Us
If your US subsidiary has a 2025 or fiscal-year 2026 return still open, or if you are unsure whether your intercompany research charges are domestic or foreign, book a consultation with our US-UK team. You can also email hello@taxyork.com or call 020 3488 8606. We will review your returns, model the elections and prepare everything required to file with confidence.
Disclaimer
This article provides general information about US and UK tax rules for research and development expenditure as understood at the date of publication. It is not tax, legal or accounting advice for your specific circumstances, and the case study is illustrative. Tax law and IRS guidance on Section 174A continue to develop, and state rules vary. You should obtain professional advice before making any election or filing any return. TaxYork accepts no liability for action taken or not taken on the basis of this article.