R&D Tax Relief in the Software Industry
IT is one of the world’s most rapidly evolving sectors and whilst some form of innovation is very often present, the components that qualify for R&D tax relief are almost always difficult to assess with any degree of confidence. Technology tends to be complex by nature and evolves at such a pace leading to difficulties in articulating what actually denotes ‘innovation’ within software development projects. This is further complicated by the fact that software development often takes place over a number of years so it is necessary to constantly review whether a claim can be made each year.
The good news is that if a company is involved in software development, there’s a reasonable chance it could benefit from this hugely generous relief. Software is an area where technology moves forward at such an unprecedented rate that companies in this sector are often faced with a number of technical challenges and complexities which is key to determining whether a company qualifies for R&D tax relief.
We’ve created a brief guide to help you ascertain whether a valid R&D tax credit claim for software development can be made.
Who can claim?
Software development usually takes place either because a company is developing software to sell or is building software to help their business run more efficiently. Companies will typically be undertaking qualifying R&D activities if they seek to overcome a technological uncertainty over the course of the project.
What is the key to making a claim?
Development involving the use of existing technology with minimal improvements or technical challenges, would not qualify for R&D tax relief. Such work would include simple configurations, routine development work or straightforward integrations of off-the-shelf products.
However, where businesses are creating, utilising, amalgamating or significantly extending technologies in an improved and innovative way will often mean qualifying R&D is taking place. A key question to the developers would be “is the company resolving software uncertainties and challenges that have not yet been overcome by a competent professional in the field?”
The R&D tax relief scheme is very much geared around the technology on which the software is built, more than the actual commercial or end user features of the product. It is therefore important to demonstrate the complexity of the software build from a programmer’s perspective. For example, a slick end-user feature may be attractive from an aesthetic perspective, but if there was no complexity involved in its creation, it’s creation is unlikely to constitute qualifying R&D activity. Routine projects that do not require any advance in capability or the resolution of technical challenges are therefore not qualifying.
What are HMRC looking for?
HMRC require companies to demonstrate how the improvements to the software were made, the difficulties they faced and how the problems were overcome. In addition, why the solutions sought were not readily available is also a key consideration. HMRC look at the degree of complexity and problem solving involved in writing software. For example, can the answer be found within open publications, meaning that any reasonably competent developer would resolve the issues without much difficulty?
Many new products have software interfaces ready to use out of the box, but others require developers to update or redesign interfaces with more advanced technologies such as software-defined networking, automation and AI. It is the latter rather than the former which are more likely to involve qualifying R&D.
Claims need to focus on the underlying technology utilised within the development of a product/process rather than just the product/process itself. This could be by developing a new, novel software application to include, for example, the development of machine learning algorithms to improve the speed and efficiency of a system. It might involve the optimisation, re-architecting, or integration of different technologies that did not already interoperate in order to provide a solution to a task which had no alternative.
Typical examples of qualifying software development;
- Bringing large cumbersome, legacy systems up to date where there is little to no documentation available.
- Implementing complex, bespoke functionality into off the shelf technology.
- Integrating multiple disparate systems to operate seamlessly and efficiently.
- Developing a platform that enables data to be automatically extracted
from several sites and analysed using intelligent algorithms. - Development of dynamic pricing functions which links price to demand.
- Integrating legacy systems with modern technologies through the
development of complex algorithms. - Overcoming issues of compatibility, stability, scalability, security and interoperability where routine or conventional methodology cannot be followed.
- Complex communications e.g. combining mobile and static technologies, structured and non-structured data, multiple operating systems etc.
- Technologically innovative (and challenging) ways of overcoming project imperatives; complexities around legislative compliance.
- Use of cutting-edge technologies with minimal amounts of history or documentation, often meaning there are no precedents to work from and iterative development must take place.
- The use of machine learning algorithms to improve upon existing processes.
- The development of blockchain technology to improve security and speed of transactions.
- Developing Internet of Things platforms and utilising this data in a complex manner.
- Implementation of AI into wider systems to better understand or complete tasks.
Examples of non-qualifying projects
- The handling of interactions with users. This covers areas such as development of data entry procedures and user interfaces.
- The visual presentation of information to users.
- Using standard methods of encryption, security verification and data integrity testing.
- Creation of websites or software using tools designed for that purpose.
- Routine adaptation of an existing product or process.
- Assembling components of a program to an established pattern or using routine methods for doing so is not R&D.
- Tweaking a system to make minor changes to fit a business requirement.
Why use a specialist?
Many potential IT R&D tax credit claims are not even attempted, because companies are rightly reluctant to spend significant amounts of time and money with no guarantee of success.
In addition, companies can’t always expect their accountant to have the specialist technical knowledge required to draw the boundaries between R&D and non-R&D activity.
Companies that do manage to submit an R&D tax credit claim themselves, or use a non-specialist R&D adviser, often do not identify all their qualifying expenditure. At the other end of the spectrum, non-qualifying projects (or aspects of a project) are often claimed, resulting in lengthy HMRC enquiries.
R&D related tax enquiries are on the increase, particularly where claims are based on software development projects. It’s therefore essential that claims are accurately prepared to minimise the risk of enquiries and potential tax penalties.
YesTax
We have been making claims in this area for years and have recently enlisted specialist technical talent in this area. James Smith joined the team last month as one of our expert software sector specialists. James has a degree in Computer Science and has programmed in several software languages. He has already provided invaluable advice to many YesTax clients.
Whether you are making a claim or not, there isn’t a question we can’t answer about this sector. If you’re in the industry and doing something similar to the examples above or you’re about to take a new project on, we’d be delighted to hear from you. We undertake complimentary reviews to ensure you are maximising the opportunity, so whatever your circumstances, please get in touch.
YesTax. Positively Better