R&D Tax Credits for Software Projects
There is a way to reclaim a large part of the cost of a software development project using R&D tax credits, even if your project seems too mundane to qualify. Here’s our quick guide on how to claim a generous tax incentive of £40,000 or more.
Upon a successful R&D claim, HMRC will pay out up to 33% of qualifying R&D spend on a software development project, whether it’s successful or not. Furthermore, the scheme has already provided over £15 billion of R&D funding support to UK businesses, which shows that it’s well worth applying.
The Research and Development Tax Credits rules set out by the UK Government require that projects “seek an advance in science or technology”, and aim to “overcome technical uncertainties”. Whilst this may sound as if a qualifying project needs to be “ground breaking”, “leading edge”, “innovative” or “pioneering”, the truth is the practical application of R&D tax credit rules are, and were always intended to be, very broad.
This means that even if your bespoke software project seems to be unremarkable in terms of newsworthiness, the R&D aspect may still qualify for tax purposes. To do so, it means rather than using existing solutions that apply commonly accepted knowledge, there should be an element of financial risk to the venture, as well as some element of research (although HMRC would argue that the “research” bit does not qualify for the relief. The key part is “development”).
Many custom software projects fall into this broad category quite easily, as a bespoke solution with unique specifications, by its very nature, means the solution doesn’t already exist and must be developed. To qualify for R&D tax credits, however, a project must go further than just being bespoke. For example, adapting or updating an existing product or process using routine methods is not considered research and development.
But combining standard technologies in a new and different way to achieve the desired result (that can’t be readily deducible by a competent professional working in the field) would qualify as R&D. This could, for example, take the form of resolving conflicts within hardware and software where there isn’t a known/documented solution, or where there isn’t a documented API solution that allows two pieces of software to talk to one another, and a solution must be programmed from scratch.
Example qualifying projects by the HMRC include:
- Developing new operating systems or languages.
- Creating new search engines using materially new search methods.
- Resolving conflicts within hardware or software, where the existence of a problem area and the absence of a known solution have been documented.
- Creating new or more efficient algorithms whose improvements depend on previously untried techniques.
- Creating new encryption or security techniques that do not follow established methodologies.
Common software development projects that tend to qualify for R&D tax credits include:
- Integration of software components into a single platform.
- Development of new software for the business that’s not available from a 3rd party solution.
- Development of new languages or operating systems.
- Development of new, custom algorithms to better optimise performance of the software.
- Improvements to security or data encryption.
- Tools to extend the functionality of software applications or an operating system.
- Extensions to database software, programming languages, or operating systems.
- Software development tools, such as tools to port data across platforms, and tools for image processing and character recognition.
- Novel data management techniques, such as new object representations and new data structures.
- Innovative methods of capturing, transmitting, manipulating, and protecting data.
- Software to run on devices with pre-installed operating systems, such as handheld GPS, mobile phones, and tablets.
As for the financial risk element, if you try and develop something new or improved to meet your needs and requirements, and in doing so, incur costs (financial risk), such as hiring skilled people or technical expertise to get the ball rolling, that potentially qualifies for development tax credits.
Even if you’ve previously tried to develop a new product or technology, and failed, doesn’t exclude you from applying, because the R&D tax relief incentive is designed to support aborted or failed projects (from a qualifying R&D project POV, project failure on technical grounds demonstrates it was technically challenging!).
Furthermore, R&D tax credits can be applied retrospectively, even after accounts and tax returns have been filed. In fact, the rules allow for claims to be made for tax accounting periods ending in the past two years.
But what if your custom software is for internal use only and will never be seen by the general public? Frankly, it doesn’t matter. There’s no restriction in the rules that the project has to be market-facing. If it’s a new technology aimed at helping improve your business, then it still sits within the qualifying zone – for example if you use new technologies to integrate your legacy systems.
One of the concerns of many companies embarking on R&D tax credits is that time-sheets itemising detailed time spent on R&D will be needed to make a tax credit claim. In fact, it is sufficient for management to provide their best estimate of the time spent by team members on qualifying R&D work. Obviously, as things scale up, it’s always good practice to properly track and record qualifying time and costs.
Finally, what if you’re a start-up with no company tax history? Again, it doesn’t matter. As a start-up or early stage entrepreneurial company, the government sees your success as potentially important to the future of the UK economy. So, with that in mind, qualifying projects can get R&D tax credits as cash paid into the company bank account despite it not having paid corporation tax or PAYE (for paying employees / subcontractors / externally provided workers / software and so on).
If you’re thinking of making a claim, it’s important to ensure its properly prepared to ensure that you maximise the probability of it being successful and maximising the amount paid out. To do that, there are several things that you can do to make your life easier:
- The project manager should document the project objectives and project approach from inception. Perhaps setting up an R&D project wiki to ensure documentation is maintained throughout the project.
- Ensure that the developers understand the basics of the R&D tax credit rules and source code comments tagged so that the final R&D write up can reference back to the underlying work, mythology and issues faced.
- Use accounting software which enables you to track R&D expenses throughout the project lifetime and not just at the end of the year. This will make the process of identifying qualifying spend much more straight forward at the year end.
HMRC publishes a manual on R&D tax relief and has provided a simple guide on R&D tax relief for small and medium-sized companies. There are also specialist HMRC units able to help with your claim, and you can find further assistance by contacting a specialist R&D tax credit advisor.
If you have a custom software project that you’d like to talk to us about, get in touch!