Published Date08-03-2019
Reading Time12 min.
Innovation is crucial to the success of businesses, and in no sector is this more obviously the case than in the fast-moving world of software development, where technological progress is constant.
It was in order to help foster and promote this innovation that the Government introduced R&D tax credits for small and medium-sized businesses as long ago as 2000, extending the scheme to larger businesses in 2002.
Although the tax relief is designed to help businesses in any sector that are advancing industry-wide knowledge through research, there are concerns that there has been a lack of uptake in R&D tax credits for software development.
This may be due to a lack of awareness about what activities do and do not qualify for software developer tax deductions, and how to go about applying for them.
R&D tax credits are available for businesses that are working on innovative projects in science and technology. There are two schemes, one for smaller companies (under 500 employees or less than 100 million euros in turnover) called SME R&D relief, and another for larger companies called Research and Development Expenditure Credit (RDEC).
Because it’s still a relatively young and growing sector, a lot of companies working on software development are likely to come under the SME scheme. It’s also an industry which depends a lot on self-employed contractors, so it’s good news that subcontractor costs also count towards software development tax credits.
In addition, SMEs can also get software developer tax deductions if they are working as partners on a project with a larger company.
The key to knowing whether you should apply for tax credits towards the cost of your R&D software development – and where most of the misconceptions lie – is in understanding who and what qualifies for the relief.
The research has to be aimed at resolving some technological uncertainty. To qualify, you would have to demonstrate what this uncertainty was and how your work was aimed at resolving it. You’d also have to show that it wasn’t a routine technical problem that could be easily solved by any professional working in the field.
Linked to this, the R&D should have potentially industry-wide benefits. It needs to advance knowledge in the sector generally, and not just be aimed at improving your product by adapting some pre-existing software.
If it was aimed only at resolving a technical problem within your own product, it might not qualify. However, the nature of software development is that a lot of it has wider applications.
Finally, it’s worth remembering that the work does not need to have a successful outcome to qualify for tax credits. Any project that meets the criteria, successful or not, could attract relief.
Knowing which software development projects are eligible for R&D tax credits can help companies take advantage of this financial benefit. The following are examples of successful R&D tax credit claims, demonstrating the diversity and innovation in the tech industry.
AI-Powered Code Analysis Tool: A tech startup developed an AI-powered platform that automates code reviews and identifies potential errors and security vulnerabilities. This tool leverages machine learning algorithms to learn from historical data and improve its analysis over time, representing a significant advancement in software development efficiency and security.
Real-Time Data Processing Engine: A company created a software solution capable of processing and analyzing large volumes of data in real-time, facilitating immediate decision-making. This engine supports businesses in finance and e-commerce, where rapid data analysis can significantly impact operational success.
Cloud Migration Tool: Recognizing the need for more efficient cloud transitions, a software company developed a tool that simplifies the migration of databases and applications to cloud environments. This tool not only accelerates the migration process but also reduces the risk of data loss, making cloud adoption more accessible and secure for businesses of all sizes.
Blockchain-based Secure Transaction Platform: In response to increasing concerns over digital transaction security, a fintech firm introduced a blockchain-based platform designed to secure online transactions. This platform utilizes advanced encryption and decentralization techniques to ensure the integrity and confidentiality of user data.
IoT Device Management Software: An enterprise specializing in Internet of Things (IoT) technologies developed a comprehensive management software that enables efficient monitoring, control, and security of IoT devices across various industries. This software addresses the complex challenges of managing large-scale IoT deployments, including device compatibility, data security, and remote troubleshooting.
These are just some examples of the sort of projects that could attract R&D tax credits. The best way to find out if any particular project qualifies is to seek advice from a specialized R&D consultancy firm.
If you think the work you have been doing might qualify for an R&D tax credit for software development, the next question is what you can claim for. You might be pleasantly surprised to learn just how many things can be included in your claim.
In terms of R&D software development, the qualifying period for the relief starts when the technological uncertainty has been identified and the objectives for the project have been set. It then continues through the feasibility studies, and the reviewing of other technologies.
Along with these studies, the design and development work on the new technology, along with testing and the production of technical documents, all count towards the credits.
And importantly, there’s a range of indirect support work, such as administration, recruitment, training, finance and HR, that also counts towards the relief if it can be linked to the R&D project.
You can claim for all this work up until the objectives of the project have been met and the new product or process is ready for testing before being put into production or use. If new problems arise after the new software is ready, you might still be able to claim for further R&D tax credits.
This is where it gets really good for software developers. There’s a whole range of qualifying costs that you can add towards your total in a claim for R&D tax credits.
Firstly, you can claim all staff costs for employees directly involved in the R&D work. This includes wages, salaries, class 1 National Insurance contributions and pension fund contributions. And it covers not just the research and development workers themselves, but any supervisors or managers directly involved in managing them.
Also covered are the costs of support staff who are indirectly involved, such as payroll, admin and HR staff. As with managers, the proportion of their time that is connected with the project can attract relief.
Externally provided staff such as agency workers or subcontractors are also covered.
You can also claim for materials used in the project. This could be consumable items such as paper and printer ink. And you can claim for a proportion of your utility bills – water, electricity, gas etc. – for the amount consumed during the work.
Any software or other equipment you have had to buy to help you in your project would also qualify. The cost of making prototypes developed purely for testing the new product or process can be counted, although prototypes developed for sale cannot – they are considered to be production items which fall outside the limits for R&D tax credits.
SME R&D tax credit is very generous. In making a claim, companies can deduct 130% of their qualifying costs from their annual profit, in addition to the normal 100% deduction they would make in their tax return, making altogether a 230% deduction. If your company is making a loss, you can claim a tax credit of 14.5% against the loss.
Larger companies that fall under the RDEC scheme get credit for 11% of their qualifying costs.
As you can see, R&D tax credits are worth a lot of money to qualifying businesses. Provisional figures for the 2016-17 tax year, the latest for which HMRC data is available, show that 38,940 companies made a total of 39,960 claims between them. These companies spent around £24.86 billion on R&D, and claimed some £3.45 billion in R&D tax credits.
If we look at the way the government classifies industry sectors, most software development is assumed to take place in the information and communication sector. In 2016-17, the sector accounted for a little over a quarter of all claims, but only a fifth of the total amount claimed.
90 per cent of the claims in the sector came from SMEs. London and the South East account for around a third of SME claims across all sectors.
Remember that if you’re working in collaboration with another company on an R&D project, both companies can claim for the costs that they incur.
You can claim for an R&D tax credit up to two years after the financial year in which you did the work. Applications are made through the Company Tax Return form (CT600), and supporting information can be submitted online.
To make an application, you need to calculate all the costs that you can relate to the R&D project, including the indirect costs mentioned above. Subcontractor or other external staff costs need to be reduced by 65%.
When you have added all the costs together, multiply the total by 130% and add to the original total, then enter this figure into your tax return.
In your supporting information you’ll need to give details about the project, such as what was the technological uncertainty, how you identified it, how your work resolved it and why it couldn’t be done by any professional working in the field.
You can claim for up to 10 R&D projects, but if you’re claiming for three or less you need to provide details for all three. If you’re claiming for four or more you must provide details for at least three, which together account for 50% or more of your total claim.
For information and advice on whether your R&D software development might qualify for R&D tax credits, as well as further help on applying for them, get in touch with FI Group at info-uk@fi-group.com.
