What is R&D Tax Relief?
The UK government implemented a tax incentive scheme for innovative businesses in the year 2000, to incentivise scientific and technical advancements.
This initiative is known as Research and Development Tax Relief (R&D Tax Relief), and it allows any UK company that’s bringing a new product, process, or service to market (or enhancing existing ones) to fuel cashflow by claiming R and D Tax Credits every financial year.
How do R and D Tax Credits work?
R and D Tax Credits allow claimants to recover up to 27% of the yearly expenditure that they allocated to qualifying R&D activities, either in cash or in the form of a Corporation Tax (CT) deduction.*
HMRC define these eligible R&D activities through six categories of ‘qualifying expenditure’. How much R&D Tax Relief you could reclaim depends largely on how much you’ve spent on the following areas during your R&D project:
• Staffing
• Subcontractors
• Externally Provided Workers (EPWs)
• Consumables
• Software
• Payments to the subject of clinical trials
In this blog, we’re going to be focusing on the fifth area of qualifying R&D expenditure – Software. We’ll be explaining what costs are included in this claimable category, to help you assess the scope of your potential R & D claim.
Remember, the inclusions that we cover today are just one of six vast areas of R&D activity that you’re able to reclaim!
Altogether, an R & D claim can offer up huge sums of money for the claimant to reinvest into the growth of their business. In fact, last year, HMRC reported the average return of SME and RDEC R&D Tax Credit claims as £57,330 and £317,829, respectively.
In our previous blogs, we took a closer look at the first four categories of qualifying R&D expenditure – Staffing, Subcontractors and EPWs, and Consumables.
To learn more about which staffing costs can be included in an R & D claim, read our related blog - Claiming R&D Tax Relief for Staffing Costs. To better understand how Subcontractor & EPW costs are reported in an R & D claim, check out Claiming R&D Tax Relief for Subcontractors and EPWs. And if you’re unsure what consumables count towards an R & D claim, read Claiming R&D Tax Relief for Consumables.
What Software costs can be reclaimed through R&D Tax Relief?
Software-driven activity accounts for over 65% of all R and D Tax Credits filed each year.
The use of software is inherently innovative and work involving the development of software is often highly eligible for R and D Tax Credits. Any type of software used in your R&D project that helps to overcome scientific or technological uncertainty can be included in R&D Tax Credits.
Costs incurred through any software licences directly used in the R&D process can be reported on your R&D claim. This might include licences for simpler software such as Microsoft Word and Excel, or costs spent on advanced project management software overseeing any employee involved in the R&D work.
Let’s run through some specific examples of eligible R&D activity within the software category:
Artificial intelligence
Machine learning
Enhancing data processing
Enhancing data security
Developing a SaaS (Software as a Service) platform
Optimising language processing software
Robotics
Augmented reality
Current legislation around Software for the purpose of R&D Tax Relief
The true definition of Software expenditure in relation to R and D Tax Credits was updated in October 2018, when HMRC decided that existing descriptions were outdated and overly simplistic - soon be rendered obsolete.
New guidance replaced generic examples with more up-to-date case studies. Nothing to do with the legislation was changed, but what counts as software R&D activity was better clarified.
So what are HMRC’s improved guidelines around claiming R&D Software Costs?
Fundamentally, your claim needs to focus on the underlying technology instead of just a software product or process. When you make a software-intensive R & D claim, it’s crucial to refer to a competent technical professional (a senior software developer, for example) in the information-gathering stage of the process.
A common misconception is that only brand new software qualifies for R and D Tax Credits.
Even if the software currently exists, enhancing it in any way counts as genuine R&D. An existing company may even have the product you’re pursuing. But if your experts don’t have that same capability — experimenting to discover a solution still qualifies as claimable software R&D activity.
Even if your project features standard processes that aren’t classed as R&D, if an innovative aspect of software was implemented, it still constitutes R&D for the purpose of R and D Tax Credits. For instance, if there is a new R&D-intensive software component that fits into a wider system, this is valid R&D activity, provided that there were underlying technological uncertainties that were addressed.
Like all areas of qualifying R&D expenditure, the claimant must report relevant software costs proportionally. An R&D Tax Credit Specialist is well-versed in extracting proportional spending and reporting it accurately.
100% of a commercial R&D project cannot be included within your R & D claim. HMRC has outlined that certain areas must be excluded from an R & D claim. For the category of software, these include beta testing, user acceptance testing, and initial market research.
As you can see, distinguishing qualifying software costs from non-qualifying software costs isn’t self-explanatory. Certain inclusions and exclusions aren’t always obvious – that’s why filing your R and D Tax Credits through an expert R&D Tax Advisor is so important.
Knowing how to correctly report financial and technical information on the R & D claim requires professional experience and specialist knowledge of R&D Tax Relief legislature. Claim Capital’s team of R&D Tax Specialists have over 25 years of experience in delivering successful and maximised R&D Tax Credit claims.
To run through the scope of your potential R&D Tax Credit claim with an experienced specialist – arrange a free, no-obligation R&D claim consultation.
*These are the updated figures in line with the new legislation announced in the April 2023 Spring Budget.
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