Software is evolving at a phenomenal pace.
Many well-known and commonplace aspects of software are rapidly expanding, for example, AI and Cloud technology, whilst more recent branches accelerate exponentially, for example, robotics and virtual reality.
HMRC, as with any R&D project, is looking to see an advance in science and overall knowledge or capability for the software industry; not just your company’s own state of knowledge or capability.
Who qualifies for R&D in software development?
The software industry has seen substantial growth in recent years with increased adoption across many sectors. Companies use 137 unique SaaS apps on average! That's a 30% increase from 2018.
This provides solid justification for any company looking to develop software, whether that's coding completely new software solutions or enhancing existing products.
Typical claimants include:
- Software development companies: a business that has teams of software developers who build custom software solutions for other businesses.
- SaaS companies: a company that creates software to provide a service, business tools or enterprise resource planning (ERP) systems.
- Non-software-specific companies: any business that performs software development to improve their existing processes, materials, devices, products or services. For example, a manufacturing company that develops a new software for quality assurance.
What types of software development might qualify for R&D tax credits?
Every day we become increasingly digitised. AI and machine learning are becoming driving forces within the software industry and virtual reality is fast taking over real-world experiences.
The software industry is so far-reaching that it almost isn't an industry in its own right, rather a fundamental part of all other industries upon which businesses are built.
There are, however, some core areas of qualifying activity in the software field that feature regularly in current R&D tax credit claims...
AI and machine learning
Artificial Intelligence (AI) is transforming the information and communication sector, with the computer science sector growing rapidly. AI is the simulation of human intelligence processes by machines, especially computer systems. These processes include learning (the acquisition of information and rules for using the information), reasoning (using rules to reach approximate or definite conclusions) and self-correction.
Machine learning is a type of AI that provides computers with the ability to learn without being explicitly programmed. It focuses on the development of computer programmes that can teach themselves to grow and change when exposed to new data.
By way of example, an AI project in R&D could be the development of the algorithms, data processing and storage technology involved in any of the following:
- Training computers to recognise human faces.
- Candidate matching in recruitment - sourcing, screening and onboarding.
- Chatbots and automated conversation tools on websites.
- Deploying automatic advertising tailored to specific individuals.
- Analysis of medical images for early detection of diseases.
Virtual Reality (VR) is an enhanced version of reality created by the appearance of virtual objects in the real-world environment. It supplements the real world with virtual elements, which are then blended together to produce new environments and visualisations that can be accessed via mobile devices or wearable technologies.
These elements are often sound, video or graphics that blend together with the natural environment, combining live footage from your surroundings with computer-generated input.
Cloud computing and IOT
A cloud is a metaphor for the internet, based on how it is depicted in computer network diagrams. It suggests an interconnected set of networks operating as one large system. Cloud computing refers to the use of computing services delivered over the internet.
The Internet of Things (IoT) describes the growing trend of devices being connected to the internet through embedded sensors that collect data, communicate with other devices or humans via the internet. The term is generally used to refer to a network of devices, vehicles, home appliances and other items embedded with electronics, software, sensors and connectivity which enables these objects to connect and exchange data. This allows them to be remotely monitored and controlled.
For example, a project in R&D might include developing a website for a business that allows users to connect and interact with devices via an API.
A large part of today's software world depends on robots - automated machines that move around pre-defined paths under computer control. The development of robotics has been a major technological advance that relies heavily on R&D activities from many different industries.
A robot is a machine that can be programmed to carry out complex tasks automatically. The term usually applies to automated machines that resemble humans or animals, which perform jobs that are dirty, dangerous or dull by switching between different sets of instructions at different times.
A project in R&D could include designing and building a robot that can teach itself to walk or carry out an activity usually undertaken by a human. Common uses for robotics are:
- Working in warehouses to pick orders.
- Driving cars autonomously (self-driving).
- Travelling into dangerous or unreachable territory (e.g. underground or in space)
Data processing and storage technologies
The way data is structured and accessed in the software industry is a major area of R&D. Data storage is a technology related to storing information in a computer; the increase of free online storage options over past years has revolutionised how we can use computers to store our data.
A project in R&D could be developing new or improved storage technology for large data files to allow them to be easily shared between devices.
What software-related expenses can be claimed for R&D tax credits?
As with any R&D project, there are a number of qualifying expenditure categories that you may be able to include in your claim depending on the arrangements and fact patterns present in your work:
- Employing competent professionals - staff salaries, employer class 1 National Insurance Contributions and employer pension contributions
- The reimbursement of employee expenses might also qualify where certain conditions are met
- Borrowing staff from group companies
- Payments to third parties possessing relevant expertise for your work
- Additional labour resource via agencies or freelancers to work with in-house staff
- Software licensing fees
- Utilities (heat, light and power)
- Consumables (materials and equipment used by the R&D process)
Qualifying expenditure may be incurred over a number of years for challenging projects stretching over several years with different areas of functional development, integrations, scaling-up or dealing with regulatory changes.
Other factors linked to R&D in software
It is important to note that the qualification of R&D for tax relief purposes requires a number of other criteria to be met. There are also different schemes of relief for R&D tax credits (RDEC or SME), which are based on criteria around company size.
Why claim R&D tax relief as a software company?
R&D tax credits offer significant financial support to businesses pushing through barriers to improve technological knowledge and capabilities. However, it is mistakenly not always thought to be relevant by many UK businesses, meaning significant numbers of businesses could be missing out on this valuable form of tax relief. Software developers often dismiss the potential to claim R&D tax credits because they don’t believe their project falls under the definition of technological advancement.
I have outlined 5 important reasons why you should be claiming R&D tax credits for your current or upcoming projects:
- You can claim deductions to meaningfully reduce Corporation Tax in the year of expenditure and even get cashback if you've already paid Corporation Tax during that year or have not been profitable.
- Under RDEC, the value of the R&D work is recognised ‘above the line’ in the Statutory Accounts, improving profitability whilst simultaneously reducing Corporation Tax payable.
- R&D tax credits are available for all qualifying software development projects carried out by companies throughout the UK, meaning you don’t have to be geographically based in a special science park or technology incubator area.
- Once you have claimed R&D tax credits once, you're in a great position to claim for subsequent costs by tracking and monitoring the progress of your project or being able to more easily identify qualifying projects year on year.
- The cash benefit is obtained quickly following submission of the company tax return that includes the R&D tax credit claim, for reinvestment in your business.
Why you should use a chartered tax adviser to prepare your software R&D tax credit claim
There are lots of intricacies involved in R&D claims and it can be difficult to keep track of all the rules and regulations.
With the software industry developing rapidly, HMRC will require the advances made to be clearly benchmarked against current capabilities and assured that the qualifying criteria across all aspects of the claim have been correctly understood and applied.
It’s important to set out your supporting claim report in a format that makes it easy for HMRC to understand exactly how you have tackled scientific or technological uncertainty through your projects. I recommend getting expert advice from a chartered tax adviser for any potential R&D project to ensure everything is in order and free from mistakes.
If you're ready to discuss your company's software R&D activities or just want to find out if you should pursue a claim for software projects, book a call with me to explore the possibility for your company to claim and where possible, estimate the potential financial benefit available.