Businesses working on cutting-edge products or processes can be eligible for corporation tax relief in the form of research and development (R&D) credits.
These were launched by the UK government in 2000 to encourage the emergence of the next Dyson or ARM, producing genuinely innovative products with global appeal, whose overseas sales boost the British economy.
R&D tax credits are very much worth claiming: they permit small companies to deduct an extra 130% of their qualifying costs from their profits, on top of the existing 100% of qualifying costs that can be deducted – a total potential deduction of 230%.
They apply to companies delivering innovations in science or technology which, let’s face it, more often than not in 2019 means software.
You only have to follow one or two technology news outlets to be aware of the pace at which software is evolving, powered by faster processing, machine learning and the availability of ever bigger data sets.
Claiming R&D tax for software development isn’t complicated, as such, but the bureaucracy takes some careful navigation.
The first question, and it’s a big one, is what counts as R&D for tax purposes?
Defining research and development
Software developers use the phrase ‘R&D’ a lot but there’s a specific statutory definition of it for the purposes of deciding whether a company is entitled to tax relief.
Here’s how HMRC puts it in its own ‘simple guide‘ (PDF):
“To qualify, the company must be carrying out R&D work in the field of science or technology.
“The relief is not just for ‘white coat’ scientific research but also for ‘brown coat’ development work in design and engineering that involves overcoming difficult technological problems.
“This can include creating new processes, products or services, making appreciable improvements to existing ones and even using science and technology to duplicate existing processes, products and services in a new way… But pure product development in itself does not qualify.”
In other words, with software in mind, it has to contribute to a wider understanding in a given field and can’t just be about a new software interface built on existing technology. It’s got to be about a fundamentally new way of doing things under the hood.
In game development in particular, coming up with a previously unexplored setting or storyline, or an interesting new visual style, won’t qualify you for R&D tax relief.
What might count is if you come up with a substantial improvement in the way 3D graphics are rendered for maximum processor efficiency, or find a unique way to generate unique level maps on the fly using machine learning to crunch real-world satellite imagery.
Another interesting detail in HMRC’s criteria is that the solution you come up with couldn’t easily have been worked out by another professional in the field. It has to have been a real stumper that could only have been solved through intensive, methodical study, testing and iteration.
How to claim
Despite reams of jargon-filled guidance, deciding which software products qualify for R&D is still essentially a matter of subjective judgement for HMRC.
They consider each case on its merits, based on the evidence put in front of them as part of your claim. It goes without saying, then, that the more clearly your documentation anticipates the questions they’re likely to have, the more likely it is your claim will be agreed.
And do be ready to have your claim rejected, even if it feels like a shoo-in. It might be, for example, that another company you’re not aware of has reached much the same solution as yours, cancelling out both your claim, and theirs.
To be fair, HMRC does have a mechanism for avoiding a lot of wasted work on claims: you can run it past them in draft form to get a sense of its likely success.
Again, approval at this stage doesn’t guarantee final sign-off, but it does tend to weed out obvious non-starters.
Which costs qualify for relief?
The range of allowable costs to be claimed against is fairly extensive. What follows are just a few of the highlights, with a particular view to the kinds of costs likely to apply in software development.
- An R&D tax relief claim can include pay, class 1 national insurance contributions and pension contributions. This only applies to staff directly involved in the R&D work, though, or who spend a chunk of time supervising those hands-on staff.
- You can also claim for agency staff costs where, again, those staff are directly involved in R&D. Relief is usually given on 65% of the total payments.
- It is also possible to claim for the cost of subcontracting R&D work out, generally at the same 65% rate.
- If you use third-party software in researching your own development process, you can claim for that, or a reasonable portion of the cost if it’s also used on other non-R&D projects.
One notable thing you can’t claim are costs associated with the use and creation of patents and trademarks. The thinking here is that you won’t need these until after the R&D has been completed so this expenditure falls out of scope of the project itself.
More money for your business
When it comes down to it, the point is to make sure that your business has the best opportunity to succeed and tax reliefs like this can make the difference between sink or swim.