The rapidly evolving nature of the software industry means it can be difficult to ascertain whether a project undertaken by the company is seeking an advancement in overall knowledge or capability or simply an advancement of their own. Even HMRC are taking steps to ensure they keep up with this fast-paced sector. HMRC’s inspectors are now supported by computer specialists to ensure that their knowledge of the industry is kept up-to-date.
This welcome change to the guidance helps eligible companies apply the BEIS Guidance accurately which should in turn result in more successful claims.
What has changed?
The criteria for R&D for tax purposes applies equally to all branches or fields of science and technology, so this hasn’t changed. However, HMRC have updated their guidance to give more information on how the criteria is applied to software projects.
There are two ways in which expenditure on the creation of software can be R&D qualifying:
- The creation or adaptation of software to resolve a technological uncertainty as part of a larger project; or
- Development of software as the goal of a project
HMRC introduces three key concepts to consider as to whether R&D has been undertaken, being: the advance; the technological uncertainty; and the boundaries of the R&D.
The key question to consider here is: What advance in science or technology is the project seeking to achieve?
To be R&D qualifying, the advancement sought must be an advance in the overall knowledge or capability of the field and not just the company’s own state of knowledge or capability. The advancement must be in the underlying technology of the project and not just the commercial output.
HMRC stipulate that the competent professional for the company’s project must be able to show how their project is new in, or an appreciable improvement to, that field of science or technology relative to what is already available in the public domain or was readily deductible.
The customisation of existing software can qualify as R&D, regardless of whether the existing software was created by the company or as a commercial off-the-shelf solution. The fundamental point is the modification of the software must enable the software to be used substantially beyond its existing capabilities. Neither routine adaptations of software nor customisation to configure existing software to the company’s requirements is R&D.
The Technological Uncertainty
The key question here is: what are the scientific or technological uncertainties?
A scientific or technological uncertainty exists when knowledge of whether something is scientifically possible or technologically feasible is not readily deductible by a competent professional working in the field. This could be using untried or untested techniques to create a new process or make appreciable improvements to existing ones.
The updated guidance states that the Company should be able to:
- Identify the challenges faced accurately;
- Explain what it is about the technology/computer-science that made it unclear as to whether software could be developed to do as required; and
- Explain what prevented routine or established methods to be applied in the specific case.
The points should be covered in any R&D report regardless, but it is good to see HMRC identify these as a key area on how to determine whether R&D has actually taken place.
The Boundaries of the R&D
The key question here is: When does the R&D project start and finish?
The guidance stresses an important point that most projects that develop a commercial product will not qualify for relief for the full length of the project.
R&D starts when work to resolve scientific or technological uncertainties start and it ends when that uncertainty is resolved or work to resolve it ceases. All commercial projects will go further than resolving technological uncertainties, with work on deployment, updates to the UI or maintenance for example, unlikely qualify as R&D. The update to the guidance points to HMRC taking a keener interest in the boundaries of what is being claimed.
What does this mean?
The updated guidance is overdue and welcome. In a sector where technological advancement is common but not easily identifiable, the guidance will help companies with a step-by-step process to help distinguish whether their projects are eligible.
The updated guidance also points to HMRC potentially taken a tougher stance on claims. By providing extremely detailed supporting guidance, HMRC are making it clear what projects will qualify and what the supporting documentation they are expecting. This is backed up by comments at the recent R&D Consultative Committee which highlighted HMRC’s concerns with reports covering 3-year periods and not identifying the accounting period in which the projects took place as well as issues with descriptions of advances and uncertainties which are too vague.
Regardless, the updated guidance should result in more companies identifying qualifying eligible projects and a higher success rate for R&D software claims.
If you have a question about R&D tax relief, contact David Philp.