R&D Tax Credits for Software Projects: A Guide

R&D tax credits are a government initiative designed to promote innovation and economic growth. Companies carrying out valid R&D can claim back up to 33% of their eligible costs as a tax credit or a reduction in Corporation Tax, which can then be invested back into further R&D projects.

Software development is a rapidly evolving industry that plays a significant role in driving innovation and economic growth. Therefore, it's essential to note that software projects can also qualify for R&D tax credits in the UK. These tax credits are not just reserved for large tech giants but are available to small and medium-sized enterprises (SMEs) developing unique software solutions.

At Tax Cloud, we’ve seen many software companies miss out on crucial costs or even entire projects, or overclaim and risk an audit from HMRC, all due to misunderstanding the nuances of the R&D tax relief schemes.

To qualify for R&D tax credits, your project must try to overcome a technological challenge or uncertainty that a professional in the field can’t easily solve. The project should also demonstrate innovation, either creating something novel or improving existing solutions in science or technology substantially. Finally, the project should involve some level of experimentation, like iterative testing, prototyping, or other methodologies aimed at overcoming the technological uncertainties.

Companies with qualifying projects can claim back some of their costs spent on carrying out the R&D; depending on your accounting period and profitability, this could be as much as 33% of your costs!

The software industry is evolving at an unprecedented rate. In the last decade, the industry has grown by more than 200%, driven by advances in artificial intelligence, cloud computing, and the Internet of Things. Software development has become the backbone of modern business, and its innovations are driving significant growth across a wide range of sectors.

As more companies become aware of the R&D tax credit scheme, it’s important to understand how the qualifying criteria apply to the IT sector; misunderstandings can lead to compliance checks from HMRC, requiring time and resources to defend your claim, which could be better spent on your R&D.

The key criteria to fulfil are:

• An advance in the overall field of technology relevant to your project (e.g., cryptography, data processing, machine learning)
• An uncertainty that the desired outcomes are even feasible
• An iterative development process to overcome this uncertainty

Advances in Software

In such a fast-moving sector, it can be hard to identify a genuine advance beyond the state of the art; by the time you submit your claim, the industry could have caught up, making it hard to demonstrate that the work you did was genuinely innovative.

The key is to prepare a solid technological baseline to demonstrate what information was in the public domain at the time of development. You should be able to show that the advance you were seeking was not available in the public domain. Competitors may have already achieved the advance, but if their solution is not publicly available, your work to replicate it will still qualify.

Your software project may form part of a larger, non-software project (e.g., data processing project for a large study in life sciences) or it may be software only (e.g., developing secure payment methods for e-commerce sites). Both are eligible, as long as you clearly articulate your advance.

Where possible, try to quantify your advance to make your improvements as clear as possible to HMRC. “Seeking to improve cryptography methods” doesn’t sound as strong as “seeking to deliver performance benefits of over 200% to RSA algorithms”. You may also wish to directly compare it to state-of-the-art technologies, proprietary or open source.

The software sector is particularly challenging for HMRC; some companies will use the general public’s unawareness of the specifics of the sector to try to cheat the system. Using buzzwords like “algorithms” and “artificial intelligence” is not enough to show that you have done qualifying R&D. Your project needs to have a clear advance over the standard methods used in the sector, beyond improvements for just your company.

The IT sector often sees companies erroneously claiming for improvements to their own products or the company’s capabilities; it’s crucial that you only claim for work that extends the capabilities of the wider field. For example, adding an AI module to your platform, but using standard methods to do it, is not an advance in the field. Similarly, customisation of an existing framework is unlikely to qualify, as this is expected to be within the software's capabilities.

Uncertainties in Software

In the IT field, it’s common for companies to mistake a general complexity for a genuine uncertainty. Many software projects will include some degree of uncertainty; this can be found in many other sectors, too. Not many can remember the last time they took on a project that was without complexity!

However, a genuine uncertainty for the purposes of R&D tax is one that a competent professional cannot easily solve. An expert in the field would not be able to say how to solve the problem easily. It should require experimentation and, usually, trial and error.

You should be focusing on the work you did here, the technological input, instead of the results of your work, or the commercial output.

To effectively communicate your uncertainty, ask yourself:

• What was it about the technology that made it uncertain whether software could be made to do what the company wanted it to do?
• What would be the typical approach that would be applied to resolve the technological uncertainty?
• Why didn’t the typical approach work?

These questions should lead you to being able to explain why your project has genuine uncertainty to it.

Particularly pertinent for the software sector is the ability to claim for ‘system uncertainty’. This occurs when your technical leads are not certain if the individual components of a system can be combined, even if the components are well-known.

Boundaries of R&D in Software

No matter the sector, the beginning and end of R&D is always the same; R&D begins when an uncertainty is identified and ends when it is resolved or abandoned. Anything related to the project before or after this period, or any work that is not directly related to overcoming this uncertainty, cannot be included in an R&D tax credit claim.

Artificial Intelligence and Machine Learning: Innovations and algorithms that push the boundaries of AI and Machine Learning technologies can qualify for R&D credits. These activities involve experimenting with new algorithms and concepts for AI, developing novel approaches to improving the accuracy of predictive models, and developing new techniques for data processing or visualisations.

Blockchain Technology: Advances to blockchain technologies can qualify for R&D credits. Activities in this area may include developing new consensus algorithms, enhancing transaction throughput, and securing blockchain systems against various attacks. There is also scope for developing new applications of blockchain technology, such as for supply chain and authentication, that may involve considerable experimentation and technological challenges.

AR & VR Technologies: The software behind immersive experiences is another area where R&D tax credits can apply. These projects may require developing new hardware or software components geared towards delivering immersive user experiences. They also involve experimenting with novel AR and VR applications, designing new solutions for interaction and usability, and integrating new hardware or software components to create a coherent system.

Cloud Solutions and Scalability: Addressing unprecedented traffic or storage challenges through the development of new cloud-based systems can also qualify for R&D credits. Such projects may involve designing new architectures to improve resource utilisation, developing innovative approaches to cloud data storage and processing, and experimenting with new cloud-based software solutions to address unprecedented traffic or storage challenges.

Projects That Don’t Typically Qualify

While the UK government recognises the value of the software industry, it's crucial to note that not all software development activities qualify for R&D tax credits. For instance, routine software updates, support and maintenance tasks, and simple website or app designs without substantial technological innovation generally won't qualify.

Routine software improvements are typically not considered R&D because they don't involve any new technological capabilities. Support and maintenance tasks are vital to ensuring software functions effectively, but they do not include developing or improving technology. Similarly, a simple website or app design does not qualify for R&D tax credits as these projects don't advance the capabilities of website or app design.

Applying for R&D tax credits can be a tedious and time-consuming process, especially for software-based projects. However, it's well worth the effort, given the potential financial benefits it offers.

The key to a successful R&D tax credit claim for a software project lies in the documentation. Companies must maintain comprehensive records detailing the activities carried out during the project, including the technological uncertainties, experimentation processes, and the end result delivered. The documentation should be clear and concise and demonstrate that the project meets the qualifying criteria for R&D tax credits.

However, you must ensure you meet all deadlines; even the most robust claim won’t be accepted past HMRC’s due dates. All claims must be submitted within 2 years from the end of your accounting period. However, first-time claimants and those who haven’t submitted a claim in the last 3 years must submit a claim notification form to HMRC within 6 months of the end of the accounting period.

Try our Advance Notification Form Checker and make sure your claim is compliant.

When you use Tax Cloud, we review all your project information for clarity and ensure that you only submit qualifying activities to HMRC. We also run through the costs that you gather, checking for any missed categories and making sure you don’t overclaim. We can answer any tricky questions (hello, intra-group transfers and state aid funded projects!) and we’ll even submit your Advance Notification Form, your Additional Information Form and your Corporation Tax return to HMRC on your behalf!

If you’re ready and raring to go with your claim, Tax Cloud will get your company the cash it deserves. Of course, if you’d just like to ask a question , we’ll be pleased to talk to you. Simply call us on 0207 360 4437 or use our contact page so we can call you back. 

Author Barrie Dowsett, ACMA, GCMA CEO, Tax Cloud