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Research and Development for small and medium sized software companies

Emma Reynolds, Partner, Corporate Tax
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As new tech and media business seeking to grow and expand, you are likely to receive calls from consultants encouraging you to consider claiming Research and Development (R&D) tax reliefs.

What are R&D tax reliefs?

R&D tax reliefs support companies who are innovating in science and technology.

  • In the case of a Small and Medium Sized Enterprise (SME), they allow profit-making companies to reduce their corporation tax liability.  For a profitable company, the claim is worth additional tax relief of up to 21.5% of qualifying spend, not including relief on the expenditure itself. Loss-making companies can surrender losses for a payable tax credit (total relief worth up to 26.97% of qualifying spend for a Knowledge Intensive company or 18.6% for others).
  • Larger companies are within the R&D Expenditure Credit (RDEC) regime and can claim a tax credit (15% for a main rate corporation taxpayer) to reduce their tax bill or as a payable cash amount. 

What qualifies for R&D relief for SMEs?

There are two aspects to consider here.

  • Qualifying activities - the activities must be looking to achieve an advance in the field of science or technology by overcoming scientific or technological uncertainty (more on this later). 
  • Qualifying costs - these are the costs associated with the qualifying activities, but they must be of an appropriate nature - staff costs, subcontracted costs and consumables are all examples. 

There have been numerous recent changes in R&D with more yet to come and considerable detail to work through in making a claim for R&D tax reliefs.

R&D and software development

In recent years HMRC have been increasingly active in their review of R&D claims, with software based claims being a particular focus. In the context of R&D, software development in itself can be the whole R&D project (e.g. creating an app), or software development could be to support a wider project (e.g. creating a new tangible product). In both cases, it is important that claims are only made for technological advancement. It isn't sufficient that the application of the technology is novel (e.g., a product outcome in an app relating to sustainability data). How the technology itself works must be an advance in technological terms. 

Software development has come a long way and there are now many tools and approaches to aid developers. The use of routine / readily deducible approaches and existing tools to create an app is unlikely to represent qualifying R&D activities. It is possible that a software development project could involve the use of routine approaches alongside novel solutions. It is therefore worth keeping in mind that the qualifying R&D activities need to be considered in isolation and it won't be the entirety of the development project which qualifies for tax reliefs.

Care needs to be taken to ensure only qualifying activities are included in any claim made and it will be imperative that the key software developers are involved in the conversation to identify the relevant activities. If HMRC open an enquiry and are uncomfortable with the activities claimed:

  • the enquiry process can take considerable time and energy away from other activities and can therefore impact on business growth
  • some or all of the tax saved or tax credits received may need to be returned to HMRC, with interest and potentially penalties
  • an open enquiry with HMRC could cause concern to new investors or a potential future buyer of the business.

Actions and points to take away

  • R&D tax reliefs offer generous returns on costs associated with qualifying activities and are worth exploring to see if they could apply to your activities.
  • Care needs to be taken to ascertain which activities qualify. This is unlikely to be the entirety of a development project and its important that the correct individuals are involved in the claim process.
  • There are complexities in R&D rules, including recent and forthcoming changes - there is much detail and nuance to be explored in any R&D claim.
  • Getting it wrong can be costly in terms of time spent engaging in enquiry discussions with HMRC, managing cashflow for repaying any incorrectly claimed tax relief, interest and potentially penalties.
  • As with all tax matters, circumstances will differ in each case and there are points of detail and conditions to consider. We have just covered a brief outline of the issues here. If you are looking to evaluate how R&D tax reliefs could benefit your business, our team can help.For more information, get in touch with Emma Reynolds or your usual Crowe contact.

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Emma Reynolds
Emma Reynolds
Partner, Corporate Tax