Does software development qualify for research and development (R&D) tax relief?
There are two manners in which software development may qualify for Research and Development tax relief.
Qualifying as part of a larger project
The first is where it is being used as a tool as part of a project, rather than being an end goal, for example, developing software to use in testing machinery, recording results, or designing prototypes. The development costs will then be allowable as part of the expenditure on this larger project.
Where the software is multi-purpose, and is used only partly for research and development work, a corresponding proportion of the expenditure would qualify as indirect costs. It is worth remembering at this juncture that a significant number of other indirect costs may also qualify, and should be carefully identified.
This could apply to any software that is being developed in other research and development work.
However, it must fall within a category of qualifying expenditure. For example, the creation of a website in order to sell a product would be classified as marketing. This means that it will qualify only if it is ground-breaking in its own right
Qualifying as an advance in science or technology
The second is where the goal of the project is to develop software which in and of itself represents an advance in science and technology. This could occur when a new algorithm is being created, or there is uncertainty that a front-end system can successfully be linked to a back-end system in use.
To qualify as a project in its own right, it must meet the ordinary rules for research and development. The key rules are:
- Success must not be guaranteed before work starts – there must be a degree of uncertainty
- The project must be an overall advance in a field of science or technology
This second rule means that, for example, an advance that is made in the field of programming will ordinarily qualify. Conversely, an advance that is made in understanding human behaviour and psychology that then leads to changes in the user interface would not ordinarily qualify.
Revenue expenditure v capital expenditure
There are circumstances where although software being developed meets the other criteria to be included in a claim, it is considered capital in nature, and so the expenses would be disallowed. This may occur where the project is creating software which would be expected to be used for a period of several years. This may cause the expenditure to be disallowable.
If the expenditure is revenue in nature, but capitalised for accounts purposes, the expenditure can still be claimed as revenue. This allows research and development costs to be claimed in the year that the expenditure is incurred, rather than being deferred over the life of the intangible asset. If this is done, it is then important to ensure that amortisation is not also claimed on the same expenditure.
There is a grey area in respect of the qualification of cloud computing as an allowable expense for relief. This is because unlike physical software, or hard copy data it is possible that it does not fall into any of the categories in which expenditure is allowable. This includes:
- systems such as AWS or Google Cloud,
- software running on a 3rd party platform, such as a data-intensive process being run on an external GPU, and
- third-party software which is being accessed online, rather than through a one-off purchase
Although some of this expenditure may qualify, this is currently an area which is largely unclear, as the original legislation has not yet been updated to reflect changes in technology. HMRC are currently exploring the potential for changes in the definition of allowable costs to ensure that all these costs are covered.
If you think there is potential that you may entitled to R&D tax relief on your software or any other project, please contact us to book a free consultation.