R&D tax credits for software development

Can software development qualify for R&D tax credits?

Software development can qualify for R&D tax relief when the project seeks an advance in a field of science or technology by resolving scientific or technological uncertainty. ^[1] The sections below show how those tests apply to software work that may qualify for R&D tax credits.

Work in software engineering is subject to the same fundamental criteria for being R&D as work in textile science, nanotechnology or anything else. ^[2] A software claim therefore rests on the technical problem being solved, not on the fact that code was written.

Which software companies can claim?

Only companies chargeable to UK Corporation Tax can qualify for R&D relief. The merged R&D expenditure credit scheme can be claimed by companies that are trading, are chargeable to Corporation Tax and have a project that meets the definition of R&D. ^[3] There are restrictions on claiming for some expenditure incurred overseas.

Many software businesses build products for clients or bring in outside developers. When the accounting period began affects whether a company can claim for R&D it has done on behalf of another company and for payments made to contractors. The contracting and externally provided worker rules are set out in the guide to how R&D tax credits are calculated, and commissioned work may need reviewing against those rules before any costs are counted.

Telling routine coding apart from a software advance

The project must aim to create an advance in the overall field, not just for the business. A scientific or technological uncertainty exists when an expert on the subject cannot say if something is technologically possible, or how it can be done, even after referring to all the available evidence.

Appreciably improving an existing process, material, device, product or service can count, but this refers to genuine non-trivial improvements which result in more than a minor or routine upgrade. As long as the scientific or technological uncertainty cannot readily be resolved by a competent professional working in the field, hardware and software methods are both equally R&D. Activities that directly contribute to R&D include creating or adapting software needed to resolve the scientific or technological uncertainty, provided the software is created or adapted solely for use in R&D.

The guidelines also give a software example that falls outside. Developing software to analyse market research data would not be R&D where it was not expected to result in a scientific or technological advance in the field of software as a whole, such as an algorithm which extends overall knowledge or capability in the field of software. ^[2] Work to adapt such software to analyse customer spending patterns would also not be R&D.

As an illustration, system uncertainty can arise when a competent professional working in the field cannot readily deduce how separate components or sub-systems should be combined to have the intended function. Whether a particular software project meets this test depends on its facts and on what a competent professional could readily deduce.

Where software R&D starts and stops

Not every task in a commercial software project is R&D. The R&D phase begins with the technical work: scientific or technological testing and analysis which directly contributes to the resolution of scientific or technological uncertainty is R&D, while work to identify the requirements for a process, material, device, product or service, where no scientific or technological questions are at issue, is not R&D.

Elements of a plan that focus on obtaining intellectual property protection or cosmetic design decisions do not directly contribute to resolving the project's scientific or technological uncertainties, are not qualifying indirect activities and are therefore not R&D. In the guideline examples, user tests concerned with testing commercial potential and assessing appeal to users are not R&D either.

R&D begins when work to resolve the scientific or technological uncertainty starts, and ends when that uncertainty is resolved or work to resolve it ceases, which can include when knowledge is codified in a form usable by a competent professional working in the field or when a prototype or pilot plant with all the functional characteristics of the final process, material, device, product or service is produced. If flaws in the design become apparent later on, work to remedy them would be R&D if they could not readily be resolved by a competent professional working in the field. When totalling costs, only costs from the start to the end of the project are included. ^[4]

What a software R&D claim needs to show

The company needs to be able to explain the work done to overcome the uncertainty, and this can be a simple description of the successes and failures during the project. It should explain why a professional could not easily work out the advance, for example by showing that other attempts to find a solution had failed.

Costs must already have been paid before the claim is made. ^[4] Licence fees for software used for R&D can be claimed, along with a reasonable share of the costs of software partly used in R&D activities: a high percentage would be reasonable for software used almost exclusively for the R&D work, and a much lower percentage for software used mostly for other tasks. For accounting periods beginning on or after 1 April 2023, qualifying expenditure includes data licence costs and cloud computing costs, although data and cloud computing costs for qualifying indirect activities cannot be claimed.

Staff costs can be claimed for the time spent on the R&D project: if a member of staff spends 90% of their time on R&D activities and 10% on other activities, 90% of their salary can be claimed. The full list of qualifying cost categories is covered in the calculation guide mentioned above.

Which R&D relief scheme applies to software development?

For accounting periods beginning on or after 1 April 2024, the merged scheme and enhanced R&D intensive support (ERIS) replace the old RDEC and SME schemes; the qualifying expenditure rules for the two are identical, but the credit is calculated differently.

The merged scheme is a taxable expenditure credit, and the page on the RDEC scheme covers its rate and how the credit is taxed. Enhanced R&D intensive support works through an extra deduction for loss-making R&D intensive SMEs, and the calculation guide explains it.

A company eligible for ERIS can choose the merged scheme instead, but cannot claim under both schemes for the same expenditure. Separately, capital expenditure is given as an example of a cost that cannot be claimed.

Which form a software R&D claim goes on

Under the merged scheme, the expenditure credit is shown as taxable income in the profit and loss account, or added to profit in the tax computations, and the supplementary form CT600L is completed. ^[5] Under ERIS, the supplementary form CT600L is completed if a payable tax credit is being claimed.

An X in box 656 tells HMRC that the claim notification form has been submitted, and an X in box 657 tells HMRC that the additional information form has been submitted. Where a claim covers a period of account of more than 12 months, a separate claim is submitted for each accounting period.

The notification steps and timing for a claim are explained in the guide to claiming R&D tax credits for earlier years.