Navigating R&D tax credit claims in the software development world

Originally set up to be a generous scheme to position UK companies at the forefront of innovation, Research & Development Tax Relief is one of HMRC’s flagship policies, and one of the most significant tax reliefs available for companies.

However, since January 2023, there has been a significant increase in HMRC scrutiny of claims in a well publicised attempt to reduce non-compliant claims, resulting in many genuine claims being caught in the crossfire.

This seems to be especially prevalent in software claims, where HMRC struggle to determine what is or isn’t qualifying R&D, leading to the head of HMRC Jim Harra declaring “My people are tax inspectors. They are not software engineers” under questioning at the House of Commons on 24^th April 2024.

Until December 2022 the number of enquiries into claims was very low, now it is closer to 1 in 20 claims within the software space. HMRC now deem the digital technology arena as ‘high risk’ which means that companies claiming tax credits within this space have a higher chance of receiving an enquiry.

As with most things in life, forewarned is forearmed. It’s important to understand not just the criteria, but how HMRC professionals interpret these, to submit claims which are legitimate and could be robustly defended in the event of an investigation.

R&D: what qualifies?

Software is continually evolving, but for a claim to be approved it needs to be evidenced that there is an advance in the overall knowledge of capability, not a company’s own state of knowledge or capability alone. A criterion that is difficult to ascertain in such a fast-moving sector.

In the eyes of HMRC, R&D is defined when a professional in the field determines that there isn’t an existing readily deducible solution, and that the new solution overcomes technical uncertainties. Simply applying or configuring software to a new application, melding software together or developing parts of software to speak to each other would typically not be classed as R&D.

The biggest issue here is that HMRC are now being far stricter in their evaluation; the technical evaluation criteria haven’t changed but they are examining each claim far more thoroughly,

Complexity vs uncertainty

To qualify a software development project must seek to advance a field of computer science which requires the resolution of a technological uncertainty, which is not readily deducible by a competent professional in the field.  However, it can be difficult to evidence the difference between a technologically complex project (not necessarily qualifying) and a technologically uncertain one.  Large enterprise software projects (e.g. new ERP deployments) can often be highly complex but if the underlying technology exists then it will not be considered qualifying R&D.

HMRC do not explicitly differentiate between complexity and uncertainty, which makes it somewhat tricky for companies to understand the all-too-vital nuances here!

Providing a technological baseline

With the new online form submission introduced in August 2023 it is now mandatory to describe the “technological baseline” of the field of the advance and when HMRC are checking the accuracy of a claim, they carry out online searches (i.e. using Google) to investigate if something similar is readily available.

Within a claim, companies need to clearly articulate the innovation developed during R&D and offer clear evidence that they have moved technology forward over the technological baseline at the start of the project. However, it can be confusing as to what is classified as “the technological baseline”.  Many companies mistakenly just focus on their own technology rather than evaluating the entire field of computer science in which they are working.  An experienced advisor who has prepared hundreds of software claims can be invaluable in helping to prepare a technological baseline because in the course of their work they will discuss hundreds of software projects each year and hence should have a good understanding of the technological baseline.

Tips for advisors in preparing R&D claims:

• Ensure technical ability: Investigations are serious, so having someone with a strong taxation knowledge-base plus technical software expertise will really increase your chances of approval. If a claim has been rejected, HMRC will ask about the advisor’s skills and technical ability and consider this when deciding whether to impose penalties for an incorrect claim submission.
• Establish a good working relationship from the off: Establishing a relationship with the client during the planning stages can really improve claim approval chances. Having real-time conversations throughout the year, rather than retrospectively at the end of the accounting period, can help identify technical details which might otherwise be forgotten.
• Thoroughly review supporting documentation: To prepare a robust R&D claim the advisor should be reviewing the supporting documentation, not just the technical development documentation but also the commercial contractual relationships between the claimant and their customers and subcontractors all of which can have a significant impact on the eligibility of the claim.

About the author

Mark Graves is a Partner and member of the Innovation Tax team. Mark primarily works on the technical analysis of software R&D claims, preparing the technical reports to support the claims, identifying qualifying expenditure and liaising with his accounting and tax colleagues on the preparation of the associated tax computations and claims.

He is experienced at handling HMRC investigations into R&D claims, although thankfully by preparing robust claims he and his team do not have that many investigations, a growing part of his work is supporting clients under investigation from claims submitted by less experienced advisors.