Can you claim R&D tax relief for software development?

If your business is taking a risk by attempting to solve a scientific or technological challenge as part of software development, there’s a chance you could claim R&D tax relief. However, it is a nuanced area with plenty of considerations for those already claiming or planning to claim. Our experts answer your questions and provide insights into software R&D.

Which types of software development can you claim for?

HMRC considers software development activities to either sit within the information and communication sector, or be activity underpinned by the field of computer science. In both cases, HMRC is looking to see an advance in overall knowledge or capability against presently available knowledge, not just your company’s own advancement. 

A software claim can fall into three areas:

1. Overcoming scientific or technological uncertainty

Resolving software difficulties and challenges that have not yet been overcome (or known to have been overcome) by a competent professional in the field. The knowledge gained must not have been adapted from freely available knowledge.

HMRC also needs to see how the improvements to the software were made, which problems were faced, and how they were overcome.

2. The introduction of new software products or systems

This could include, for example, the development of novel software capabilities to improve the speed of a system. It might be the re-architecting, or integration of different technologies that did not already interoperate.

3. Improving an existing product or system

This consists of improving the capability of an existing product or system. It can’t simply be configuring a software product for your business, but it could include adapting systems for integration (with web programmes, new hardware, new devices or making legacy technologies interoperate).

Common areas of qualifying R&D

There are particular branches of software development that have the potential to contain qualifying activities. Here are some of the more common areas for qualifying software R&D:

• Artificial intelligence (AI) and machine learning 
• Infrastructure development and cloud computing
• Platform and application development
• Systems integration
• Data processing and storage technologies
• Internet of Things (IoT)
• Augmented reality
• Robotics

Yet software R&D can be difficult to identify given its technical nature, so we’ve taken a deeper dive.

Who qualifies?

The types of companies that could qualify for R&D tax relief for software development include:

• Companies that develop a software product
• Companies that provide software development services
• Businesses that develop software in-house
• Any business that undertakes a unique software development project

What R&D expenditure can be claimed as part of software projects?

There are many types of expenditure which you can claim for as part of an R&D project. These range from direct and externally provided staff, to licence costs and consumables.

The core areas of costs include:

• Direct R&D staff costs
• Externally provided R&D staff
• Consumable items such as fuel and power used in the R&D process
• Prototypes, when created to test the R&D being undertaken
• Subcontracted R&D within the SME and RDEC schemes
• Data and cloud computing costs (for accounting periods beginning on or after 1 April 2023)
• Pure maths (for accounting periods beginning on or after 1 April 2023) – mathematical advances in themselves are treated as science for the purposes of R&D tax relief.

Find out more about how changes to the R&D incentives in 2023 relate to cloud and data costs.

Which staff roles count towards R&D tax relief?

Your R&D team will likely span several different departments in your business. This means that a variety of different job roles could be eligible for tax relief.

They could include: 

• Software engineers
• Developers
• Project managers
• QA and testing specialists
• Senior management

What software guidance is available from HMRC?

HMRC provided updated guidance on software R&D as part of its Guidance for Compliance 3 (GfC3). Used in conjunction with the DSIT guidelines, GfC3 provides contextualised guidance, specific examples and clarifies what information HMRC requires for software R&D claims.

Read more about HMRC compliance, GfC and what it means for your software R&D claim. 

When you make a software R&D tax relief claim, it’s vitally important to include a competent technical professional (usually a senior developer) in the information-gathering stage of the process. The competent professional is someone in your business who has a successful track record, notable experience and skills or qualifications in your relevant area of science or technology for which you are claiming. They will assess which of your business activities count as research and development (R&D) and attribute and apportion your qualifying expenditure to these activities. This will help populate the Additional Information Form (AIF) and technical narrative for the claim submission.  

Since the publication of this specific software guidance, there are two further significant developments to be aware of when considering whether you are eligible to claim R&D tax relief.

1. Pure mathematics – since April 2023, pure mathematics has been included in the definition of R&D for tax purposes. This change recognises that mathematical techniques are frequently used in science, and are in themselves treated as a science for the purposes of the guidelines. This disambiguation should give tech firms more confidence when claiming.
2. Data and cloud computing costs – this definition change was accompanied by the inclusion of data and cloud computing costs in qualifying R&D expenditure. It is particularly beneficial to businesses operating in AI and machine learning. It’s important to note that when it comes to data there are stipulations around not simply being a broker of the data – you need to be actively using the data, essentially the end point of the data’s journey. 

Read more about the impact of changes to data, cloud and maths.

Additional Information Form

HMRC introduced the AIF as a requirement for all R&D claims submitted from 1 August 2023. Although the form mandates how supporting information for your R&D claim needs to be provided, it doesn’t help with the specifics, including what to write and how to position it. ForrestBrown can help software companies present the relevant information in the right way to support your R&D claim. 

It is clear that HMRC wants more specifics from the people doing the R&D. Due to the pace of change within the software industry and high turnover of IT contractors, this can prove a problem. It’s therefore increasingly important to capture details of your software R&D projects – you’ll need to provide more detail across significantly more case studies than ever before. ForrestBrown’s sector specialists can help you navigate the increased complexity around software R&D claims.   

Misconceptions around software claims

Here are the most common myths we’ve heard in the context of software development:

1. Only new software qualifies

This is not true. Even if the software currently exists, improving existing software and overcoming new challenges still counts as genuine R&D. A rival software developer may already have the capability you seek. But, if your experts don’t have that technical information available to them — experimenting to discover a solution — then that may still count as qualifying R&D activity.

2. Part of the project wasn’t R&D

Even if the project has standard elements within it, if a new aspect was implemented, it could still constitute R&D. For instance, if there is a new component that fits into a larger existing system. This could still be valid R&D providing that there were underlying technological uncertainties that needed to be resolved within the additional component and its incorporation into a wider system.

Some businesses limit the scope of their R&D by failing to include project management, development of tooling for the product and indirect activities that qualify, like certain finance activities.

3. We weren’t taking a financial risk

One of the key criteria of a qualifying R&D tax credit claim is that there is uncertainty in the outcome, i.e. you don’t know for sure if what you’re doing is going to be successful. If this uncertainty is present in your project, you will be taking a financial risk in undertaking the project, and therefore it may well qualify for R&D tax relief.

4. We used subcontractors and they don’t qualify

For many years, the use of subcontractors has counted as qualifying expenditure for an R&D software project providing that the work they perform on the project is R&D. This was still the case even if the subcontractors were based outside the UK. However, it is no longer as straightforward as this. Software companies need to be aware of changes to the rules around subcontracting as part of the introduction of the merged scheme. This reform came into force for accounting periods on or after 1 April 2024, and includes changes to qualifying overseas expenditure.

5. You can’t claim R&D tax relief for software developed for internal use

The guidelines do not specify a wider applicability or benefit of the work, so it is possible to claim for software developed for internal use and internal projects can qualify. The same criteria applies. Namely, there needs to have been an advance in overall knowledge and capability more widely within a particular field, and this must have been through the resolution of technological uncertainty. It should also have been a project rather than an ad hoc piece of work or desk research.

6. You can’t claim for failed projects

Projects that are ultimately unsuccessful or aborted can also qualify as R&D. The guidelines recognise that a project may not have been taken forward owing to insurmountable technical or commercial challenges, but that the scientific and technological planning was R&D. What is important is whether there was an intention to achieve an advance in science or technology, not whether it was achieved.

7. Capitalising software expenditure doesn’t have an impact on my claim

Another area of confusion is around the accounting and tax treatment of software development. Capitalising the costs of software development is a common practice for accounting purposes. Some businesses that work by outsourcing software development are often recommended to capitalise software R&D costs.

Imagine this scenario: you’ve spent a lot of money on a big project that is intended to benefit your company for years to come. Your business (or your accountant) spreads out the costs on the balance sheet over multiple accounting periods. This is where you make your company appear more profitable in the current year to give more clarity to shareholders and investors. This is entirely normal.

It does not stop you from claiming R&D tax relief. But what’s important to bear in mind is that capitalising expenditure in this way could have an impact on the size of your R&D claim. Fortunately, there is a tax mechanism to allow you to do both, but it takes expert analysis to decide which is most beneficial to your business.

You should carefully weigh up the pros and cons of doing this with a chartered tax adviser that specialises in R&D tax relief (like ForrestBrown).

What can’t you claim for?

We’ve looked at what qualifies as R&D within software development, but inevitably, there are things that you can’t claim for. These include completely routine projects that do not require any advance in capability or the resolution of technical challenges.

It’s also important to note that not all of a commercial project is eligible, even where there is R&D taking place. Beta testing, user acceptance testing and initial market research are all areas of a project that must be discounted.

You can’t always expect your accountant to have the specialist technical knowledge required to draw the boundaries between your R&D and non-R&D activity. Companies that submit an R&D claim themselves, or use a non-specialist R&D adviser, often do not identify all their qualifying expenditure, missing out on valuable funding as a result.

How ForrestBrown can help

ForrestBrown’s combination of specialist software sector experience, tax knowledge and understanding of HMRC’s evolving requirements means we’re ideally placed to support your software R&D claim at a time of increased complexity and scrutiny.

As innovation incentive specialists, we help businesses make the most of their investment in innovation. This spans grant funding, patent box, capital allowances and R&D tax relief. We were named best independent consultancy firm at the Taxation Awards 2023 in recognition of our technical excellence and service innovation.

Meet the ForrestBrown software experts

At ForrestBrown, we’ll assemble the best possible team to support your claim. This will include sector specialists with decades of experience in the software industry who are able to discuss your innovation on a peer-to-peer basis, speaking directly to engineers. Ultimately this saves you time and helps create a more robust claim at a time of increased HMRC compliance.