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The increased risk of HMRC enquiries into software R&D claims

Tom Jones senior tax manager
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A lot has changed since research and development (R&D) tax relief was introduced in 2000. With each passing year, the incentive has attained greater awareness and adoption. HMRC’s annual analysis consistently shows more businesses claiming each year.

But there are concerns that this increase in R&D tax relief is not driving an increase in business R&D expenditure, according to reporting from the ONS. As a result, HMRC and the Treasury are taking a closer look at how the relief is targeted. This increased emphasis on quality means more compliance checks (or enquiries, as they are commonly called).

Software R&D is an area of particular focus for HMRC, with the approach to reviewing software R&D claims evolving significantly in recent years. In 2018, we took part in a working group which updated HMRC’s guidance on software R&D.

We also reported that HMRC has started sending ‘nudge’ letters to businesses making claims for software R&D urging them to review and address any errors in their claims. This proactive approach complements HMRC’s long-established use of its internal software team to support enquiries into R&D claims.

R&D tax relief remains a stable and generous tax incentive and a good fit for software businesses or those doing software R&D. But adjustments are required to reflect changes in policy and practice from HMRC and ensure that your business is enquiry-ready.

Why is HMRC focused on software R&D tax credit claims?

Software R&D has become a focal point of compliance efforts for a few reasons. Of course, the reason HMRC initiates an enquiry varies from case to case.

Some cases are flagged for a specific risk or because of a change in the value or nature of the R&D claimed. For others, HMRC may simply be ‘fact finding’ with no specific concerns apparent. HMRC has also recently initiated a random selection process for enquiries. Whatever the trigger, enquiries always need to be carefully managed.

But for software R&D in particular, the trend towards greater scrutiny is happening for a number of reasons, namely:

  • Complexity: Software is a complex field. The sector uses lots of jargon and technical terms, so it can be difficult to articulate an advance in software capability to a non-software specialist. Companies often underestimate the level of technical detail HMRC require when conducting an enquiry.
  • Fast-moving: Software development is an area where the technological baseline progresses quickly. What was R&D a few months ago might be routine now due to the open-source approach the sector takes to development. Similarly, this makes it difficult for HMRC to keep up with the boundary between routine and R&D activities. This places the onus on the business to provide the right evidence that their project was R&D when it was undertaken, even if an enquiry is taking place months or even years later.
  • Not all code is R&D: All software development involves creating new code. But only some new code is R&D. There is no easy way to differentiate this without software expertise and an understanding of the concepts in the tax definition of R&D, so defining eligibility and the boundaries of any R&D work can be tricky.
  • It’s diverse: There are a multitude of disciplines and specialisms within the field of software development. This makes explaining the challenges you faced in your particular project all the more challenging, and HMRC will not necessarily have a software specialist on their team who has similar experience.
  • Sub-sectors are secretive: In the software industry, deducing the wider baseline of what is ‘new’ is hard since a lot of cutting-edge development is very secretive. This is particularly the case in fin-tech, for instance. This puts the onus on software experts to make these assessments and, in my experience, even the most brilliant software professionals aren’t always confident making these calls.

Common software R&D claim errors

When you couple the unique complexities of software development with the worrying trend in the R&D tax advice market for spurious advisers providing bad advice, it makes sense for this sector to take extra care.

Software R&D errors generally fall into two rough categories: simple errors and complex errors. Simple errors are rooted in bad advice. For example, a firm is told by a poor-quality adviser that they can claim for implementing an off-the-shelf expenses software package. Or replacing a paper-based process with some simple software, improving efficiency in their business but not adding anything to capability across the field of software.

These errors can be avoided by engaging an experienced, regulated adviser who will steer you well clear of basic errors, or by reading up on the definition of R&D and accompanying guidance (keeping to information from reliable sources of course!). These sorts of mistakes are worryingly commonplace and a big part of the reason why HMRC has zoned in on the software sector.

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A software specialist edge

Here’s how our software specialists give Old Mill and its clients an edge when claiming for software R&D or dealing with an HMRC enquiry.

Complex errors are, as the name suggests, more nuanced and often come down to translating your R&D projects and expenditure to HMRC.

Tom Heslin technical specialist
Key contact

Tom Heslin MSc

Associate Director

  • Leads our sector specialist team
  • Sat on the HMRC subcommittee that drafted software guidance for R&D tax relief
  • Master’s in Medical Image Computing

At ForrestBrown, we have helped many businesses that have carried out genuine software R&D but have still faced challenges from HMRC. In these cases, the issue was not so much the R&D in and of itself.

Instead, our support focused on presenting the information clearly, consistently and coherently. In software projects, there needs to be a particular emphasis on clearly identifying the boundaries of the R&D activity from wider commercial projects.

As noted, software innovation constantly changes, but enquiries can occur several years after the project took place. Defending an R&D project which was truly novel at the time but now fairly routine can place a lot of pressure on a company’s technical staff. Good records go a long way, and sector expertise from your R&D tax adviser can make a vital difference here in supporting your competent professionals.

Many companies underestimate the level of challenge they might receive from HMRC. Some years ago now, part of the role of HMRC’s R&D specialists was to help educate companies on R&D tax relief. However, with the number of claims this team now handles, the onus today is very much on the business to present its case for relief to be due.

This means that understanding the drivers behind HMRC questions has become essential to securing a successful outcome when software R&D claims are enquired into. Our specialist enquiry support team provide both technical advice and help you with a strategy for resolving the enquiry to achieve the best possible result.

Our directors Jenny Tragner CA ATT and James Dudbridge discuss how ForrestBrown resolves enquiries for our clients.

Are you facing an HMRC enquiry into your software R&D claim? ForrestBrown can help resolve the issue >

How ForrestBrown can help with your software R&D claim

All of the complexity presented here can be simplified with good advice. Not just tax advice, but tax advice combined with sector expertise and HMRC practice insights.

At ForrestBrown, we have software developers on our team. The assessment of your R&D projects sits with your software team, but this can be an unwelcome burden if HMRC challenges your claim: it’s up to you to defend your assessments.

Tom Heslin technical specialist

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Tom Heslin MSc

Associate Director

Ben Wyatt

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Ben Wyatt LLB

Senior Sector Specialist

Tree - sector specialist

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Senior Sector Specialist

When you work with ForrestBrown, challenge and validation are built into our process. Our software experts vet your assessments, helping to unpack the legislative definitions in a way that your team can understand and apply to your work.

This creates robust, quality-assured claims that secure maximum financial reward for you. Tom Heslin, associate director and senior software specialist, is uniquely positioned to do this since he quite literally helped write HMRC’s software guidance.

Our specialists, like Tom, speak to your software experts as peers. This saves time but, most importantly, enables us to give you a realistic assessment of risk. That is:

  • How HMRC will likely view your project(s).
  • What misunderstandings or challenges are possible. 
  • What further evidence is available to protect you from a lengthy debate with them.

For a comprehensive overview of claiming R&D tax relief for software development, read our article on the topic >

We never guarantee that a client can avoid an HMRC enquiry. They sometimes happen randomly. But we do absolutely ensure that our clients will be enquiry ready.

The support we provide can take many forms, depending on the needs of your business. We’ve supported businesses already dealing with an enquiry from HMRC, whether their claim was prepared by a different adviser or by themselves.

We also regularly support clients with targeted advice on the impact of business changes, or consultancy to get enquiry-ready, such as reviewing claims or records. And for complete peace of mind, the ForrestBrown team can handle your R&D tax relief claim from end-to-end, including full enquiry support.  

Unmatched software insight

ForrestBrown offers substantial technical expertise in the software sector. This results in R&D tax relief claims which are robust and unlock the full value of your R&D. Whether your business is facing a specific challenge or if you are looking for ongoing consultancy, we can help.