Time and again, Alma Consulting deals with, and hears of, instances where software development businesses have fallen short of the tax reliefs they are entitled to because of a lack of understanding.
Many VARs, systems integrators and software developers are missing out on hundreds of thousands of pounds in R&D tax relief each year. They either simply do not know what they are entitled to, or believe the industry naysayers’ myths.
R&D costs are upfront debits and any tax relief should be grabbed with both hands to maximise the funds available for research efforts. But first there are five main misconceptions that need busting to unlock these potential benefits.
This is a common misconception fuelled by several factors. The main one is that there is no simple, one-size-fits-all checklist in place to determine what qualifies for relief.
Added to this is the fact many organisations do not view research and development as R&D because it just seems to be part of their day-to-day work. The idea of an R&D initiative tends to conjure up images of test tubes and white lab coats, so many software development firms believe they are not eligible for relief.
However, by taking the time to look into their activity in detail, alongside guidelines on the definition in R&D, many software development firms actually discover that much of the work they are carrying out is eligible for tax relief.
The software industry is extremely R&D intensive. The fast-paced nature of application development means the goal posts are constantly moving and companies need to be consistently innovating to stay in the game.
Software development is by no means restricted to specialist companies, it covers every single industry sector: from retailers upgrading tills or manufacturers improving warehouse management systems; to F1 teams gathering and analysing vast amounts of data, and investment managers developing evermore complex algorithms for high frequency trading. Any company that has attempted to upgrade its back office IT systems will have probably encountered issues requiring some level of bespoken development.
One of the biggest challenges for software development claims lies in how to present supporting information to the tax inspectors in order to secure the relief. HMRC does not employ software specialists, therefore companies must present their projects in such a way as to convince, without creating confusion.
Despite far fewer claims being made overall, £1.1billion in tax relief was awarded in 2011. The portion claimed by large companies accounted for 67 percent of this, even though the rate of relief for large companies is far less generous than for SMEs. This picture clearly illustrates that the relief given out to date, is heavily skewed to larger claimants.
Many smaller companies feel overwhelmed by the complex definition of R&D, which underpins the relief, and they do not have the resources available to get up to speed on this specialist area of taxation.
It can also be a challenge to put R&D relief on the boardroom agenda, particularly when faced with the misconception that the business “doesn’t do R&D” and uncertainty over the eligibility of trial activities.
As it is a tax relief, the rules must be written into tax legislation and that can make them less accessible to smaller businesses. However, help is at hand for software development firms.
HMRC publishes its own guidance manual on the subject of claiming as well as dedicating a whole section of its website to this topic. In addition, there are seven specialist units within HMRC whose primary focus is to provide R&D claims advice.
Further assistance can also be found in the form of specialist advisors, who operate within this field and can help software development companies to scope out their claim potential and apply for relief on a no win, no fee basis.
The tax relief was introduced to encourage UK companies to increase the amount of R&D activity they undertake but this may well remain hidden in the tax line of financial statements and largely “invisible” to R&D decision-makers.
In addition, until April, 2013, only SMEs could recognise an immediate benefit from their claim by converting the relief to a payable credit, if they were loss-making for tax purposes. Under the large company relief, all loss makers got was an increased pool of losses.
This year, the Government moved to address these issues with the introduction of R&D Expenditure Credits (R&DEC). As a taxable flat-rate credit, it has been positioned as having enough hallmarks of a grant, meaning it can be accounted for “above the line” and is more visible to those with the power to increase R&D investment.
For large software development companies, this means R&DEC can be offset directly against operating costs, a welcome profitability boost at a time when margins are becoming ever tighter. If there is no tax liability to offset the credit against, HMRC will pay it in cash to the claimant, so it could also provide a cash boost.
R&DEC is available to large companies and certain SMEs that are restricted from the SME R&D tax relief regime due to their circumstances. Most SMEs can already access a payable cash credit for their R&D expenditure in certain circumstances.
SIs and VARs that often carry out R&D on behalf of a customer, or those that receive subsidies or grants to cover R&D expenditure, can find themselves locked out of the more generous SME rates and access to the payable credit. These companies may claim under the large company scheme but,in the past, many have chosen not to claim relief at all. The introduction of the R&DEC should be good news for many of these companies, who will be able to claim a cash credit for the first time.
The belief that tax relief requires aggressive planning is an extremely common misconception that is often raised in relation to R&D The debate has also been further intensified with global news headlines involving hot topic of discussions about corporate tax avoidance and evasion and the gap between what is legal and what is morally acceptable.
In reality, many software development businesses do not realise there is a huge distinction between tax planning, where a structure or transaction is developed that results in a favourable tax position, and tax incentives such as R&D tax relief – a scheme designed by the Government to provide a favourable tax position.
Software development companies certainly need to make sure they meet the relevant criteria and follow the rules but, if their claim is robust, they will be able to recover their entitled relief.
This may have been a legitimate concern a few years ago, with opposition politicians openly challenging R&D incentives.
These incentives not only appear to be here to stay now, but have also improved in generosity in recent years. The rate of relief for SMEs has increased from 175 percent to 225 percent in the past three years alone. The introduction of R&DEC for large companies also represents a significant step forward, as it is the first time these organisations can obtain a cash credit for their R&D.
Looking ahead, while it is impossible to predict what will happen after the next General Election, the precedent has been set that the UK wants to attract, encourage and retain R&D companies. To do this, the incentives must remain globally competitive.
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