R&D Tax Credits and Software: Incorrect Accounting Policies

Software developers are losing out on £000′s of R&D Tax Credits simply due to bad accounting. This is really shocking, because in these tough economic times every avenue to extra funding should be maximised. And when there’s a golden opportunity out there to claim substantial cash back for reinvestment in innovation, claiming R&D Tax Credits is a no-brainer.

What are R&D Tax Credits?

R&D Tax Credits is a scheme that’s open to all UK companies (not just software) that are registered for UK Corporation Tax. Essentially providing up to 33% of qualifying R&D spend back as a credit, it’s one of the most generous tax reliefs in existence. The credit itself is administered either as a rebate on this (or prior) year’s Corporation Tax, or as a cash lump sum if the company made a loss.

The scope of R&D work and costs that will attract R&D tax relief is purposefully extremely broad. From staff salaries to NI contributions, pensions, materials and much more, a wide variety of R&D costs can be included in an R&D Tax Credits claim.

And the even better news is that the software has the potential for some of the very biggest claims – and easily too. Because, by its very nature, it’s hugely innovative.

Software technology moves on apace with technical challenges and complexities part of everyday life. But even the most ‘run of the mill’ work can easily lead to an R&D tax relief claim.

The important thing to focus on is not the finished product itself, but the development of the product or process that led to the product. So it could be a new, novel application software, or developing machine learning algorithms to make a particularly system more efficient. This is about re-architecting, optimising or integrating different technologies to bring a solution to a problem that wasn’t already available.

What kind of software development may qualify for R&D Tax Credits?

Typical examples of qualifying software development include:

• Overcoming issues around security, stability and compatibility
• Updating old or unwieldy systems, and system integration
• Creating off-the-shelf technology from highly bespoke, complex functionality
• Modernising existing technologies through developing complex algorithms
• Complex communications, for example, combining static and mobile technologies, multiple operating systems, structured and non-structured data etc.
• Technologically challenging and innovative ways of overcoming legislative compliance issues
• Use of cutting-edge technologies with minimal amounts of history or documentation, often meaning there are no precedents to work from and iterative development must take place
• Devising Internet of Things platforms
• Implementing AI into wider systems to tasks can be completed more effectively
• Developing blockchain technology to improve speed and security of transactions

What’s the problem?

Sadly there are too many common mistakes when it comes to R&D tax relief claims. There are plenty of myths out there. But it’s really staggering how many software companies are unable to claim R&D Tax Credits simply because of incorrect accounting. This is a real shame as it’s the prime government-backed incentive to encourage investment in research and development.

The biggest and most fundamental error we’ve come across here at Myriad is that businesses capitalise costs associated with developing software for sale as a FIXED ASSET.

Not only is this accounting treatment incorrect, it also means that you pretty much give up your 25% R&D tax funding entitlement. This is because under the R&D tax relief scheme you can only claim ‘revenue expenditure’ and not ‘capital expenditure’.

The answer?

So what is the correct accounting treatment exactly?

The answer to this question can be found in accounting standards SSAP13 and IAS38. To save you the trouble of having to read and interpret these standards, we’ll quickly summarise it here:

SSAP 13 – Accounting for research and development

Pure and applied research should be written off as an expense in the year of expenditure;

Development expenditure should also be written off in the year of expenditure. However in certain strictly defined circumstances it is permissible to defer development expenditure to the extent that its recovery can reasonably regarded as assured. Such deferred development costs must be amortised in future years

IAS 38 – Intangible Assets

Research phase: Recognised as an expense when incurred

Development phase: Recognised as an expense when incurred unless certain criteria are met then the costs should be capitalised in the balance sheet as an Intangible Asset.

In conclusion, the correct accounting treatment is to expense R&D costs relating to the development of software that is intended for sale. It may be possible to capitalise these costs as an Intangible Asset providing the recovery can be reasonably assured. The good news is that eligible R&D costs capitalised as an Intangible Asset will most likely attract R&D tax relief.

So what can I do if I have treated R&D costs relating to developing software as a Fixed Asset?

The first thing we would recommend is to obtain professional advice. It is important to ensure that you are made aware of the impact a material accounting policy change has upon the business. Myriad Associates has extensive experience in advising and dealing with such a change. We will guide you through the following process:

• Development of an accounting policy in accordance with SSAP13 and IAS38;
• Preparation of a full risk register and benefits schedule relating to the change in accounting policy. The benefits schedule will outline the R&D tax relief opportunity.
• Detailed workings and a schedule of accounting entries to support the change in accounting treatment.
• Advice and guidance on the requirement to file amended Statutory Accounts at Companies House.
• Preparation of a maximised R&D tax relief claim.
• Completion of Amended Company Tax Returns (CT600) and tax computations.

Do you need help with an HMRC enquiry?

Has your R&D tax relief claim attracted the attention of HMRC? Don’t panic.

Enquiries into R&D tax relief claims by HMRC are on the rise. Our highly-qualified team will provide the utmost support to secure a beneficial resolution for your HMRC R&D enquiry, so that you can rest assured knowing your business is in safe hands.

We are well equipped to offer actionable advice on any R&D tax relief enquiries made by HMRC as well as provide proactive reviews that can help ensure complete peace of mind during these uncertain times.

If you’ve been contacted by HMRC about your R&D Tax Credit claim, or you’d simply like to know more, please do get in touch using our contact form or call our friendly team on 0207 118 6045.

Speak to the R&D tax experts at Myriad Associates

No matter what area or sector your company operates in, if you’ve engaged in any R&D projects recently then R&D Tax Credits could well follow.

Get in touch with our specialist team who can advise you on your eligibility and the best way forward. So why not see how much the difference could make today?

Simply send us a message or call 0207 118 6045.