By Lisa James, BD and Marketing Director, LimestoneGrey Chartered R&D Tax Credit Specialists
In the med-tech and life sciences sectors, software is often integral to innovation. While software that simply supports a larger R&D project (e.g., for basic data capture) can be an allowable cost, a different level of scrutiny applies when the primary advance is the software itself, whether in isolation or alongside a hardware development project.
For projects like a new AI diagnostic platform or a complex data analysis tool, it’s not enough for the application to be new. HMRC will look for evidence of an advance in the underlying software technology. You must demonstrate how you are advancing computer science or software engineering in the IT industry as a whole, not just in the med-tech sector. The claim must show that a competent professional would find the underlying technological challenges to be non-trivial and uncertain at the outset.
With software claims under increased scrutiny, it is critical that businesses understand and follow HMRC’s guidance for software development projects. This article looks at the critical risk areas in preparing software R&D tax credit claims.
The Commercial vs. Technological Innovation Challenge
Many businesses embarking on software projects naturally highlight the novelty, market disruption or customer-facing features of their product. While these are important from a commercial perspective, and can be vital pieces of information for grant applications, they do not meet the criteria for R&D tax relief.
HMRC’s guidance is clear: qualifying R&D must aim to resolve scientific or technological uncertainties by resolving scientific or technological uncertainties. This means demonstrating a level of advancement in computer science or software engineering, not simply building new features or platforms that are commercially novel (but not technologically). For software, this might involve:
– Developing new algorithms to significantly enhance performance or scalability beyond known industry benchmarks
– Creating novel system architectures to solve complex integration challenges that are not addressable with standard methods
– Inventing new data handling or security techniques to overcome limitations in existing technology
Unfortunately, many claims focus solely on product innovation rather than underlying technology, leading to rejection or HMRC enquiries.
The Moving Target: Establishing a Technological Baseline
Software technologies evolve at lightning speed. This makes it crucial to clearly define the technological baseline, the state of technology in the wider industry before your project began, to demonstrate that your work went beyond it.
Failing to establish a clear technological baseline at the start can weaken a claim’s validity, even if significant innovation occurred. You must be specific, reference the state of knowledge and technology during the relevant accounting period and avoid hindsight bias when documenting the technical challenges you faced.
The “Invisible” Nature of Software R&D
Unlike tangible product innovation, software development is more abstract. This can make it more difficult for non-technical stakeholders to grasp where the qualifying R&D actually lies.
It’s vital to involve the competent professionals within your team (the people with deep understanding of the technical aspects of your project) to help identify the qualifying aspects of your project.
To substantiate your claim, especially when completing the mandatory Additional Information Form (AIF), you must articulate how your project overcame specific technical hurdles. What were the specific technical challenges that a competent professional in the field could not readily resolve? How did your project attempt to resolve those uncertainties?
HMRC is less interested in the final product and more interested in the systematic process of experimentation, iteration and problem-solving you undertook.
HMRC’s Guidance on Software Claims
Due to the high number of incorrect or inflated claims in the software sector, HMRC has published specific guidance for software-related R&D tax relief. This guidance outlines the types of software activities that may qualify, provides sector-specific examples and reinforces the distinction between commercial and technological innovation. All claimants should familiarise themselves with this guidance.
Professional Tips for a Stronger Software R&D Tax Credit Claim
– Start Early: Document technical baselines and uncertainties during development, not after. A good advisor will assist you with this process
– Utilise the Developers: Empower your tech leads. Your developers and system architects are the ones who can best articulate the technological uncertainties, so involve them directly in helping gather information for the technical narrative
– Be Specific: Describe technical problems and how they were tackled in terms of algorithms, system architecture or data handling. Avoid vague statements
– Prepare for the AIF: Structure your internal documentation around the key questions of baseline, uncertainty and advance to make completing the mandatory form more straightforward
– Engage a Chartered Tax Specialist: The rules are complex. Work with advisors who have proven experience in software-related R&D claims and a deep understanding of HMRC’s expectations
Disclaimer: This article provides general information and does not constitute professional tax advice. You should consult with a qualified tax advisor to discuss your specific circumstances.