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Software development and R&D tax credits: an explanation of the increased HMRC scrutiny 

Innovation is widespread within the software sector, providing opportunities for qualifying companies to access funding from R&D tax credits. The latest R&D tax credit statistics report produced by HMRC supports this, with over 13,400 ‘Information and Communication’ R&D tax credit claims submitted in the 2018/2019 period alone – an industry sector that is second only to manufacturing.

Increased levels of scrutiny on software-based R&D tax credit claims

We at LimestoneGrey are aware of additional scrutiny being applied on software-based R&D tax credit claims by HMRC inspectors. Indeed, we have been approached by companies who have prepared their own claims, or used their own accountant, to help respond to HMRC requests for additional information.

So why the increased scrutiny?

The rules defining what is or is not R&D is the same for all sectors, including software. The issue with software-based claims is that it is often much more difficult to make the distinction between a project that is commercially innovative versus one that is technologically or scientifically innovative.

Matthew Jones, founder and managing director at LimestoneGrey, commented:

Most, if not all, software development takes place because there is a void in the market.  There would be no need to develop your own software solutions if you could buy the same product off the shelf.

This is where the problems arise.  Essentially, anyone developing software that currently does not exist believes they are performing qualifying R&D.  This is not necessarily the case.

Just because a company is developing a unique software solution, this proves one thing and one thing alone – commercial innovation.  R&D tax credits do reward innovation; however, it must be shown to be technological innovation.

Therefore, if a commercially innovative software product is developed through the application of current technologies, it is unlikely to qualify. It must be shown that the underlying technology is being advanced, or at least trying to be.

This is where it becomes tricky.  A qualified adviser will be able to identify the relevant information needed and present this in the correct format for HMRC scrutiny.  It is not sufficient to describe what makes your software unique or different, and this is where most people get it wrong

Matthew Jones

Managing Director, LimestoneGrey

R&D tax credit information requests

When HMRC now see a software-based claim, they can apply additional checks.  If they are unhappy with the content of the initial submission, they may request additional information from the claimant company before they can approve the claim.

These requests can take two different forms.  The first is commonly referred to as a ‘nudge letter’, providing the claimant company with a reminder of the relief rules and instruction to ensure claimants are happy with the content of their submission.

The other is an enquiry letter.  

What is an R&D tax credit enquiry?

An enquiry is a process initiated by HMRC which allows them to look deeper into an R&D tax credit claim submission, giving them more time to investigate its eligibility if they have concerns over the content.

HMRC will request specific information in relation to the R&D activities and the technological advancements being sought, often asking for an incredible amount of detail which can be quite onerous for the claimant company to supply. This will of course delay any potential payment, or prevent it being issued at all.

Should HMRC conclude that a submission is not correct, they have various powers available to them, including the ability to issue financial penalties to the claimant company.

Matthew Jones commented:

‘It is imperative that you have trust in your adviser’s ability to correctly define your R&D activities as the validity of an R&D tax credit claim is the responsibility of the claimant company.  HMRC will come after the claimant (not the adviser), therefore you need to have full confidence in the information being submitted in your company’s name, and confidence that the information presented is the right information to meet HMRC’s requirements.’

LimestoneGrey is a chartered R&D tax credit consultancy, that is regulated by the ICAEW and CIOT, and only uses qualified professionals to conduct work on behalf of clients.

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