As a software development company Founder, you may already be claiming R&D tax relief, or you may be looking at your first claim; either way here are five tips that may help you get the most out of your claims.
1. Overseas Developers
It’s quite common for software companies to outsource their work to overseas subcontractors (to stay quite ‘light’ as a business themselves) or to have employees located overseas.
This can often result in Founders (mistakenly) thinking:
“Well, my employees aren’t in the UK, therefore, I can’t qualify for R&D tax relief.”
That is NOT the case. You can still qualify for R&D tax credits.
I raise this point first as I had this exact question and assumption from a software company Founder as he had dismissed making any claims for this reason.
Luckily we were still within the time-frame to be able to file a retrospective claim (once I had explained that his assumption was mistaken!) and he managed to secure a cheque for £115,000 just six weeks later (if we hadn't had that chance conversation, that £115k would have gone up in smoke as unclaimed or time-barred)!
What matters is where your company is located - so, if you’ve got a limited company that is registered in the UK (subject to UK corporation tax), then it is within the bounds of R&D tax relief.
It doesn’t matter where your employees or your subcontractors are based. It’s where your company is based that is critical.
The next point to watch out for is grants e.g. Innovate UK grants etc, as can cause all sorts of problems for R&D tax relief.
In a nutshell, they don't place nicely together (and it can be quite complicated)!
Let's back up first: you may be aware that there are two R&D tax reliefs:
- SME R&D relief
- RDEC (Research Development Expenditure Credit relief).
The SME relief is the one that applies to most companies. It’s the most generous of the two reliefs. So that’s the one you ideally want to claim (although the RDEC relief is still better than nothing!).
Where grants come into play, it means that the SME relief is either entirely excluded or partially excluded.
The exclusion kicks in because you can't receive the SME R&D tax relief on 'subsidised expenditure'. This is reasonable when you consider that otherwise, you would be generously rewarded on expenditure that wasn't actually incurred by you (it was covered by the grant!).
However, all is not lost.
You can still qualify for relief under the RDEC scheme even on the subsidised expenditure (i.e. grant covered expenditure). Now, that’s not half as beneficial as the SME scheme, but don’t be put off. It is certainly worth claiming.
There are further potential technicalities if the grant is 'Notified State Aid' (subject of a separate post) as this may mean that the entire project expenditure (even the unsubsidised element) may be restricted to the RDEC relief only.
If you’ve already received a grant then you will have to explore the nature of the grants and the impact on your claim.
If you haven’t yet applied for or accepted a grant, it’s often worth crunching the numbers first and seeing which route is going to work out best for you.
3. Claim for Past Projects
Another tip is making sure you’re going back in time to claim on retrospective projects, where applicable.
Founders are often unaware that you can go back to claim R&D tax relief for projects undertaken during accounting periods ending in the past two years.
So, at the time of writing (2nd July 2020) a company with a 31 December financial year end could file a claim that covers:
- Year ended 31 December 2018 AND
- Year ended 31 December 2019
It will be a case of filing amended company tax returns for these retrospective periods that in essence overlays any previous returns that have been filed (the only change likely being for the R&D tax claim).
4. Employee Costs Are Key
Another tip is that, for software companies, one of your main qualifying costs for R&D is going to be your employee costs.
So, their gross salary, employer's NIC and company pension contributions (plus potentially relevant travel & subsistence costs in certain circumstances).
Be aware that where you’ve got subcontractors, there is this blanket 65% cap adjustment applied to their costs.
So, whatever amount of costs that your subcontractors invoice your company, you will be restricted to 65% (as the maximum amount claimable). And that’s before you take into account any potential % adjustments that you might have to make for the duality of other activities that might be included in their invoice outside of the R&D work.
The 65% automatic adjustment doesn’t, however, apply for your employees.
You just need to consider the percentage time that your employees (and directors) spent on the qualifying R&D projects that you have identified.
Taking this into account, you can see how important it is to structure your workforce in terms of the impact on your R&D tax cashflow - savings on subcontractors in other ways may be more costly from a R&D tax perspective.
Also be aware, there is a PAYE cap likely coming into force from the 1 April 2021 (delayed from 1 April 2020).
5. Founder Remuneration
Finally, on a similar note, think about your remuneration as a founder and how it is structured.
As, for more established companies it can be quite common to structure your remuneration as a small salary and the rest as dividends.
Be aware that dividends are not a qualifying cost for R&D.
So if you have a salary of around £8,000 and say dividends of £92,000, you are limited to claiming a percentage of the £8,000 only. This can be highly frustrating (and costly!) in cases where you may be heavily involved in the qualifying R&D work...
On this basis, consider how you could structure your remuneration package such that you perhaps withdraw more by way of salary (if you’re heavily involved in the R&D work yourself). You may wish to crunch the numbers first.
It is always important to consider your taxes holistically, in terms of both your personal income tax and business tax circumstances. This helps you achieve a better overall result.
Bonus tip: HMRC R&D tax credit guidance for software companies
HMRC acknowledges the potential complexity for software companies in determining the boundaries of software development work that qualifies for R&D tax relief.
On this basis, they have published two guides exclusively for aimed at companies in the field of ICT and software development.
The interpretation of the DTI Guidelines for software has been around for a while but the update on case-studies of what constitutes qualifying projects in the eyes of HMRC was published more recently.
Both are essential reading for any company in the software development space that is considering filing a claim for R&D tax credits.