Advancements in Software Development

No other sector comes close to software development when it comes to pace of advancement, especially in areas around AI and machine learning. ChatGPT, one of the prevalent generative AI tools, launched its first main model in November 2022. Fast forward to today, and AI has integrated itself into most areas of our professional and personal lives. Furthermore, the pace of advancement is unlikely to slow, with AI-driven code generation, intelligent bug detection and tools that allow projects to be scaled faster than ever. Indeed, Innovate UK’s 50 Emerging Technologies report identified areas such as AI emotion and expression recognition, and brain machine-interface technologies as some of the key technologies we may see in the future.

This rate of advancement makes identifying qualifying R&D projects ever more complex. What may have been a project qualifying for R&D tax relief one or two years ago could now be considered routine, and certainly the use of AI or related technologies will not necessarily mean that a project will qualify for the relief.

AI is also affecting the process of claiming R&D tax relief. This ranges from tools which record and summarise interviews with competent professionals, to systems which will outright prepare and submit a claim on a company’s behalf. This latter category is the subject of significant controversy, and we understand that HMRC are actively monitoring for claims that may have been prepared by AI.

HMRC’s Approach to Software R&D Claims

HMRC acknowledge that in some fields there are difficulties in determining whether a project is R&D for the purposes of the relief. Software is one such area and hence HMRC have developed specific guidance to link scenarios common within the software sector to general R&D guidelines.

The guidance is useful in that it highlights fields where HMRC have seen qualifying claims, such as robotic process automation, geoinformatics, augmented reality, artificial intelligence, computer vision, cloud or mobile computing, and internet of things. It also gives some useful detail in relation to what HMRC would be looking for specifically in relation to software claims, including system uncertainty, developing new or improved data architectures, and extending software frameworks (e.g. software development kits, or software libraries) beyond their original design.

Because of the pace of change within the software industry, HMRC employ their own computer specialists to ensure that their knowledge of the industry is kept updated. The specialists provide advice based on their knowledge of the software industry, but their role is advisory in nature, and it is the HMRC caseworker who will make the decisions in relation to an R&D claim.

Mandatory Random Enquiry Programme (MREP)

Concern from HMRC over non-compliance in the R&D tax relief space has grown in recent years, under the perception that there has been large scale fraud and error – as high as £1.2 billion in 2021/22 according to HMRC. As a result, HMRC has been carrying out a MREP, with as many as 1 in 5 R&D tax relief claims now being enquired into by HMRC.

For small and medium-sized enterprises (SMEs) in particular, the enquiry process can be challenging due to the time, resources and complexity involved in reaching a resolution with HMRC. This has meant that on occasion enquiries cannot be defended, and a claim is conceded, even when the underlying projects were arguably qualifying.

Given the risk of enquiry, and cost of defending a company’s position, many would be claimants are dropping out of the regime – HMRC figures show that SME claims fell from 71,905 in relation to 2021/22, to 55,325 in relation 2022/23 – a drop of around 23%. Given that the Information and & Communication sector make up such a significant proportion of claims, there has no doubt been an impact on the software development space by HMRC’s MREP.

Furthermore, claims are likely to drop even further, with multiple changes to the regime that have, and will make, an R&D tax relief claim less worthwhile, both in terms of the benefit available and the compliance obligations required in order to successfully make a claim.

Conclusion

R&D tax relief is a powerful incentive for fostering innovation in the software development sector. With the rapid advancements in areas such as AI, the potential for groundbreaking projects is substantial. However, applying the broad principles of R&D relief eligibility to the fast-paced advancements we are seeing in this space, in the context of a challenging enquiry landscape and changes to the regime, have made a significant difference to the risk profile of making a claim.