What Counts as R&D for Tax Credit Purposes?

R&D Tax Credits are a valuable government incentive designed to reward businesses for investing in developing new products and processes. However, one of the most common questions businesses ask is: What exactly qualifies as R&D?  Understanding the criteria set by HMRC can help you identify eligible projects and activities and ensure you maximise your R&D Tax Credit claim.

HMRC’s Definition of R&D

R&D for Tax Credit purposes is defined by HMRC as work that:

1. Seeks to achieve an advance in science or technology
   • This means your R&D project must aim to make an improvement in a field of science or technology. This could involve creating something entirely new or significantly improving an existing product, process, or service.

2. Addresses scientific or technological uncertainty
   • Your R&D project must deal with technological uncertainties that cannot be easily resolved by a professional in the field.

3. It cannot be readily deduced by a competent professional, and the development work is carried out by systematic investigation
   • If how to develop the solution to your problem is already widely known or can be easily worked out by a knowledgeable expert, it will not qualify as R&D.
   • The R&D project work is carried out by way of systematic investigation. A key part of systematic investigation is the test phase. The reason for doing the tests along with the test design and results is typically where the R&D lies.

The details of HMRC’s position are set out in their guidelines (CIRD81900 Conditions to be satisfied; BIS guidelines). These guidelines can appear daunting, vague and difficult to apply in practice within the context of your own business.

As such, many businesses misinterpret the guidelines and in effect prepare the wrong project descriptions that they present to HMRC as an eligible R&D Tax Credit project.

Misconceptions of what constitutes an eligible R&D project

Here are some very common misconceptions:

1. We often hear businesses say, “We have developed a unique and innovative product that qualifies as R&D”. Unfortunately, neither uniqueness nor innovation are criteria to determine if a project qualifies. This is because it is not the functionality or what the product does that is the focus, IT IS HOW THE PRODUCT IS DEVELOPED that needs to be addressed. In other words, it is the journey you need to evaluate not the destination. The advance in any particular field of science or technology is achieved through HOW the product was developed not what the product can accomplish. For example, it is not the fact that a software product can connect consumers with mortgages that is the advance, it is how the underlying algorithms, software architecture and models created during the development process that give rise to the R&D. The first advance is a commercial advance. The work on algorithms, architecture and modelling s an advance is in the area of computer science.
2. “The R&D needs to be ground-breaking”. This is also not true. Of the 3 main criteria that need to be addressed, technological uncertainty is the most important. This particular criterion is also the least understood. We often hear companies say our uncertainty is “We didn’t know if we could develop a product that could be manufactured at a reasonable cost” or “We did not know if our software platform could integrate with a particular dataset”. In the first statement “cost” is a constraint. The question is, how does the cost constraint give rise to technological uncertainty? The second comment is too vague and superficial. You need to dig deeper to understand why this integration is a technological uncertainty. A good tool is to ask “why” three to five times to arrive at the uncertainty. For example, why is it that this integration is challenging? Because the dataset is unique. Why does that cause an uncertainty? Because we are not certain if our platform architecture can handle the dataset. Why is that an uncertainty? You can see that as you drill down with this 5 “Why” question technique you start to arrive at the essence of the technological uncertainty.

3. “We are adding AI capabilities into our software product. We researched and tested a significant number of AI models over a 4-month period. We selected two models and spent 6 months incorporating the models into our software and tested the outcome”. Here there is no indication that any new technology has been developed. The company simply incorporated another company’s technology into their product. It is not clear if any new technology has been created. While the incorporation of the AI model was time-consuming, the company is not creating a new AI model but merely using existing technology in their existing product.

How can RDP help?

We have been assisting companies for over 35 years with R&D Tax Credit claims and I can safely say that even competent professionals struggle with the definition of R&D. That is why our clients seek our assistance year after year. Furthermore, our clients appreciate, and take great comfort, that our service includes RDP’s support of their R&D Tax Credit claim when HMRC carry out a compliance check. In fact, we have assisted many companies, who used a competitor of RDP to prepare their claim, to assist with an HMRC review of that claim.

For a free assessment to determine if any of your projects qualify, or want to find out more about what Counts as R&D for Tax Credit purposes, please contact 0208 214 1341 or [email protected] to discuss further.