Software Agencies Working for Customers: Who Can Claim R&D Tax Relief?

Many software agencies assume they cannot claim R&D tax relief because they develop software for clients. Others assume they can claim because their developers did the technical work. Neither assumption is necessarily correct.

Imagine a software agency develops a machine-learning platform for a customer. During development, the team encounters a technological challenge that requires work beyond what is readily available within existing knowledge.

Who can claim the R&D tax relief, the customer or the software agency?

For accounting periods beginning on or after 1 April 2024, the rules around contracted-out R&D changed. HMRC's guidance looks at the contract and the surrounding circumstances to determine whether the customer intended or contemplated that R&D of that sort would be undertaken when the contract was agreed.

The existence of qualifying R&D is a separate question from who is entitled to claim relief for that R&D.

Why this matters

Getting this wrong can mean:

• claiming relief that belongs to somebody else;
• missing a valid claim altogether;
• both parties claiming for the same activity; or
• being unable to support the position if HMRC raises questions.

When the customer specifically commissions R&D

Consider a customer that has already identified a technological problem as part of its own R&D project.

It engages a software agency to undertake a specific part of that R&D.

In this situation, the customer will generally be the party able to claim for the contracted-out R&D, subject to the relevant rules.

HMRC gives a specific example involving a software development company contracted to undertake part of another company's R&D project.

As always there are some exceptions. For example, where the customer is an overseas entity outside the UK corporation tax regime, the contractor may potentially be able to claim even where the customer intended the R&D.

Can the software agency claim if it discovers the R&D? What if the customer simply wants a software product?

This is where things become more interesting.

A customer may commission a software platform without knowing that R&D will be needed. For example, a retailer might commission a software agency to develop a new inventory platform without anticipating that resolving a particular technical challenge will require R&D.

During development, the agency may encounter a technological uncertainty that cannot readily be resolved using existing knowledge.

The agency may then undertake its own R&D to resolve the problem.

HMRC specifically recognises this situation and states that a contractor can potentially claim for R&D undertaken to fulfil a contract where the customer did not intend or contemplate that R&D of that sort would be carried out.

So, working for a customer does not automatically prevent a software agency from claiming R&D tax relief.

What if both the customer and agency undertake R&D?

A customer and agency may also undertake separate R&D activities as part of the same wider project.

For example, the customer may be developing a new technology while the agency is independently resolving a software integration problem.

Where the activities represent different R&D activities, both parties may potentially claim for their own qualifying R&D. The activities and expenditure simply need to be clearly distinguished.

What if the R&D started before the contract?

Software agencies can also undertake technical R&D before a customer contract exists.

An agency may develop a prototype or investigate whether a technically challenging requirement can be achieved while preparing a proposal.

For example, an agency may test whether a proposed software architecture can achieve a level of performance that has not previously been demonstrated, before knowing whether it will ultimately win the customer's work.

HMRC recognises that qualifying pre-contract activity can potentially remain the agency's own R&D, even where the agency subsequently wins the customer contract.

Why the contract matters

The contract is important, but it is not the only thing that matters.

HMRC says the terms of the contract should be considered alongside the surrounding circumstances. These can include factors such as IP ownership, financial risk, autonomy over the work, how the resulting R&D will be exploited and how the decision to undertake the R&D was made.

This is why two software projects that appear commercially similar can have different R&D treatment.

Key Takeaways

When assessing R&D undertaken as part of a customer project:

• The company performing the development does not automatically get to claim the R&D.
• The customer paying for the development does not automatically get to claim it either.
• The contract is important, but it is not the sole consideration.
• The surrounding facts and circumstances also need to be considered.
• The key question is whether the customer intended or contemplated that R&D of that sort would be undertaken when the contract was entered into.
• Separate R&D undertaken independently by the agency may potentially have different treatment.

The key question

If your business develops software for customers, don't simply ask: Who did the development?

Consider instead: Was the R&D something the customer intended or contemplated when the contract was entered into or did the agency undertake its own R&D while delivering the project?

Free Guide: Software Agencies & R&D Tax Relief

We've prepared a practical guide covering five common customer-contract scenarios and the evidence businesses should consider when assessing their position. Download our free guide to learn:

• Five common customer-contract scenarios.
• Who may be entitled to claim in each situation.
• The evidence software agencies should retain.
• Practical review questions before submitting a claim.

Contact us to get a copy of the guide.

We regularly help software agencies review customer contracts, statements of work and technical evidence to determine who can claim R&D relief under the post-April 2024 rules. If you'd like us to review a specific project or customer arrangement, get in touch.

This article is for general information only. The correct treatment depends on the contractual, technical and commercial circumstances of each project.

HMRC guidance may develop over time, and the application of these rules will depend on the specific facts and circumstances of each arrangement.