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Introduction
- Research and
development
(R&D) tax
credits are
a positive measure,
intended to
focus support
on innovative
activities that
benefit UK industry
and indeed,
deliver wider
benefits for
the UK. For
this to be successful
it is necessary
that a boundary
be drawn between
activity that
qualifies and
activity that
does not - so
a definition
of "research
and development"
is required.
- For tax purposes,
what constitutes
R&D is defined
by reference
to accounting
standards, which
are set out
in Statement
of Standard
Accounting Practice
13 (SSAP 13),
and to the ‘Guidelines
on the Meaning
of R&D for
Tax Purposes’
issued by the
Secretary of
State for the
Department of
Trade and Industry
(‘the Guidelines’).
This Commentary
is intended
to help in the
interpretation
of the Guidelines;
it does not
supersede them.
Paragraph references
in this document
are to paragraphs
of the Guidelines
unless otherwise
indicated. Not
all the paragraphs
in the Guidelines
require further
comment and
as such several
do not feature
in this Commentary.
- The Guidelines
and this Commentary
must both be
read in their
entirety in
order to understand
their meaning
and intent.
This is because
many concepts
in the definition
of R&D are
interrelated
and cannot be
applied in isolation.
Taking extracts
out of context
can produce
misleading conclusions.
- Paragraphs
1 to 10 of this
Commentary are
introductory.
Paragraphs 11
to 78 of this
Commentary are
extracted from
the Corporate
Intangibles
and R&D
(CIRD) Manual,
which has been
prepared for
the staff of
the Inland Revenue.
They are being
published for
the information
of taxpayers
and their advisors
in accordance
with the Code
of Practice
on Access to
Government Information.
- It should
not be assumed
that the CIRD
manual in general
or this Commentary
in particular
are comprehensive,
nor that they
will provide
a definitive
answer in every
case. The staff
of the Inland
Revenue are
expected to
use their own
judgement, based
on their training
and experience,
in applying
the guidance
to the facts
of particular
cases. In particular
difficult or
complex cases
they are able
to obtain further
guidance from
specialists
in Head Office.
- The CIRD manual
is based on
the law as it
stood at date
of publication.
The Inland Revenue
will publish
amended or supplementary
guidance if
there is a change
in the law or
in the Department's
interpretation
of it. The Inland
Revenue may
give earlier
notice of such
changes through
Tax Bulletin
or a press release.
- Subject to
these qualifications,
readers may
assume that
the guidance
in this Commentary
given will be
applied in the
normal case;
but where the
Inland Revenue
considers that
there is, or
may have been,
avoidance of
tax the guidance
in this Commentary
will not necessarily
apply.
Tax reliefs
for R&D
- Prior to the
introduction
of the R&D
tax credits
in April 2000,
tax relief was
given for expenditure
on ‘scientific
research’. Claims
were concentrated
in the area
of pure science.
The introduction
of the Guidelines
made clear that
R&D for
tax purposes
is undertaken
in other sectors
such as engineering
and software.
- Most current
R&D expenditure
qualifies for
a deduction
- that is, it
receives 100%
tax relief.
In addition,
there are three
special types
of relief for
expenditure
on R&D.
- R&D
Allowances
give 100% relief
for virtually
all capital
expenditure
on R&D.
- R&D
tax credits
for SMEs,
introduced in
April 2000,
give an extra
50% relief (making
150% in all)
for current
R&D expenditure
on staff costs,
consumable stores
and some sub-contract
costs.
- R&D
tax credits
for large companies,
introduced in
April 2002,
give an extra
25% relief (making
125% in all)
for current
R&D expenditure
on staff costs
and consumable
stores.
- ‘Staff costs’
are defined
in the R&D
tax credit legislation
to include only
those staff
working actively
and directly
on R&D.
The indirect
activities listed
at paragraph
29 of the
Guidelines do
not qualify
for the R&D
tax credits.
Commentary
on the Guidelines
- Paragraph
3 sets out
the basic principles
of what constitutes
R&D activity
for tax purposes,
which are then
expanded upon
in the rest
of the Guidelines.
To be R&D,
an activity
must be:
- creative
work i.e.
non-routine
work, work containing
novel elements
or outcomes
- undertaken
on a systematic
basis i.e.
excluding one
off or ‘lucky’
discoveries.
Novelty, innovation
or uniqueness
in the product
or process are
not sufficient
to demonstrate
technological
or scientific
advancement.
It is how such
attributes arise
that is important.
An effort to
achieve scientific
or technological
advancement
will be accompanied
by experimentation
or analysis
in a situation
where there
is scientific
or technological
uncertainty
about whether
or how the advance
can be achieved.
Of course many
important advances
have resulted
from fortuitous
discoveries
(for example,
penicillin and
saccharine),
and a subsequent
effort to exploit
such a chance
discovery could
be R&D.
For example,
a laboratory
doing routine
analyses of
chemical samples
to assure the
quality of a
production process
discovers a
new and potentially
useful substance
in one of its
samples, arising
from a defect
in the production
process. The
discovery of
this substance
does not mean
that the analysis
work can be
reclassified
as R&D.
However, if
a separate programme
of work is then
carried out
to determine
how the new
substance was
formed and what
its properties
are, then this
would be R&D.
- to increase
the stock of
knowledge not
just the knowledge
within the company
or to
use the stock
of knowledge
to devise new
applications
etc. R&D
activity can
lead to the
creation of
a new product,
but the creation
of a new product
is not necessarily
the result of
R&D. In
a business context,
this means that
when a new or
improved product
or process is
created, it
must embody
a scientific
or technological
advancement
to be qualifying
R&D. For
the avoidance
of doubt, this
means that development
work can qualify
on an equal
basis with research
work.
- within
the fields of
science or technology,
excluding
the humanities
and social sciences.
See paragraph
16 for the
treatment of
activities outside
the scope of
science and
technology but
which are integral
to an R&D
project.
- Paragraph
4 sets out
the relationship
between the
accountancy
definition of
R&D in SSAP
13 and the Guidelines.
To be R&D
for tax purposes
an activity
must meet the
requirements
of both, but
in this regard,
only that part
of SSAP 13 to
do with defining
qualifying activities
should be considered.
The remainder
relating to
accountancy
treatment (for
example the
treatment of
subcontracted
R&D) has
no relevance
in this context.
- Paragraph
5 outlines
the three basic
categories of
R&D. Of
these, ‘development’
requires the
most clarification
of its nature
and limits for
tax purposes,
including the
need to establish
what constitutes
substantial
improvement.
- The key question
in a number
of sectors,
such as engineering,
where technology
generally advances
by small amounts
at a time, is
‘What constitutes
substantial
improvement?’
- Substantial
improvement
means to change
or adapt something
to the point
where it is
obvious to a
competent professional
user that the
‘improved’ version
is different
to the original.
As with all
R&D, work
aimed at substantial
improvement
must be creative
(contain novel
elements, involve
innovation)
and involve
scientific or
technological
advance. If
something falls
well within
the current
capability of
the industry
sector as a
whole, then
even if it is
a major improvement
on a previous
version, work
aimed at developing
it by a company
is not R&D
(but see also
paragraphs 19
and 20 of this
Commentary).
- It is important
to stress that
substantial
improvement
is not limited
to companies
at the very
leading edge
of R&D activity
in a field or
sector. As long
as the work
represents innovation
relative to
the sector as
a whole, it
may be R&D.
For example,
the existence
of high-fidelity
audio equipment
does not prevent
activity to
create lower-performance
equipment from
being R&D
(for example,
through technological
advances leading
to lower cost
through innovative
circuit design
or speaker construction).
However, if
a company is
simply catching
up with the
general state
of the industry
the work will
not be R&D.
- Paragraph
6 identifies
the presence
of an
appreciable
element of innovation
as a requirement
for an activity
to be R&D
for tax purposes.
We interpret
"appreciable"
as meaning "significant
or perceptible"
i.e. a non trivial
advance. In
this context
innovation is
the creation
or the attempted
creation of
a new device,
product or process
resulting from
study and experimentation
or the introduction
of something
novel.
- It is not
sufficient that
something is
novel or innovative
to the company.
The work must
be more than
merely duplicating
what has been
done before.
- It can be
difficult on
occasions to
establish and
verify whether
something is
novel or innovative.
But we accept
that there can
be innovation
where several
companies are
working at the
cutting edge
in the same
field, and are
doing similar
work independently.
- There can
also be circumstances
in which companies
are carrying
out genuine
innovation unaware
that someone
else has already
covered the
same ground.
Where work has
already been
done but this
is not known
in general because
it is a trade
secret, and
another company
repeats the
work, this would
not be barred
on the grounds
of duplication.
Nor would it
be barred if
it were known
that something
has been achieved,
but the details
of how were
not publicly
available. In
judging such
circumstances
we would have
regard to whether
or not a competent
scientist or
engineer, or
R&D manager,
in the relevant
field ought
to have been
aware that the
ground had already
been covered
(for example,
if the information
could have been
obtained by
a search of
the Patent Office
databases.)
- Paragraph
7 comments
on qualifying
activities listed
in SSAP 13.
- Testing will
fall within
the Guidelines
up to the point
of resolution
of scientific
or technological
uncertainty,
discussed below
in the context
of paragraph
10. Testing
which does not
form part of
the resolution
of scientific
or technological
uncertainty
is almost always
a routine activity
and hence is
not R&D.
- A prototype
is an original
model on which
something new
is patterned,
and of which
all things of
the same type
are representations
or copies. It
is a basic experimental
model possessing
the essential
characteristics
of the intended
product. The
design, construction,
and testing
of prototypes
generally fall
within the scope
of R&D for
tax purposes.
This applies
whether only
one or several
prototypes are
made, and whether
they are made
at the same
time, or one
following the
other. Constructing
several copies
of a prototype
after successfully
testing the
original is
not part of
R&D for
tax purposes.
The role of
prototypes in
development
is further discussed
in the Commentary
on paragraph
19 of the
Guidelines.
The use of prototypes
in the software
field is covered
in the Commentary
on paragraphs
21 – 28
of the Guidelines.
The boundary
of R&D and
other related
activities
- In paragraphs
9 to 20,
the Guidelines
explore the
dividing line
between R&D
and other related
activities
- Paragraph
10 outlines
the importance
of the concepts
of ‘novelty’
and scientific
or technological
uncertainty
in determining
whether an activity
is R&D.
For work to
be R&D it
must both be
novel and involve
the resolution
of scientific
or technological
uncertainty.
(This should
be understood
in the context
of the basic
principles set
out at paragraph
5.)
- ‘Novelty’
means that work
must be intended
to lead to a
scientific or
technical advance
or substantial
improvement
of a product,
process or service.
In other words,
for activity
to be R&D,
it must be aimed
at creating
something –
which need not
be tangible;
new knowledge
is a legitimate
aim of R&D
– or at improving
substantially
something which
already exists.
Periodic changes
to existing
products, services
or processes
– even though
they may represent
some improvement
– would normally
be excluded
from R&D,
unless they
involve an appreciable
element of innovation
and either break
new ground or
represent technical
advances (paragraph
14). Note
that R&D
requires only
that the aim
of work
should be substantial
improvement;
if the result
of such work
is incremental
improvement
then it is still
R&D (paragraph
18). Work
which aims to
make only incremental
improvements
is not R&D,
but there are
likely to be
activities which,
taken as a whole,
result in incremental
improvements,
but which include
some elements
of much more
significant
development.
Such activities
would count
as R&D.
- It follows
also that a
rolling programme
of R&D,
intended to
lead, over the
years, to substantial
improvements
but which is
exploited during
that time to
produce successive
(incremental)
improvements
to products,
should qualify.
- R&D also
includes ‘novel
work which draws
on or creates
a new source
of knowledge
which might
lead to the
breaking of
new ground or
a technical
advance and
which subsequently
might entail
the creation
or development
of a new or
substantially
improved product,
process or service’
(paragraph
13).
- ‘Scientific
or technological
uncertainty’
means whether
there is reasonable
doubt whether
something is
scientifically
possible or
technically
feasible, or
how to achieve
a desired technological
advance. It
is presumed
that those carrying
out the work
will have the
appropriate
skill, experience
and knowledge.
Where such a
person is able
to specify,
with reasonable
confidence,
how to achieve
the advance,
the activity
would be routine
and not R&D.
- The uncertainty
may derive from
a number of
sources, such
as the need
to engineer
to a particular
set of constraints
or specification,
or the need
to make a complex
system of components
function effectively.
(Note however
that the converse
is not true:
the need to
meet a particular
specification
does not of
itself mean
that there is
any technological
uncertainty.)
It is assumed
that a company
would be able
to list the
technological
uncertainties
being resolved
(or that have
been resolved)
in the course
of the R&D
project.
- In engineering
and software
engineering,
technological
uncertainties
will typically
arise from turning
something that
has already
been established
as scientifically
feasible into
a cost effective,
reliable and
reproducible
product or process.
In the case
of software
projects, for
example, uncertainties
may arise due
to system complexity,
feature interaction
and software
conflicts.
- Scientific
and technological
uncertainty
applies at the
level of the
project as a
whole: individual
tasks contributing
to the overall
project need
not themselves
be subject to
technological
uncertainty,
as long as the
whole project
is aimed at
resolving technological
uncertainty
(paragraphs
13-15, 25-27).
In other words,
routine tasks
that are required
to help resolve
the overall
scientific or
technical uncertainty
are R&D
for tax purposes
if the project
viewed as a
whole is R&D.
This includes
the writing
of software
to assist in
carrying out
the work (paragraphs
25-27) -
and the use
of research
in the humanities
and social sciences
where it has
bearing on resolving
the technological
uncertainty
(paragraph
16). For
example, the
testing of a
prototype device
or system (including
a software prototype)
may itself be
straightforward,
but it will
count as R&D
if done as part
of a project
to develop a
novel device.
Because of the
structure of
the R&D
tax regime a
subcontractor
carrying out
a routine task
as part of a
larger project
e.g. testing,
may not qualify
for the tax
credits even
though the activity
would qualify
if the client
company undertook
it directly.
- The scope
of the term
"project"
in the previous
paragraph of
this Commentary
may not be obvious.
Consider a company
which designs
and manufactures
petrol engines
for cars. At
one extreme,
it may wish
to develop improved
spark plugs
for an existing
engine. The
technological
uncertainty
associated with
this work is
resolved once
prototype plugs
have been fully
tested in the
engine: the
"project"
therefore comprises
the work up
to the end of
that testing
(including work
which would,
considered alone,
be "routine"
- such as the
testing). At
the other extreme,
the company
may require
an engine incorporating
new spark plugs,
a new combustion
chamber design,
lighter materials
and other improvements
such that the
overall engine
is substantially
improved (for
example, using
less petrol
to achieve slightly
greater performance,
generating less
pollution).
In this case,
not only the
work on the
spark plugs,
but also development
of the engine
through to testing
the prototype
is a "project".
- Work done
before tackling
a technological
uncertainty
(e.g. pre-production
planning or
bringing a firm’s
level of expertise
up to the norm
or beyond for
the sector)
does not count
as R&D (paragraph
12). Work
done after the
technological
uncertainty
is resolved
is not R&D
(paragraphs
13-15).
Work not relevant
to resolving
the technological
uncertainty
but still relevant
to the project
(for example,
cosmetic or
marketing-related
changes to a
product’s design,
or work on intellectual
property rights
connected with
the product)
is not R&D
(paragraph
13).
- Technical
and scientific
planning activities
directly supporting
an R&D project
can qualify
as part of that
project. These
may include
defining scientific
or technological
objectives,
assessing scientific
or technological
feasibility,
identifying
scientific or
technological
uncertainties,
estimating development
time, schedule,
and resources,
and high-level
outlining of
the scientific
or technical
work, as well
as the detailed
planning and
management of
the work. Other
elements of
a company’s
planning activity
relating to
a project but
not directly
contributing
to the resolution
of scientific
or technological
uncertainty,
such as examination
of the project’s
financial, marketing,
and legal aspects,
are not R&D
within the meaning
of the Guidelines.
- The set
of activities
directly contributing
to the resolution
of the overall
scientific and
technological
uncertainty
at the project
level are R&D,
within the meaning
of the Guidelines
(as long as
the project
as a whole is
novel, in the
sense described
above).
Scientific
and Technological
uncertainty
arising from
complex systems
- Scientific
and technological
uncertainty
may result from
the complexity
of a system
rather than
uncertainty
about how its
individual components
behave. For
example, in
electronic devices,
the characteristics
of individual
components or
chips are fixed,
but there can
still be uncertainty
about the best
way to combine
those components
to achieve an
overall effect.
However, simply
assembling a
number of components
(or software
sub-programs)
to an established
pattern or following
routine, known
methods for
doing so involves
little or no
uncertainty
and is therefore
not R&D.
- Similarly,
work on combining
standard technologies,
devices, and/or
processes can
be R&D if
non-trivial
combinations
of established,
known technologies
and principles
for their integration
carry a major
element of technological
uncertainty;
this may be
called a ‘system
uncertainty.’
If the technological
specifications
or objectives
to resolve the
‘system uncertainty’
are such that
the basic design
of the underlying
technologies
must be changed
to achieve the
integration,
the overall
project may
be R&D.
(In both cases,
the intended
outcome of the
work must be
novel if it
is to be R&D.)
- In contrast,
if R&D is
done to develop
a new component
to slot into
an existing
system, or a
system which
is substantially
the same as
an existing
system, there
is unlikely
to be significant
system uncertainty.
Assuming that
use of the new
component in
the existing
system constitutes
a substantial
improvement
to the system,
then necessary
development
work on closely-related
components are
also R&D.
If substantial
change to the
system is required
to incorporate
a new component
or components,
and the work
is intended
to create a
new or substantially
improved product,
process or service,
this is also
R&D.
- Paragraph
12 refers
to the requirement
that the
activity
must be intended
to lead to a
substantial
improvement
in the business’s
products, processes
or services.
- ‘Substantial
improvement’
– mentioned
in the notes
on paragraph
5 of the
Guidelines above
– means to change
or adapt something
to the point
where it is
obvious to a
competent professional
user that the
‘improved’ version
is in some way
‘better’ than
the original.
How big a change
is necessary
to achieve this
depends on the
state of knowledge
and technology
in a particular
industrial sector;
expectations
in some newer
or faster-moving
sectors can
differ from
those in more
established
or constrained
ones. For example,
historically,
it was long
accepted that
the power of
new computers
roughly doubled
every 18 months,
so a chip which
was 1% faster
might not be
considered much
of an improvement
(all other things
being equal),
but an increase
of 1% in the
efficiency of
electricity
generation from,
say, a wind
turbine may
well be a ‘substantial
improvement’.
- Scientific
and technological
improvement
is not limited
to physical
properties:
reducing the
production cost
(and hence the
price) for a
product could
be a substantial
improvement,
but again how
big a reduction
counts depends
on conditions
prevailing in
the particular
sector.
- ‘Substantial
improvement’
in the context
of engineering
and other development
is contrasted
by the Guidelines
with ‘incremental’
development
(paragraph
18). Simply
changing or
updating a product,
process or service
is not of itself
sufficient to
qualify as substantial
improvement
(paragraph
14). If
a product, process
or approach
is substantially
set then any
further changes
to it are not
R&D (paragraph
13).
- In judging
whether there
was intent to
make ‘substantial
improvement’
of a product,
process or service,
we would have
regard to the
nature of the
improvement
or improvements
sought by the
R&D project,
and arguments
as to why they
would constitute
a substantial
improvement.
(This could
for instance
include examples
of new applications
made possible
by the improved
version, such
as devices made
practical by
markedly lighter
batteries.)
- Paragraph
13 introduces
the phrase ‘experimental
development’
to emphasise
that not all
work that a
company might
view as development
is necessarily
R&D in the
meaning of the
Guidelines.
‘Experimental
development’
should therefore
be read as meaning
‘activity which
is development
and hence R&D
within the meaning
of the Guidelines’,
i.e. work which
is subject to
technological
uncertainty
and aimed at
creating new
or substantially
improved materials,
devices, products,
processes and
services.
- This contrasts
with ‘Commercial
development’
involved in
turning a functioning
prototype into
a final commercial
product is not
R&D; this
exclusion for
example covers
some items such
as market research
which are specifically
excluded from
R&D by SSAP
13 (paragraph
8) and the
activities outlined
in paragraph
31. However,
it may be necessary
to undertake
further R&D
before a product
can be manufactured
and sold; paragraph
58 of this Commentary
gives some examples
of the kind
of work that
may be required.
- Paragraph
13 highlights
that R&D
is still taking
place while
the (scientific
and technical)
viability of
earlier R&D
is being established
or further technical
improvements
are being made,
as long as the
overall requirement
for novelty
is also fulfilled.
Once work moves
on from eliminating
technological
uncertainty
(i.e. the product,
process or approach
is substantially
set) then further
work on ‘finishing’
the product,
process or approach
is not R&D.
- Paragraph
14 distinguishes
R&D from
periodic updating
- Work on periodic
updating is
not R&D
for tax purposes
unless it involves
an appreciable
element of innovation
(see paragraph
6). As discussed
above, the outcome
of a programme
of R&D may
be an incremental
or series of
incremental
improvements.
- Periodic updating
includes activity
that is directed
at changing
the physical
appearance or
superficial
characteristics
of a product
without altering
its utility,
efficiency or
function.
- Paragraph
15 covers
the border between
R&D and
subsequent commercial
development.
It is recognised
that after the
initially-identified
uncertainty
has been resolved
there may be
situations where
further R&D
is required.
- A project
is complete
when the activities
associated with
resolution of
the scientific
and/or technical
uncertainty
are complete.
- When the technological
character of
the product
or process is
substantially
set, and the
primary objective
is to develop
markets, to
do pre-production
activity, or
to get a production
or control system
working smoothly,
then the work
is no longer
R&D for
tax purposes.
However, if
further scientific
and/or technological
uncertainty
exists under
these circumstances,
then work on
studies to resolve
these scientific
and/or technological
problems may
still be R&D
for tax purposes.
- Paragraph
16 excludes
humanities except
as part of a
wider qualifying
R&D project.
For example
in the development
of night vision
on-screen instrumentation
for pilots it
may be necessary
to conduct ergonomic
and psychological
testing as part
of the wider
project.
- Paragraph
17 draws
out the idea
that it is the
context or aim
of activities
rather than
the activities
alone that determines
whether they
amount to qualifying
R&D, as
discussed in
the Commentary
on paragraph
10 of the
Guidelines.
- Paragraphs
19 & 20
refer to
the use of prototypes
and pilot plant
as a guide to
identifying
the end of the
R&D activity
- In many cases
the process
or product is
developed to
the prototype
or pilot stage
for experimental
or technical-trial
purposes. That
is, prototypes
are used to
test the feasibility
of the concept
or hypothesis.
Possibly, the
construction
of a whole series
of pilots or
prototypes may
be involved,
as problems
are met and
either overcome
or bypassed.
It may be that,
in this phase
of the development,
the original
objectives have
to be modified
significantly
or perhaps even
changed entirely,
depending on
the technological
opportunities
that become
apparent. Such
work would fall
within R&D
for tax purposes
- Subsequently
the product
or process is
developed to
meet the requirements
of commercial
use or production.
This may involve
activities such
as scaling up
from pilot plant
size to commercial
size, certification,
or developing
an economical
means for commercial
production.
In some cases,
the technologically
successful prototype
may have been
fabricated using
methods or materials
that are too
expensive to
be practical
for commercial
use. Such activities
are not necessarily
of themselves
R&D for
tax purposes
but if they
require scientific
or technological
uncertainties
to be resolved,
then further
R&D may
take place.
For example,
in scaling up
a process, it
may become clear
that the behaviour
of a substance
in bulk is markedly
different from
its behaviour
in the pilot
plant in a way
which can only
be understood
by carrying
out new R&D.
Software
(paragraphs
21-28)
- The Guidelines
distinguish
between two
sorts of software
activity which
may qualify
as R&D:
(i) software
as the aim of
the R&D
(i.e. work aimed
at creating
software or
knowledge about
software engineering),
and (ii) software
used as a means
of achieving
an R&D goal,
within a larger
R&D project
(paragraphs
25-28).
In both cases,
software
is given equal
treatment to
other forms
of technological
activity
(paragraph
21).
- It is recognised
that functionality
is often implemented
in products
using software
rather than
hardware. The
technological
uncertainties
that have to
be addressed
in creating
software are
the same in
concept as those
faced by engineers
seeking a physical
implementation
of a product
or process.
In the case
of software
projects technological
uncertainties
may arise, for
example, from
system complexity,
feature interaction
and software
conflicts.
Software
as the aim
of the R&D
(paragraphs
21-24)
- For a project
to be software
R&D (i.e.
R&D in sense
(i) above),
it must fulfil
the same criteria
as any non-software
activity to
qualify as R&D:
- Scientific
or technological
uncertainty,
which will be
resolved if
the R&D
project is successful;
and
- ‘Novelty’,
which in the
context of development
means seeking
to create new
or substantially
improved materials,
devices, products,
services or
systems.
- The Guidelines
include some
examples of
work in the
software field
that might qualify
as R&D (paragraph
22) and
of software-related
work which is
considered to
be routine/non-novel
and therefore
does not qualify
as software
R&D (paragraphs
23 and 24).
This is meant
as an illustration
of how the fundamental
tests might
apply to software,
rather than
a hard and fast
rule.
- For example,
an ‘enhanced
query language’
(paragraph
22) would
need to constitute
a significant
improvement
on the original
query language
to be ‘novel’,
while extensive
‘adaptation’
of software
could in some
circumstances
require development
of new functionality
and new technical
knowledge, and
therefore could
fulfil the uncertainty
and novelty
criteria and
hence count
as R&D –
it would in
effect create
a substantially
improved product,
service or system.
- Software R&D
is usually aimed
at resolving
technological
rather than
scientific uncertainty.
This can include
(paragraph
7):
- design of
products, processes,
services or
systems involving
new technology
or substantially
improving those
already produced
or installed;
- testing in
search for,
or evaluation
of, product,
service or process
alternatives;
- design, construction
and testing
of pre-production
prototypes and
models and development
batches;
and
- construction
and operation
of prototypes.
- ‘Prototypes’
in this context
can be read
as ‘builds’
of the software
in question,
for example,
alpha and beta
stages of the
normal development
and testing
process prior
to commercial
release although
the criteria
for the end
of R&D still
apply: once
the scientific
or technological
uncertainty
is resolved,
or the structure
and functionality
of the software
is substantially
set (paragraph
13). As
with all R&D,
if, subsequently,
unforeseen problems
(e.g. system
and software
conflicts) arise,
resolving them
may constitute
an additional
phase of eligible
R&D.
- Projects aimed
at developing
the initial
release of saleable
software which
is ‘leading
edge’ in some
technological
way are often
R&D for
tax purposes.
To develop software
at the leading
edge of today's
technologies
generally requires
the developer
to come up with
new constructs,
such as new
architectures,
algorithms or
database management
techniques (i.e.,
make substantial
technological
advance), and
there can be
specific uncertainties
as to the viability
of these. If
the software's
competitive
edge stems merely
from advance
in an area other
than technology,
such as business
management,
or improvements
in financial
management techniques,
the project
is unlikely
to be eligible
unless implementation
requires technical
innovation.
- As with any
other product,
simply claiming
to have developed
the first or
best software
suite for a
given purpose
does not in
itself prove
that the taxpayer
has made a technological
advancement.
A new and unique
software suite
can be built
using only well
known combinations
of constructs,
tools and methods
without technological
advancement.
This is analogous
to designing
and building
a unique and
complex office
building without
making any advances
in the field
of civil engineering.
- Note that
an advance in
technology can
rarely be described
by listing software
functions and
features at
an ‘end-user’
level. Advances
are typically
made through
innovation in
software architectures,
designs, algorithms,
techniques or
constructs.
- There is always
some uncertainty
about anything.
In software
development,
as in other
scientific and
technological
fields, uncertainties
that can be
resolved through
brief discussions
with peers,
or simply through
a few lines
of analysis,
are routine
design uncertainties
rather than
technological
uncertainties.
Likewise there
is routinely
the need to
calibrate or
optimise or
clean up new
software. These
challenges are
not technological
uncertainties
unless it can
be shown there
is a fundamental
problem with
the technologies
that must be
addressed. Refer
to paragraph
29 of this Commentary.
- In engineering
or software,
as in other
fields, to determine
whether or not
R&D is taking
place the test
to be applied
to a particular
project (see
paragraph 33
of this Commentary
for a definition
of ‘project’)
is whether persons
of appropriate
skill and expertise
would be able
to specify,
with reasonable
confidence,
how to achieve
the desired
advance. Where
such a person
is able to specify,
with reasonable
confidence,
how to achieve
the advance,
the activity
would be routine
and not R&D.
- As with other
forms of R&D,
the scope of
the overall
R&D project
is defined by
the technological
uncertainty:
once the uncertainty
is substantially
resolved (for
example, once
the overall
structure/architecture
of the software
and of its key
component routines
and engines
is resolved
and functioning)
the R&D
is over. Subsequent
tasks such as
the preparation
of user documentation
will not be
R&D. Refer
to paragraph
29 of this Commentary.
- As with R&D
in general,
not every component
of or activity
involved in
a software R&D
project needs
to be novel
in order for
the whole project
to be novel.
Software
used as a
means of achieving
the R&D
goal (paragraphs
25-28)
- Software is
frequently used
as a tool or
mechanism to
help resolve
technological
uncertainty,
i.e. to conduct
research and
development.
The Guidelines
refer to this
as ‘Software-based
R&D’, but
‘Software-using
R&D’ is
probably a more
accurate general
description.
Again, software
has equal treatment
with other forms
of technological
activity and
is treated just
like any other
tool or equipment
used to further
an R&D project.
Individual tasks
contributing
to the overall
project need
not themselves
be subject to
technological
uncertainty,
as long as the
whole project
is aimed at
resolving technological
uncertainty
(paragraphs
13-15, 25-27).
- This includes
the use of existing
or slightly-customised
software to
assist in carrying
out the work
(paragraph 25).
Paragraphs 26
and 27 give
examples of
situations where
software is
used as a tool
as part of a
larger R&D
project. Note
that the larger
project must
itself be R&D.
Also note that
the cost of
acquiring or
obtaining access
to such software
is not qualifying
expenditure
for the R&D
tax credits
- Paragraph
28 describes
a situation
where a project
(analysis of
market research
data) lies outside
the scope of
science and
technology,
and hence would
not be R&D.
For this reason,
developing software
for the purpose
would not constitute
software-based
R&D. However,
if the software
development
was expected
to result in
a significant
scientific or
technological
advance such
as a new query
language, then
the work contributing
to that advance
would be software
R&D, but
in the sense
(i) described
above (relating
to paragraphs
21-24).
Use of Software
in Engineering
- Functionality
in technological
products is
often implemented
through software.
As long as
there is technological
uncertainty
to be resolved,
both software
and hardware
implementations
of function
would be R&D
in the context
of the overall
project.
It is conceivable
that a situation
might arise
in which implementing
a hardware solution
was routine
(and as a result
technological
uncertainty
was at an end)
while a software
solution still
had significant
uncertainty
associated with
it, or vice
versa. In this
case, work on
the ‘uncertain’
solution would
be R&D while
work on the
‘routine’ solution
would not, because
all of the technological
uncertainty
associated with
the project
had been resolved.
However, in
practice there
will usually
be continuing
technical uncertainty
associated with
the project
regardless of
how function
is implemented.
Qualifying
indirect activities
- Paragraph
29 lists
a number of
qualifying indirect
activities.
For the purposes
of the R&D
tax credits,
only staff costs
of those actively
and directly
engaged in R&D,
consumable stores
and certain
sub-contracting
costs are allowable.
The list in
the Guidelines
does not overrule
the tax legislation
prescribing
qualifying expenditure.
- Paragraphs
30 & 31
list a number
of exclusions.
R&D would
normally exclude
work on:
- market research
or sales promotion;
- calibration
of standards
and quality
control or routine
testing of materials,
devices, products,
or processes;
- routine data
collection;
- research in
the social sciences
or the humanities;
- the commercial
production of
a new or improved
material, device,
or product,
or the commercial
use of a new
or improved
process;
- style changes;
- periodic alterations
to existing
products even
though they
bring about
some improvement;
- operational
research not
tied to specific
R&D activity;
- corrective
action in connection
with break-downs
during commercial
production;
- legal and
associated work
on patent applications,
records and
litigation;
- acquisition
of rights in,
or arising from,
R&D
- construction,
relocation etc.
of facilities
or equipment
other then those
used solely
for R&D
- education
and training
and provision
of scientific
or technical
information;
- routine computer
maintenance
or software
development;
- specialised,
but routine
medical care;
- policy studies.
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