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Software development – should you claim R&D relief or the capital allowances super deduction?

02 November 2021

Since the introduction of the new Super Deduction in March 2021, we have had many discussions with companies across numerous industries about how they may benefit from this new lucrative first year allowance. At first glance, the main beneficiaries will be companies incurring expenditure on tangible and physical assets such as property investors, hoteliers, retailers and manufacturers investing in plant and equipment. However, there is also an opportunity for companies incurring expenditure on software and similar intangible assets to also benefit from the super deduction.

With research and development (R&D) relief also potentially available for such expenditure, it will be important to consider on a case-by-case basis what claim and which regime will provide the most beneficial result.  

The Super Deduction

On 3 March 2021, the Chancellor announced two new first year allowances (FYAs), the 130% ‘super deduction’ and the 50% ‘SR allowance’ for expenditure on ‘new and unused’ plant and machinery that qualifies for plant and machinery allowances. Plant and machinery qualifying as main pool expenditure will be eligible for the 130% super-deduction, with plant and machinery qualifying as special rate pool expenditure eligible for the 50% SR allowance.

The key points and considerations for these FYAs are –

  • They both apply for expenditure between 1 April 2021 (under contracts entered into after 3 March 2021) and 31 March 2023
  • The FYAs are only available for expenditure incurred after 1 April 2021
  • They are only available to companies subject to corporation tax (not individuals, partnerships, or LLPs)
  • They are not available for leased plant and machinery unless the plant is ‘background plant’ within a building leased to a tenant
  • Where the assets are later sold, super deduction claims are clawed back automatically through balancing charges in the year of disposal

Software expenditure

Since April 2002, capital expenditure incurred on computer software and websites, and associated costs such as development costs, will automatically fall into the corporate intangible assets regime rather than the capital allowances regime. Under the intangible assets regime, the tax relief follows the accounting treatment for expenditure incurred on software, with amortisation normally allowable as a deduction in the tax computations and returns.

It is important to note that this is the default treatment for capital expenditure incurred on software. In some instances, expenditure on software and other intangibles may be considered revenue in nature and, therefore, either expensed in full or, if it is capitalised, eligible for a first year tax deduction where it is attributable to R&D activities, (s1308, CTA 09).

Elect in to capital allowances regime?

As one alternative to the intangibles regime, companies have the discretion to elect into the capital allowances regime, so that plant and machinery allowances can be claimed instead. The election can be made under Corporation Tax Act (‘CTA’) 2009 s815, and has to be submitted within 2 years of the end of the accounting period in which the expenditure was incurred.

Generally, whether a company elects out of the intangibles regime and into the capital allowances regime is a decision based on how quickly the tax relief can be realised. This depends the on rate at which software is amortised within the company’s accounts, comparable to the 18% writing down allowance available for main pool plant and machinery expenditure or, if available, the opportunity to claim under the 100% AIA (currently £1m until 31 March 2023). In practice, the AIA is both capped and is shared between groups and connected companies, so is often exhausted before considering an AIA claim for software expenditure. However, as software falls into the main pool for plant and machinery allowances, the super deduction would be available provided the expenditure incurred meets the other criteria (set out above).

A key condition for super deduction eligibility is whether or not expenditure is incurred under contracts entered into after 3 March 2021. For software acquired from a third party, this condition should be relatively simple to meet as contracts, purchase orders and invoices should be documented and available. For internal software development, which will include capitalised internal staff costs, this condition will be more challenging to meet. We are still awaiting HMRC manual guidance for the super deduction, so their view on super deduction eligibility with no formal contract or for in-house development is unclear. This point will need to be carefully considered, and eligibility of the project confirmed, before a claim can be made.

More so now than ever, companies should carefully consider whether a s815 election would be beneficial over the intangibles regime; the 130% super deduction available provides a big opportunity to both enhance and accelerate the tax relief available compared to amortisation relief over a longer period.

R&D on software expenditure

Where expenditure on software development is revenue in nature, i.e. it requires constant enhancement and development to stay relevant and up to date, it will often be possible to make a R&D tax credit claim for the qualifying expenditure. This is the case if the expenditure is expensed to the Income Statement or capitalised as an Intangible Fixed Asset.

R&D tax relief is very valuable to a claimant company as it is cash generative; worth between 11% (after tax) to 33% of qualifying expenditure; and R&D tax credits under the R&D Expenditure Credit regime (for large companies), and in certain circumstances for SMEs, can be accounted for in pre-tax earnings, thereby boosting EBITDA.

In addition, quite often more activities and costs qualify for R&D tax relief than the company initially expects.

Choosing the best relief

With the introduction of the super deduction, it has never been more important for businesses to carefully consider the different tax reliefs available for qualifying software expenditure. There are three key practical considerations:

  1. What will the expenditure qualify for? – Not all software expenditure incurred will qualify for these tax reliefs; the super deduction has stringent contract and expenditure incurred date requirements and R&D relief is only available for technological and scientific development projects. Considering the entitlement to claim will be imperative in order to be able to weigh up the benefits of one claim over another.
     
  2. Have we captured the relevant information and expenditure – Accurate information and documentary evidence are required for both super deduction and R&D claims: if you don’t have good records how can you be sure you have claimed all you are entitled to claim? All relevant expenditure should be identified, including expenditure incurred on software licences, software development, in-house development salaries, domain and hosting fees and any third party contractors and professionals.
     
  3. Modelling to understand the benefit – Once entitlement is established and expenditure is identified, it will then be important to model the relevant tax reliefs available alongside the wider corporate tax strategy to understand the impact. Considerations will include the creation of losses and therefore loss carry backs and carry forwards, the opportunity cost of claiming the super deduction instead of R&D, and how your claim affects tax planning for current and future years. It will also be important to model for any potential balancing charge and clawback for super deduction claims.

How we can help

BDO’s specialist R&D and capital allowances teams can help businesses investing in software to capture qualifying expenditure, consider the tax reliefs available, model the impact of respective claims on your wider tax profile – giving you the tools to choose the most beneficial route for your business. We specialise in preparing both R&D and capital allowances claims on behalf of clients and have an outstanding track record in agreeing claims with HMRC.

For help and advice on the tax reliefs available for software development please contact Carrie Rutland, Steve Watts or Sean Alexander.