Research and development tax credit in information technology

General principles of the R&D tax credit

The general principles set out in the R&D tax credit web information apply to developments in computer science and information technology. Before lodging a claim for R&D in IT you should be familiar with the guidance on what R&D activities are eligible. In summary, to be eligible for the R&D tax credit, activities must:

• be directed at acquiring new knowledge or creating new or improved materials, products, devices, processes or services, and
• include systematic, investigative and experimental ("SIE") activities, and
• either:
  • seek to advance science or technology by resolving scientific or technological uncertainty, or
  • involve an appreciable element of novelty.

Issues relating to information technology

Identifying eligible R&D in computer science and information technology presents a number of issues, including:

• identifying:
  • scientific and technological uncertainty, or
  • an appreciable element of novelty
• differences between typical R&D processes in IT and other sectors
• how eligible activities should be recorded and tracked in such a fast moving area.

Find out more

• The expenditure limit on internal software development
• Applying to have the limit on internal software development expenditure increased

Scientific or technological uncertainty

To claim the tax credit based on scientific or technological uncertainty you must document:

• the publicly available state of knowledge at the time you began the R&D and the steps taken to determine whether generally known techniques (existing practice) could resolve the issues
• the issues which were scientifically or technologically uncertain
• the programme of experimentation which was undertaken.

Uncertainty in software development arises when the solution, or the method of arriving at the solution, to a technical problem is not publicly available or deducible by a competent professional in that field, after they have analysed the problem using generally known software development techniques. For there to be scientific or technological uncertainty the resolution of the problem can only be found through a programme of experimentation in which a possible solution or solutions are tried.

Many uncertainties in IT developments are not scientific or technological uncertainties, but arise from other sources of uncertainty. Uncertainties in IT that are unlikely to be eligible as SIE activity include the following:

• accurately identifying technical requirements (systems analysis)
• identifying which approach will deliver best results (systems engineering)
• uncertainties around staff skills and capability to deliver
• uncertainties around usability or market acceptance.

Note, however, that in some cases eligible uncertainties may arise in the course of this work.

 

Appreciable novelty

To be eligible for the R&D tax credit as involving an appreciable element of novelty, the activities must involve:

• a development or 'extension' of technology, or
• a new use of existing technology, beyond the uses of that technology that are known on a reasonably accessible, world-wide basis.

Technology is defined as the practical application of scientific principles and knowledge. The relevant comparison is with the knowledge about that technology - what it can do and what it can be used for - that is publicly available on a reasonably accessible, world-wide basis.

Appreciable novelty requires more than just a new feature or a unique development. To meet the requirement for appreciable novelty there must be concepts that are not obvious to professionals in that field, for example:

• new thinking
• an original idea, or
• an inventive step.

Many feature extensions and customisations are made with known combinations of constructs tools and methods which are publicly available, and for which the technology is neither developed nor used in an appreciably new way.

An appreciably novel development could be:

• evidenced by a patent, or
• one that would be recognised by competent professionals in that field, as making a meaningful or significant development or new use of the technology.

If your R&D is aiming to gain market advantage through a technological advance, you may have the basis for a claim for appreciable novelty. To claim the credit based on an appreciable element of novelty you must:

• document the current state of the publicly available technology at the time your R&D began
• identify the appreciably novel element in your proposed development or use of the technology; that is, what is the original thinking or new idea that has been introduced (or was pursued) in the claimed activities
• identify the programme of experimentation which was undertaken.

 

Typical IT development processes

The following sections examine some typical IT activities and consider where eligible R&D might arise. The guidance is not exhaustive but is intended to illustrate the key concepts.

Pre-production, feasibility analysis, proof of concept and systems analysis

Systems analysis typically involves a design phase which includes a systematic investigation of technical requirements, and an exploration of which technologies can be applied to achieve those requirements, which may include things like performance accuracy, reduced costs, reduced complexity and provision for growth. Some businesses will operate an initial 'pre-production' or 'feasibility' or 'proof of concept' stage where key issues are identified and work is undertaken to determine what needs to be resolved for a successful outcome.

Proof of concept work and systems analysis typically first consider whether existing technologies can meet the requirements. Where the development path is identified through an analytical process, without the requirement for an experimental approach, and development is based on available tools and known constructs in proven combinations or adaptations of them, the project is unlikely to be eligible for the R&D tax credit, for the reasons set out in Eligible R&D activities v development based on existing practice.

Where proof of concept work or systems analysis identifies a need for which a competent professional in that field cannot identify an appropriate existing technology or methodology, there may be scientific and technological uncertainty, or a need to think outside the box, or use unconventional approaches - which may constitute appreciable novelty.

Such work will involve pushing beyond (developing) the technology horizon of today or the use of new approaches. For such work to be eligible you will need to be able to identify:

• the scientific or technological uncertainty, or the appreciable element of novelty, and
• the programme of SIE activities that was required to seek to resolve the uncertainty or introduce the novelty.

Problem-solving

During a development, problems may arise which defeat competent professionals in the relevant field and which require experimentation to test hypotheses about what is causing the problem.

It may be that systems components are interacting oddly or that an element in a development is not performing as expected despite having been tested. In these cases eligible technological uncertainty may exist.

However, problem-solving in software development may be hard for professionals, without there being scientific and technological uncertainty. A development may encounter difficulties that require an approach that is beyond the skills and knowledge of in-house professionals, but it may be deducible by professionals with experience in the relevant field.

Good record-keeping, identifying the steps taken to determine the state of knowledge at the time, is particularly important in software development where the state of knowledge moves rapidly.

Systems uncertainty

One type of uncertainty is system uncertainty, which refers to uncertainty about the successful integration of software components or technologies. The concept of system uncertainty alone does not justify a claim for the R&D tax credit.

A scientific or technological uncertainty in systems integration exists only if the integration involves interactions between components or technologies that were unknown or unpredictable before the integration and the means of resolution is not known to or deducible by a competent professional in that field.

If aspects of the systems integration require an SIE approach to test hypotheses about the sources of problems or the means of resolution then these aspects of the integration, while not making the whole integration project eligible, may provide a basis for a claim for the R&D tax credit.

Modelling, simulation and mathematical advances

There may be advances in science and technology or appreciable novelty where the key advance is in mathematics, statistics, physics and similar fields, but the realisation of the project goes hand in hand with significant software development. In these instances the SIE activities may result in the development of a new algorithm or model and software development may be an eligible support activity.

Testing

Testing is a routine part of software development. The presence of testing does not satisfy the requirement that there is a systematic, investigative and experimental approach. Testing may however be an eligible activity for the R&D tax credit if it is part of an attempt to resolve a scientific or technological uncertainty or to introduce an appreciable element of novelty. Such testing will be eligible if it meets the criteria as a support activity.

Research projects designed to test user interfaces are unlikely to be eligible because they research human behaviour (social sciences) rather than seeking to resolve scientific or technological uncertainties.

Testing the security of an application or the reliability of processes is also unlikely to be eligible in its own right as it is a normal part of product evaluation and/or quality control. However, these activities may be eligible as support activities.

Systematic, investigative and experimental (SIE) activities in IT

To be eligible R&D software development must involve SIE activities which are directed towards a particular purpose and follow a logical progression involving:

• hypothesis
• experimentation
• observation, and
• evaluation.

Hypothesis

For your work to be eligible for the tax credit, you must have one or more hypotheses. A hypothesis is a theory, not a fact; and it must be testable, and the outcome must not be currently known.

Experimental approach

You should be able to show that your experimental approach was designed to systematically test the hypothesis and that it involved making observations or measurements, aimed at resolving the uncertainty or introducing the element of novelty.

R&D processes in IT differ from those used in other industries. When faced with technological uncertainty many software developers design experiments using prototype code. Prototype code is not fully featured and is quickly built, to check out critical performance issues or interfaces. The code is often abandoned following testing but the successful architectures and constructs are carried forward to the final design. It is not necessary to build prototype software to meet the requirement for SIE activity. However, where this approach is used the claimant should be able to readily identify any scientific or technological uncertainty or element of novelty and the activities designed to test the proposed solutions.

Record keeping

For general information on record keeping requirements you should refer to the section on keeping records to support your claim. The following paragraphs discuss some sources, with particular relevance to information technology.

What constitutes appreciable novelty or scientific and technological uncertainty depends on the current state of knowledge and the technology at the time the eligible R&D activity commenced.

Because of the speed of change in IT, it is important that records, from that time and documenting the current state of knowledge, are retained to substantiate a claim. These may not be reviewed until some years later.

Stage-gating and issue tracker systems that identify the problem, the steps taken to identify known solutions and, in the absence of a solution, and the SIE activities undertaken to overcome the problem, are particularly helpful in isolating the uncertainty and the eligible activities undertaken to resolve it.

Examples of sources that may assist you to document the then current state of knowledge include Web pages, dated wiki entries, blogs, good academic references, patent searches and notes of discussions with competent professionals.

Eligible R&D in software is often episodic and only a subset of the activities on the larger project. It is therefore important to document when the issue that involved appreciable novelty or resolving uncertainty arose, and to have systems in place that can identify and record when this was resolved and when the eligible R&D finished.

 

Date published: 24 Mar 2009

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