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UK Software Companies Missing Out on R&D Tax Credits by Overlooking Indirect Costs

In the UK, software companies often engage in research and development (R&D) activities that qualify for valuable tax reliefs, but many overlook the opportunity to claim indirect R&D tax credits. These credits can be claimed not only for in-house innovations but also for outsourced or collaborative R&D work in the UK. By understanding how to leverage indirect costs—such as software development services, subcontracted work, or third-party technical research—businesses can significantly reduce their tax liabilities. This guide will explore how a software company can determine indirect R&D activities with practical demonstrative examples.

Background

Company A is a mid-sized UK technology company specialising in software development for the healthcare industry. During its claim period, it sought to develop an AI-based platform to help analyse large datasets for predictive insights. This involves solving significant technological uncertainties in algorithm design, data processing, and scalability.

As part of its product development process, Company A frequently engages in activities that indirectly support its core R&D projects. These activities, while essential to the R&D process, do not directly result in an advance in science or technology. However, under HMRC’s R&D tax relief guidelines, many of these activities can still be claimed if they contribute to the overall success of the R&D project.

What are Indirect R&D Activities?

Indirect R&D activities are those that do not directly involve resolving scientific or technological uncertainties but are nonetheless essential to supporting the core R&D. Under UK regulations; these activities can still qualify for R&D tax relief if they fall within certain specified categories. Let’s explore how Company A developed its AI platform and the indirect activities it can claim.

Identifying Indirect R&D Activities

1. Scientific and Technical Information Services

To support its core R&D, the software company tasked its data science team with preparing detailed reports on the testing of their AI algorithms. These reports were essential for internal discussions, external presentations, and future improvements. Although the report preparation did not directly contribute to resolving technological uncertainty, it helped disseminate R&D findings across the organisation and stakeholders.

Example: The company’s lead data scientist compiled a comprehensive report on AI performance across different testing datasets, which was used to inform further medical research.

2. Indirect Supporting Activities

The R&D team required dedicated financial and administrative support to manage the budget, contracts, and staffing for the project. The company’s finance team allocated time to ensure that all R&D expenses were correctly tracked, and the HR team managed the recruitment of specialised data scientists and AI researchers.

Example: The HR department spent considerable time recruiting PhD-level AI researchers, essential to the project, and payroll services ensured timely payments to the R&D staff.

3. Ancillary Activities Essential to R&D

Maintaining a dedicated data lab for R&D was critical to the success of the project. The company leased additional lab space for its R&D activities and ensured that the high-performance servers required for data analytics were maintained.

Example: The IT team maintained the server infrastructure used exclusively for running large-scale AI models. While this equipment was not part of the core innovation process, it was crucial for conducting the experiments.

4. Training for R&D Support

As part of its AI platform development, the company introduced several cutting-edge tools and techniques. To enable its team to use these tools effectively, it organised specialised training programs on AI frameworks and data processing technologies.

Example: Bringing in an external expert to train the team on TensorFlow, an open-source AI platform. This training helped the team develop and test their algorithms, making it a qualifying indirect activity.

5. University Collaboration

The company partnered with a local university where postgraduate students worked on ancillary research that fed into the project. While their specific research was not part of the company’s core R&D efforts, the insights provided by these students contributed indirectly to the broader understanding of data processing methodologies.

Example: A university team conducted a literature review on existing data-sorting algorithms, which the company used to validate its own approach, making the university collaboration a qualifying indirect activity.

6. Feasibility Studies

Before initiating the development of the AI platform, a series of feasibility studies were conducted to explore the viability of different AI architectures. These studies involved preliminary tests and evaluations, helping the team decide on the right technology stack for the project.

Example: The company evaluated whether using GPU clusters or cloud-based AI solutions would better meet their scalability needs. The studies were vital in informing technical decisions, but since they did not directly contribute to resolving the core R&D uncertainty, they were categorised as indirect R&D activities.

Outcome: Maximising R&D Tax Relief

By carefully documenting indirect activities, Company A was able to maximise its R&D tax relief claim. In addition to the direct costs of their core AI development, they were able to include:

• Time and resources spent on scientific reports.
• Administrative and HR support for R&D staff.
• Maintenance and leasing costs for R&D-specific equipment.
• Training costs related to AI frameworks.
• Collaboration with the university research team.
• Expenses related to feasibility studies.

The inclusion of these indirect R&D activities increased Company A’s claim by 20%, allowing it to recover a significant portion of its R&D expenditure. This financial relief helped the company reinvest in its technology stack and hire additional staff, ultimately accelerating the development and commercialisation of its AI platform.

Lessons Learned:

1. Broad Scope of R&D Tax Relief: Many activities that support core R&D, such as reporting, personnel management, and equipment maintenance, can qualify as indirect R&D activities, which companies often overlook.

2. Importance of Documentation: Clear documentation of both direct and indirect activities is key to maximising R&D tax relief claims. Company A’s finance and HR teams kept detailed records, which were essential during the tax relief submission process.

3. Collaboration Opportunities: Collaborating with academic institutions can qualify as an indirect activity, providing access to additional research capabilities while offering tax relief benefits.

Conclusion

Company A's case highlights the significance of understanding indirect R&D activities and their potential to substantially bolster a company's eligibility for tax relief. By identifying and documenting them, businesses can optimise the financial assistance offered by the UK's R&D tax relief program, consequently promoting additional innovation and expansion.

If you have questions about this article or the R&D tax credits scheme, contact us, or dive deeper into the world of R&D tax credits with our comprehensive R&D tax credits explained page – check it out here! 🔍