Tax inspector training could boost software tax credits

Valid tax credit claims are often turned down, say industry organisations

Business groups are welcoming the possibility of specialist training for tax inspectors, to improve the take-up of research and development (R&D) tax credits for software developments.

Industry organisations such as Intellect and the Confederation of British Industry (CBI) say inspectors’ lack of understanding of software development means valid claims for tax credits are being turned down.

The government has agreed to work with the industry to establish whether extra training would help solve the problems, according to a report on tax credits and innovation published by the Treasury and HM Revenue and Customs (HMRC) this week, alongside the Chancellor’s Pre-Budget Report.

‘The government will consider whether there is a need for further training of HMRC staff to better understand the processes of R&D generally, particularly in areas such as software and engineering where difficult issues can arise,’ says the report.

The investigation is part of the Treasury’s intention to make the tax credits system clearer and applied more consistently. It also fits in with recommendations published last week in Sir George Cox’s review of creativity in UK business.

The R&D tax credit system was introduced in April 2000 to stimulate innovation, and to help make the UK an attractive location for the research facilities of global companies.

Companies investing upwards of £10,000 in research can deduct up to 150 per cent of that expenditure when calculating annual profits for tax purposes.

The incentive is of considerable importance if the UK is to be able to compete with emerging economies such as those of India and China, according to the Cox report.

‘The concern is not so much for the current capability of the fast-growing countries, but rather for the pace and scale with which they are building their hi-tech industries, their scientific base, their research capabilities, and their skills base and educational facilities,’ it says.

But software-heavy R&D projects can lose out when applications for tax credits are put to HMRC, says Tom Wills-Sandford, director of public affairs at Intellect.

For example, some companies have had applications refused because their use of a standard computer language has left tax inspectors assuming the development could not possibly qualify as ‘innovative’.

‘It is ludicrous, like saying you cannot build an interesting house using bricks,’ said Wills-Sandford.

Improved training for inspectors would have a significant impact, he says.

‘If the UK is going to have a knowledge economy, one of the major components is how much R&D is done here,’ he added.

‘Confusion and erroneous application rejections are not encouraging that. People start to lose faith and stop trying to apply for the credit, and before you know it, software development has gone offshore.’

The problem is that software may not be tangible in the same way as more traditional, product-oriented developments such as engineering, says Tim Bradshaw, senior policy adviser for technology and innovation at the CBI.

‘It is easy to look at a new drug or aeroplane engine and actually see the R &D,’ he said.

‘It is more difficult to understand the way that software is developed, and how incremental changes build up over time into a new product or service offering.’

Consistent application of the tax credit is important not just for companies investing in software development specifically, but also for all businesses conducting development that has a software component.

According to CBI figures for the last tax year, the tax credits system helped smaller companies to reduce their development costs by five per cent, some way short of the government’s 9.5 per cent target.

And larger companies saved only three per cent, compared with a 7.5 per cent target.

‘One of the factors behind the figures is that people are only claiming for the projects on which they know they will get money back,’ says Bradshaw.

‘If it looks as though there will be a problem, or they will have to have an argument because HMRC does not understand, then companies do not want the hassle.’

Improving the effectiveness of the R&D tax credits scheme is a central recommendation of the Cox review of business creativity.

The report was commissioned by the Treasury to consider how UK business can best compete in the global marketplace.

It calls for a dedicated unit in HMRC to ensure consistency, and to shore up business confidence in the credits scheme.

‘Tax inspectors need to recognise that this is an incentive scheme to be encouraged, not an avoidance scheme to be policed,’ says the report.

‘To be fair, many tax inspectors accept this and approach the matter in a pragmatic manner, but that is far from universal.

‘Companies cannot be expected to increase their R&D investment in the hope that they will encounter an enlightened tax inspector.’

Improving the training of tax inspectors and, therefore, the clarity of the scheme is very much in line with the recommendations of the Cox report.

‘The tax regime plays a significant part in [international organisations’] decisions about where to site a research programme or, more important, a research facility,’ it says.

‘However, it is not a simple matter of who offers the most generous allowances.

‘An important consideration is the clarity of the scheme, along with its ease of application and the confidence of the projected claims being allowed.’