A Clean Break

So How Does it Save you Money?

If, for example, you are a SME and spend GBP 100,000 on salaries for staff involved in pure R&D work, that GBP 100,000 becomes GBP 175,000 for the purpose of calculating your corporation tax liability.

The rate of corporation tax for many small companies is currently 21 per cent, so in this example, if the company is profit-making, this relief is worth an extra GBP 15,750 in tax it would otherwise have paid.

If you are a loss-making SME, using the same expenditure as above, you could opt to sacrifice the GBP 100,000 (not the GBP 175,000) from your corporation tax loss and get a cash tax credit instead from HMRC of 24.5 per cent - in this example GBP 24,500.

To a loss-making start-up this cash tax credit can be a lifeline, but it is a lifeline many companies fail to see, let alone grasp - but it should be noted that there is a requirement to have paid sufficient PAYE in the claim period to cover your cash tax credit.

In Summary

As is evident, many of the costs that qualify as R&D are typical costs for start-up SMEs. At the same time, there is a strong chance that many SMEs incur this standard expenditure on R&D, directly or indirectly.

However, SMEs often incur this expenditure without realising the opportunity that is available to recoup against it via R&D tax credits. Given the subjective nature of R&D, and the considerable scope within the HMRC definition, companies need to look closely at their activities to ensure they do not overlook a tax break that was created with a genuine motivation to encourage these businesses to continue to innovate.

But There's More - Alex Chapman

It is worth stressing that developers should also consider carefully the claims for R&D Tax Credits prior to the new regime being effective - ie December 9, 2009.

There is no question in my mind that the tax change opens up the system for developers and removes a significant barrier to claims. However with an expert hand to guide them, developers could also find that they can claim much more than they might have thought under the 'old rules'. This is because the definition of intellectual property under the old rules was sufficiently wide as to give developers much greater room to claim if they set out their claims appropriately.

Many developers consider the intellectual property requirement and the fact that under their development contracts the project is described as a "work made for hire" and therefore consider that it precludes them from claiming in respect of the R&D spend on anything other than the core underlying development tools or technology that they expressly own.

However This is Incorrect - Even Under the Old Rules

The new rules remove the issue going forward but it is worth knowing that there is a difference between what intellectual property would be assigned to a publisher as a "work made for hire" and what intellectual property would be created by a developer in the development of a game that would qualify as R&D spend.

However a "work made for hire" has a specific meaning that comes from US legislation - the United States Copyright Act (1976) - and importantly only relates to copyright works. Under section 102 of that Act it is expressly stated that copyright protection extends to (and therefore a "work made for hire" can only include) "original works of authorship fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device." That means it does not include anything in which copyright does not subsist.

However, intellectual property for the purpose of R&D tax credits includes "any industrial information or techniques likely to assist in the manufacture or processing of goods or materials".

Industrial information includes development techniques, methodologies and processes. It is not protected by copyright and so is not necessarily transferred to the commissioner of a "work made for hire". Additionally recent court cases have held that there is no copyright in the functionality or "feel" of software.

Therefore when considering the intellectual property that is retained by a developer under a contract expressing the project to be a "work made for hire" or otherwise assigning the copyright in the project, developers should note that they in fact retain far more than they might think and can therefore claim in respect of a greater R&D spend than they might think.