Why R&D Tax Relief Is A Serious Issue For SaaS SMEs & Startups
If you’re a regular visitor to our blog, you’ll know that it’s helpful to have a creative, flexible CFO, and that there are many useful schemes specifically designed to help start-ups leverage their money as much as possible. You may not have seen as much discussion of R&D tax relief, an increasingly important area of tax law that we specialise in at ForrestBrown.
R&D tax relief can be a lifeline for start-ups, and especially for start-ups grappling with complex technical challenges and nascent technologies. This is often a sticking point, as the sort of technically proficient CEOs, CTOs and software engineers we’re speaking to can be the first to talk down their own work. We’ll get to why this can prove to be a costly mistake in a while, but first we’ll give you a quick overview of what R&D tax relief is, and what it can do for you.
How Much Can Companies Claim In R&D Tax Relief?
For every £100,000 that an SME spends on qualifying R&D activities they are able to recoup up to £33,350 from HMRC. The amount of relief available via R&D tax relief has risen consistently over the past five years, and since the requirements for a minimum R&D spend have been removed, SME or start-up companies that carry out qualifying research and development activities could often stand to receive significant benefit.
Companies can claim for R&D tax relief in a number of ways, but at present the companies that get the most value per R&D tax claim are small, early-stage innovative, loss-making businesses. That describes a significant majority of start-ups, however it is worth noting that ‘small company’ for R&D tax relief purposes is a company that has less than 500 employees and revenues of less than €100m or gross assets of less than €86m. Larger companies that fall outside of the SME definition can still benefit from tax relief of approximately 6-8% of qualifying expenditure.
What Can Companies Claim For?
Companies can claim for expenditure on R&D projects that meet the Department of Business, Innovation and Skills (BIS) guidelines on the meaning of research and development. The guidelines are relatively comprehensive and the definition of research and development is quite straightforward; a project that constitutes research and development must seek an advance in science or technology, and the project must seek to resolve scientific or technological uncertainty to achieve this advance. It is acceptable to attempt an advance, but ultimately fail to achieve the advances sought. The key is uncertainty, which must be scientific or technological in nature and not, for example, merely commercial challenges that need to be overcome. If a project can be demonstrated to have advanced the technological baseline, and costs have been incurred to achieve this advance then HMRC will support the project with some of the most generous R&D tax incentives available under EU State Aid rules.
A company might claim for developing new techniques to deal with big data, for grappling with a context-based associate rule mining algorithm; for a neat heuristic to use in a load-balancing algorithm across distributed environments; for advances in accessibility, or the implementation of non-standard cryptographic techniques; or even developing flooring for a pigsty to comply with tougher new EU directives.
There’s no one circumscribed industry that can claim for research and development which means that no sector goes without. That said, SaaS businesses are particularly likely to have a large, valid R&D tax claim, and SaaS start-ups tackling big problems are particularly likely to experience a sizeable benefit from such a claim.
Here’s how an R&D claim could help your business, after which we’ll discuss why SaaS start-ups specifically could benefit from innovation-based tax relief.
How R&D Claims Can Help SaaS Startups
R&D claims can help SaaS start-ups at all stages in their growth, as the extra value gained from an R&D tax claim can be hugely helpful both in terms of attracting investors to funding rounds and in terms of directly easing the pressure on early start-ups with short runways.
Ultimately, although we believe that funding a start-up follows more of a virtuous circle than a linear ramp pattern, we can analyse the benefits of R&D tax relief in terms of two main stages of development. Pre-investment companies and post-investment companies have concerns that, while similar, are different enough that we can explore them as separate topics.
Pre-investment R&D Tax Claim
- Can strengthen cash flow fairly rapidly, with most R&D claims processed by HMRC within less than 28 days
- Gives management the time and space to work out inevitable teething problems
- Demonstrates to investors that the company is financially astute, and maximising those funding options available to them
- Provides evidence to potential investors that you have a moat, and your work can not be easily replicated
- Minimises the impact of difficulties on the way to the final product:
- Pivoting your business or product to focus on something new
- Hitting research and development dead-ends
- Finding unexpected technical challenges that hinder delivery of a complete product
Post-investment R&D Tax Claim
- Allows for extra runway in a business with a high burn rate
- Incentivises a business to retain a talented team during a difficult early period with higher salaries which can be recouped
- Demonstrates to the board that management have a firm grasp of finances
The core benefits of successful R&D tax claims for start-ups can be summarised as ready cash, irrefutable demonstration of innovation, and risk mitigation.
Which SaaS Projects Count As R&D?
The key test is that the solution adopted would not have been immediately apparent to a suitably qualified professional within the field.
Here are some examples that may, depending on specific circumstances, potentially qualify as research and development projects:
- Experimenting with new architectures, data structures, databases and algorithms to deal with intense and unique scalability challenges, performance and reliability requirements. Writing an algorithm to schedule tasks in the most optimal fashion.
- Developing new tools and modifying existing tools to assist with the new workflows. Developing a plugin for your IDE to automate or enable a desirable workflow.
- Identifying opportunities for performance improvement using unconventional methods. Testing the performance characteristics of RINA, TCP/IP and DCTCP for your use case, techniques around improving the performance of RINA.
- Ensuring that your service is secure. Designing your service in a new or unusual way in order to minimise the attack surface presented.
These examples can equally apply to non-SaaS software companies, but SaaS companies can often be more likely to have on-going R&D projects, and the uncertainties presented are likely to be more frequent than those within the realms of more traditional software development projects.
Why Can SaaS Companies Specifically Benefit From R&D Tax Relief?
Software-as-a-Service companies, and especially start-ups, are particularly likely to benefit significantly from R&D tax relief claims. This is partly down to the nature of the work carried out, and partly due to difficulties that all SaaS companies must face and overcome. The former ensures that, yes; you are likely to be receiving significant levels of R&D tax relief. The latter ensures that the money reclaimed will have more of an impact on the overall success of your company.
The costs of hardware, hosting and infrastructure for a SaaS company can be relatively rigid and inflexible. The software has to be developed with inherent scalability, it has to be absolutely secure, and ‘five nines’ of reliability is now considered by many to be the bare minimum standard for the sector. These costs decrease runways and pile on pressure from the outset – meaning that an injection of cash courtesy of HMRC can prove critical to a SaaS businesses survival.
These costs, of course, indicate complexity. Because your minimum viable product is not necessarily a minimal viable product, you can’t start small and iterate. Because you can’t start small and iterate, you need to invest a huge amount of money resolving scientific and technical uncertainties, perhaps before you receive your first customer – perhaps even before you receive your first investor. By resolving scientific and technical uncertainties, you are more likely to be eligible for R&D tax relief, and during early phases of development where cash flow is extremely important.
Modern cloud computing is still maturing, and many algorithms (for example some load-balancing algorithms or consensus algorithms) have only just left the rarefied air of academic research’s ivory towers. Whether they take flight or flounder depends on how well real world companies resolve technical uncertainties and find ways to implement these algorithms in real world scenarios. Existing on the cutting-edge of research, if you run a SaaS start-up it’s likely that a lot of the activities you may even consider to be routine will qualify for R&D tax relief.
How To Learn More About R&D Tax Relief
ForrestBrown are R&D tax relief specialists who would be happy to help you if you’re thinking about the possibility of making a claim, or suspect that you’re not claiming as much as you could. We regularly publish in-depth articles about the world of research and development tax, so follow us on LinkedIn or read our latest news to keep up-to-date with the latest developments.
Post produced in partnership with Simon Brown and Adam Kotas at ForrestBrown.