How SaaS Companies Lose out on a 33.35% Tax Break

In our last article, we briefly introduced some of the key concepts around R&D tax claims and explained why Software-as-a-Service startups are an important beneficiary of R&D tax schemes.

Here we're talking about something closely related – how SaaS companies miss out on R&D tax relief that they should receive. A lot of the work a typical SaaS company carries out can be categorised as research and development, so the focus of this post is how research and development in SaaS startups is so easily missed or overlooked.

R&D tax credits reward high-tech businesses for seeking to resolve scientific and technical challenges, and HMRC consider any business investing more than 4% of their turnover on research and development to meet the definition of being ‘high tech’. Many SaaS start-ups invest multiples of turnover in qualifying R&D activity so the case for why R&D tax credits should be explored is clear.

Algorithm Development and Optimisation

Computer Science is now a well-established discipline, and it is now less likely for smaller companies to implement an entirely novel algorithm. If a smaller company has implemented an entirely novel algorithm, it would certainly know about it. Designing efficient algorithms requires a higher level of intuition than the most obvious solution; it’s a full engagement undertaking that requires a clear understanding of the environment.

SaaS startups are, in this sense, unique in that they are able to entirely control the environment their code runs in, they are not bound by traditional structures so often have extremely niche setups. The combination of hardware and infrastructure setup, and talented software engineers means that there may be many smaller optimisations in known algorithms for these specific, niche setups that are discovered by SaaS startups. Unique heuristics and performance optimisations designed for very specific setups still constitute an advance, and can qualify just as much for R&D tax relief, as a unique and original algorithm.

A SaaS business might easily develop refinements to, or heuristics for, load-balancing algorithms, consensus algorithms, or any of the most common algorithms of interest with respect to large data sets.

So why might these not be picked up as research and development? Principally, because these heuristics might mistakenly be considered too niche or specialist. In reality, what matters is whether your work seeks to resolve a technical or scientific uncertainty, and whether a competent professional could easily have replicated your work – not how generally applicable your results are.

It may also be the case that a company puts a great deal of effort and money into investigating alternative heuristics that might be optimal for a specific use case, only to discover that the status quo is most efficient. Although in this case the company did not benefit from the research, research and development still took place, an advance was being sought and a technical uncertainty has been resolved, so an R&D tax credit claim should still be pursued.

Writing For Scalability and Reliability

Writing for scalability and reliability constantly drives SaaS companies to innovate. The very high scalability and reliability required to become a successful SaaS business means that even development that is well-understood when it comes to client-side software can have additional technical uncertainty. When the additional security challenges that come with SaaS are thrown into the mix, it is apparent that there are numerous scientific and technical uncertainties surrounding even comparatively simple SaaS tools that need to be investigated and resolved.

Developing for scalability and reliability, though, feels relatively ordinary. Moreover, many talented software engineers take pride in treating scalability and reliability as a natural consequence of writing competent code. In the eyes of R&D it shouldn’t be, it’s often a consequence of writing exceptional, often innovative code that solves a technical problem that still thwarts many competent developers.

Why SaaS is Unique

SaaS is in a unique position with respect to R&D tax claims because the issues around data management, security, scalability and reliability are, taken together, unique to the business model.

The ability to frequently and regularly roll out updates to all your clients incentivises and directly rewards on-going research within the company in a way that traditional client-side software licensing did not. This can actually disguise qualifying R&D, as research that ultimately went nowhere gets forgotten and on-going research and development can become so integrated with everyday activities it doesn't 'stand out' as being a step forward.

Finally, the control you have over your core platform as a SaaS business means that you can spend less time dealing with obscure edge-case bugs caused by strange interactions on unusual system setups, and focus on resolving the core technical challenges presented.

Translating From Software Engineer

One of the main ways innovative software startups miss out on R&D tax credits is through their software engineers, and the self-deprecating way in which they can view their own work. Not because they aren't innovative enough – quite the contrary. Software engineers are so focused on problem-solving, and resolving technical challenges in general, that they often stop registering their own successes as being extraordinary or innovative.

When a software engineer talks about small tricks, or adopting a new architecture, or simply how they implemented a particular part of the system in a way that personally pleased them, your ears as a CFO, CEO should prick up straight away. Innovative approaches can easily lead to significant research and development claims, and talented software engineers often simply do not shout about the fact they have achieved something that would flummox most developers.

Modest software engineer syndrome can cost SaaS startups hundreds of thousands of pounds a year in lost R&D tax credit claims.

How Can I Avoid Missing Out On R&D Tax Credit Claims?

Being informed about R&D tax credit claims is the best way to ensure that your business avoids missing out on R&D tax relief. There are many subtleties involved with R&D tax claims – we haven't even touched on the effect that grants and other types of funding can have on R&D tax relief in this article, as an example – so there is almost always something unique to your situation that is all-too-easy to overlook.

The more aware you are of the potential for research and development tax relief, the more likely you will be to successfully claim a significant cash injection. Get in touch if you’d like to talk through pre-planning options or to discuss which of your activities could qualify for relief.

Post produced in partnership with Simon Brown and Adam Kotas at ForrestBrown.