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System Development Capitalisation

Hi all

My organisation has recently developed the operating I.T.  system at the request of a client (who utilises this system). The costs have been recharged to the client in full. I intend to capitalise the costs incurred for the development but am unsure if any issues arise due to the fact that the costs have been recharged to the client and reflected as revenue within the current period?

Any help would be greatly appreciated



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By merlyn
08th Aug 2012 14:13

Are you claiming R&D tax

Are you claiming R&D tax relief for the expenditure ? If so then you can't capitalise the costs and also claim this relief.

If you aren't claiming R&D tax relief then you should look into it as it may be more beneficial that capitalising the costs.


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09th Aug 2012 12:26


I appreciate you deal with software based R&D claims but it is not strictly correct to say that is you capitalise the expenditure in the accounts it will be ineligible for R&D tax relief.  The rules changed for accounting periods after January 2005 - I refer you to the link you provided to the client which contained a further link (attached below) to explain the treatment of qualifying expenditure that is capitalised in the accounts and can be included in an R&D claim.

I don't want to get drawn in to discussions re R&D claims as they are notoriously complex but thought I should mention this relaxation of the rules that appears to have gone under the radar.

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08th Aug 2012 14:41

Hi Merlyn thanks for your reply

The intention was to classify the expenditure as an intangible asset and then claim R&D tax relief on the CT return (adjusting for depreciation etc) at year end.

Would applying the above method be incorrect?








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By merlyn
08th Aug 2012 14:46

Do you mean you want to use the Research and Development Capital Allowance scheme ?

Sorry I only deal with revenue expenditure with regards to R&D tax relief, which you may qualify for depending on the nature of the development work undertaken and how your client engaged you.



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08th Aug 2012 16:08

Yes I believe thats the scheme I will be using, treat the assets as intangible and depreciate, then make the necessary claim of R&D relief at year end through the CT return.


Thanks for yourcomments Merlyn, its much appreciated. Any advice/documentation you have with regards to the revenue expenditure for R&D tax relief would also be appreciated as it may be more beneficial to my organisation to adopt another approach?





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By merlyn
08th Aug 2012 16:48

The HMRC rules can be a bit complex but I’ll try to give you some pointers.

In order for a work to qualify for R&D tax relief it has to be performed by a limited company and meet the following criteria -

1) It must be project driven
So must have defined goals, a project plan etc

2) Must be seeking an advance in science and/or technology
This basically means you must be trying to do something which either hasn't been attempted before, or which there is limited information about in the public domain. It doesn't have to be unique, so if someone else has already achieved a finished product, but haven't released details on how they achieved this, then work to try and create the same product may qualify.

3) Must be trying to overcome technological or scientific uncertainty –
This is the one most people struggle with, what it really means is that at the start of your project there is an uncertainty that one or more of your project goals may not be possible. It can’t just be your uncertainty but more of a general industry one.

An uncertainity is almost always a question and some examples for software development are  "Can we create a stable interface between system X and system Y?", "Can we get results from system X within 1 second?" or "Is it possible to make the system do X?"

4) The knowledge couldn’t be readily deduced by a competent professional
This ties into number 3 and qualifies that the uncertainty isn’t just yours.

What you need for a successful claim is a breakdown of your R&D expenditure and a technical summary which explains to the HMRC what projects you have worked on and why they meet the guidelines for R&D tax relief.

Once you have worked out what you have spent on your qualifying projects (including staff costs, software, electricity etc) then for a corporation tax paying firm it's worth about 20% (based on an SME).

You can claim back for the past 2 accounting periods, so if you paid corporation tax for these periods then you will get a refund from the HMRC and if your claim is worth more than the tax you paid you can either create an additional loss and then carry this forward to use against corp tax liabilities in the future or you can surrender this loss for either 14% or 12.5% cash depending on which year it was.

The technical summary is the most complicated bit and this is the bit my current firm help clients with. The trick is to not make them too complicated as the HMRC generally aren't experts in industry.

Once you have ammended your tax return (CT600) to show your R&D expenditure that is sent that along with your tech summary and figures spreadsheet to one of 7 HMRC specialist units for processing. Then within about 30 days the HMRC either approve the claim and process your refund (or approve your loss to carry forward), or they open an enquiry which means they either think your figures are a bit high, or want to come and see the work you are claiming is R&D.

I've dealt with a few enquiry's and they aren't actually that bad, but it does help if you have used a specialist firm to help with your R&D claim as they usually attend the enquiry with you and will fully prep you on what to expect, what to say etc.

After the enquiry the claim is either then approved, or rejected.

I've submitted around 100 claims for software companies and as yet haven't had an enquiry opened, but it does all rely on a well written technical summary.

There are also some rules regarding subcontracted work, where you have been paid by a 3rd party to undertake development work, I can provide more infomation if required.

Hope this helps



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08th Aug 2012 17:09

Thats very interesting!

We've never done 3rd party work but I'll look into our projects and compare to your comments


Thanks again


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By merlyn
08th Aug 2012 17:17

No problem, my background is software development.

So if you have any questions regarding what work may qualify let me know.

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08th Aug 2012 17:27

I will review and let you know, thanks for you help on this!

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By merlyn
10th Aug 2012 01:19

Whilst I agree the rules regarding R&D tax relief can be complex, when I asked the HMRC about capitalised costs being included as part of a claim, they told me the following - 

If the labour charge is not prevented from being an allowable deduction and it is capitalised in the accounts, then it can be included in the tax computation with an enhancement to calculate the profit/loss for tax purposes.

If there is no adjustment in the CT computation, then R&D tax relief is not due.  

Expenditure can only obtain R&D Tax Credit relief if it is deducted in the CT computations. If you capitalised your R&D expenditure you can’t get relief on it.

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10th Aug 2012 09:13


What they are saying is if you don't claim the revenue expense as a tax deduction in the first place then you can't claim the enhancement.  Therefore, say you capitalise £100 of qualifying labour - you must first claim a £100 deduction in your CT computation and then claim the enhancement.  If you don't claim the £100 in the first place (ie as a tax deduction) you can't claim the enhancement on its own. If you read your comments again :

If the labour charge is not prevented from being an allowable deduction [IE IT IS QUALIFYING EXPENDITURE FOR R&D IN THE FIRST PLACE] and it is capitalised in the accounts [CLEARLY THIS CONFIRMS THAT YOU CAN GET R&D RELIEF FOR CAPITALISED EXPENDITURE OR WHY BOTHER TO MENTION IT] , then it can be included in the tax computation [IE BY TAKING A DEDUCTION AGAINST PROFITS FIRST] with an enhancement to calculate the profit/loss for tax purposes [IE THEN YOU CLAIM THE ENHANCEMENT AFTER CLAIMING THE PRINCIPAL AMOUNT].

If there is no adjustment in the CT computation, then R&D tax relief is not due [IE IF THERE IS NO DEDUCTION FOR THE PRINCIPAL AMOUNT IN THE TAX COMPUTATION YOU CAN'T CLAIM THE ENHANCEMENT]

The last line "If you capitalised your R&D expenditure you can’t get relief on it. " That is simply wrong and contradicts what they are saying at the start of the same statement and is clearly a contradiction of the legislation and HMRC guidance at the link I sent - please note I have made a number of R&D claims including capitalised (deferred) revenue expenditure and have never had any issues with HMRC - but you must firstly claim the initial cost as a tax deduction and then claim the enhancement.DEDUCTION IS TAKEN FOR THE PRINCIPAL [IE  

HMRC guidance per my link states :

Deductibility in computing profit of expenditure incurred in an accounting period beginning on or after 1 January 2005

So long as:

expenditure is recognised either as a deduction in computing the profit or as an intangible asset in accounts beginning on or after 1 January 2005, andthe expenditure is not prevented from being an allowable deduction in calculation of profit for that period (for example because it is pre trading expenditure for a company within the large company scheme, or because it is capital expenditure for tax purposes) , andthe expenditure is incurred during the accounting period,

then FA04/S53 allows expenditure to be deducted in computing the profit when it is incurred irrespective of whether it appears as a deduction in the profit and loss account.

Therefore, if you capitalise qualifying costs they are intangibles - therefore you meet condition 1 above.  The second test is whether the cost is qualifying for R&D or not (stands on its own merits and relates to the tests you outlined previously - qualifying project etc) and the last test is self explanatory.  Therefore, you can get R&D tax relief on capitalised expenditure. As noted above I have done this a number of times for clients and HMRC agree.

I hope that has helped to clarify matters. 


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By merlyn
10th Aug 2012 09:25

Thanks for the update.

The text in italics is what the HMRC sent me when I asked about including capitalised expenditure, it's also the same view my previous employer had regarding capitalised expenditure and I assumed they would know being a top 20 accountancy firm.

I will raise this with the HMRC again though.




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10th Aug 2012 09:36


Good luck, hopefully you will get to speak to someone better informed this time.

I also found when I was working at a Top 20 firm that many people had missed this, that was why I thought this would be a good forum to raise awareness. 

I found another useful reference that clarifies why this relaxation was brought in, it states (link below):

When R&D revenue expenditure can be deducted

FA04/S53 introduced a change to the rules for when expenditure can be eligible for the R&D tax relief, the change is given effect for expenditure incurred in accounting periods beginning on or after 1 January 2005 by a statutory instrument (SI2004/3268).

The effects are explained more fully at CIRD81450. The reason for this change was to prevent the adoption of IAS from delaying the availability of R&D tax relief (CIRD98500). The change applies whether the revenue expenditure is recognised as an intangible asset under IAS or under UK GAAP.

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02nd Jan 2013 15:28

A numerical example?

Ok so on the basis that you can claim relief at 225% on the capitalised intangible asset, how do you reflect it in the tax comp? Probably being dense here but I want to be certain here.

For example if you capitalised £200,000 as a development cost (qualifying for R & D relief) in a period obviously it hasn't yet been shown as a deduction against tax.


Does that mean you have to include a relief figure in the CT comp at £450,000 (225% of £200,000) to account for the normal deduction for tax purposes (as opposed to accountancy purposes) or do you only get to claim the enhanced element at £250,000 (125%)?


I'm suspecting it's the first option otherwise you would be losing out all the time.



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