Software development projects can qualify for R&D tax credits with additional criteria for software developed primarily for use by the taxpayer deemed ‘internal-use’ software.
Thus, the first step is making the determination as to whether the project involves creating internal-use software or non-IUS.
External or commercial software (non-IUS) is
defined as:
- Software developed for sale, lease or license for separately stated consideration
- Software used in R&D
- Software used in a production process that qualifies as R&D
- Software developed as part of a hardware/software product (embedded software)
- Software which provides a computer service where customers conduct business with the taxpayer primarily for the use of the taxpayer’s computer or software technology
Note: There are currently no final regulations covering either external or internal-use software and the prior version of the IUS regulations has been revoked. Guidance is expected from Treasury but it is unclear when such guidance may be forthcoming.
The above-listed types of non-internal use software have to meet the Four Part Test as follows:
- Technical Uncertainty Test
The activity must be intended to eliminate technical uncertainty about the development or improvement of the product or process. This uncertainty exists if the information available to the company does not establish the capability or method for developing or improving the product or process, or the appropriate design of the product or process that would achieve the desired result. - Process of Experimentation Test
A process of experimentation (POE) is a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. - Technological in Nature
The activity must be undertaken must be technological in nature. Whether this test is met depends on whether the process of experimentation utilized in the research fundamentally relies on principles of the hard sciences. The hard sciences are defined as the physical or biological sciences, engineering or computer science. - New or Improved Business Component
The activity must be intended to be useful in the development of a new or improved business component of the taxpayer (which means a new or improved product, process, formula, technique, invention or software component).
Additional Three-Part Test for Internal-Use Software
In addition to the Four-Part Test, if the software is internal-use software (developed primarily for the taxpayer’s internal use), then the following additional three tests must be met:
- The software must be innovative, in that it is intended to be unique or novel, and is intended to differ in a significant and inventive way from prior software implementations or methods
- The software development involves significant economic risk, in that the project involved a significant commitment of resources, and because of technical risk, the taxpayer is uncertain as to recovery of project dollars within a reasonable period
- The software is not commercially available.
Contact us today to learn more about how we can assist in securing you R&D Tax Credits.
