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Advice for software companies: Accounting for intangibles

For software companies, taxation can be tricky terrain to navigate. It is crucial for all business owners to understand their accounting requirements, but it is of particular importance for developers that they understand how the income they receive from different countries is treated and the activities that derives this income is perceived.

Software can be categorised differently which impacts on the availability of tax reliefs within the UK and can lead to international withholding tax issues. As a result, keeping a close eye on your processes and knowing what reliefs your company may be eligible for is vital. Whatever the size of the business, getting your tax strategy right will enable you to avoid paying more than you should.

Potential pitfalls

Developers licensing software may receive their income as royalties, which brings with it the potential for companies licensing their technology overseas being subject to withholding tax on these payments.

As a result, businesses can be landed with unexpected tax bills; owners therefore need to ensure that only relevant transactions are correctly labelled as royalty income. Where these types of outputs are for other services connected with software the withholding tax burden can be reduced. It is critical to explore your options and understand how your profits are defined.

Companies trading internationally should also be aware of the relevant double tax treaties in existence and their potential benefit when receiving royalties. The UK Government has tax arrangements in place with most other countries to govern and limit the likelihood of double taxation, with nil or reduced rates of withholding tax often applying when in accordance with the respective treaty. Reviewing this and applying for the relevant treaty benefits can minimise the potential for loss of efficiencies with overseas tax. Where withholding tax cannot be avoided companies should look to reclaim double tax through their company tax return.

However, this is only possible to the extent of the income being subject to both withholding tax and UK corporation tax with the lower amount reclaimable. As such a claim is made through a company tax return this can lead to significant delays in receiving relief which, for smaller firms dealing with large sums, can be problematic. Ultimately companies need to structure their arrangements carefully and take into account the UK position on international tax.

Are you missing out on R&D relief?

For many software companies, tax reliefs are crucial elements of budget and cost plans and should not be overlooked. Research and Development (R&D) tax credits may be claimed by UK companies undertaking a trade and activities which seek to achieve an advance in science or technology, even if people involved in the development are based overseas, e.g. Indian subcontractors. R&D tax relief exists to encourage innovation and provides valuable cashback to those who invest in software development.

Of crucial importance to obtaining the correct relief is the categorisation of software – R&D cannot be claimed on capital expenditure. As such, the product or service developed must be an ‘intangible asset’ or ‘revenue expense’ in order to qualify. For these purposes an ‘intangible asset’ is one which meets the accounting definition, broadly where there is access to future economic benefits from the asset, and developers will have to ensure their outputs fall into either of these categories if they hope to receive aid from the Government.

Patents are another useful tool and should also be considered for software companies, particularly those undertaking R&D. The Patent Box is a scheme providing a 10 per cent corporate tax rate on income deriving from patented goods, and is valuable for those businesses that are used to paying large sums for patents. Having been phased in initially, full relief will be in place by 2017 and is becoming increasing attractive. Care should be taken though when considering whether to patent in the first place. Those who have profits from sales or licenses that involve UK or EEA patents are in the best position to benefit from this relief and claim through the company tax return.

Smaller companies, or those worried about trade secrets being out in the open, must also be wary; once you take a leap into the market with patents, the risk of copycat designs naturally increases. However, not patenting means you could be copied by a competitor so it is worth weighing up the pros and cons and speaking to a patent attorney.

Getting your taxation strategy right as a software company can be complex, and not just if trading internationally. However, there are schemes and credits available to aid the process and encouraging more to innovate in the industry is no bad thing. Ultimately, seeking advice from an advisor will ensure you avoid unnecessary double taxation and enable you to take full advantage of the breaks available to you. 

Mark Shewring, Partner at haysmacintyre  (opens in new tab)

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