The Digitalization of the Workplace: Is Internal-Use Software Eligible for the R&D Tax Credit?
In the era of the digital age, there are few areas of our lives which are not impacted by the use of technology. The business world, in particular, is moving faster and becoming more global, more mobile, and more digitized. Ultimately, as technology advances, the digitalisation of the corporate workplace is inevitable.
As a result of this digitalization, many companies have internal-use software (IUS) systems in place. To clarify, IUS includes software that has been acquired, internally developed, or modified exclusively to meet the entity’s internal need. Nonetheless the question remains, can companies capitalize on the costs incurred in developing this type of internal software?
Traditionally, it was a grey area for companies seeking to qualify for the Research and Development (R&D) tax credit on the grounds of IUS. The hurdle to qualify was harder, with companies needing to pass the high threshold of the innovation test – a three-prong test where the taxpayer must prove that the software is innovative, the software development involves significant economic risk, and the software is not commercially available. Moreover, IUS had conventionally been sketchily defined by the IRS as anything that is not a third-party-facing or a commercially available product.
However, the recent change in regulations from the Department of Treasury clarifies and relaxes the IRS’ position over IUS – which is now defined as software that is developed by the taxpayer for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business.
Moreover, the Treasury and the IRS have clarified that any software designed to interact with third-party customers may now forego the high threshold of innovation test, even if that software was not designed with the goal of selling, leasing, licensing or otherwise marketing it to unrelated third parties.
For years, taxpayers shied away from claiming a research tax credit for internal use software due to definitional uncertainty and the expense of defending software claims in an IRS examination. Overall, the new regulations provide favorable guidance with a broader and more realistic definition of software eligible for the credit. Through enhanced clarity, companies can now have greater confidence when investing in software innovation.
Swanson Reed is a specialist R&D tax firm and has helped many clients across a diverse range of industries. Contact us for more information on how we can advance your company’s market value and boost its bottom line through the Research and Development Tax Credit.
