The uncertainty around cloud expenditure and R&D tax relief

The recent HM Treasury R&D Tax Reliefs Report has highlighted an interesting point on the future inclusion of cloud computing services as eligible costs within the R&D tax regime. The document suggests that while cloud computing costs will become eligible from April 2023, any costs relating to cloud servers and storage (defined by the Treasury as general overheads) will remain ineligible for R&D tax purposes.

The fact that the Treasury has identified one category of cloud services as eligible and another as ineligible for R&D tax purposes poses several questions and could make claiming for cloud costs an extremely complex process for many companies. Amazon Web Services (“AWS”), for example, is a cloud provider that many companies use to facilitate their R&D activities. AWS identify several product categories for their services, including “Compute”, “Storage”, “Database”, “Machine Learning” and “Blockchain” among others. Looking at the specific services within each of these categories provides an insight into what these services are used for and how they could contribute to R&D activities. The Compute category, for example, includes services such as:

• AWS Lambda (used to run serverless processes and code for applications and backend services),
• AWS Elastic Beanstalk (used to run and manage web applications), and
• Amazon Elastic Container Service (used to run and manage Docker Containers).

These are all examples of Software as a Service (“SaaS”) and Platform as a Service (“PaaS”). It is expected that where these “computing” services will be used directly for R&D, the relevant portion of these costs will be included within a R&D tax claim under the software cost category. The point to note, is that all these services are ultimately hosted on Amazon’s servers and any data will be stored on their databases. This includes services within both the Storage and Database product categories and so these costs will remain ineligible under the proposed rules. As these cloud computing services, and the hosting and storage of them, are so interconnected it will be extremely difficult for businesses to separate and accurately apportion the R&D activities and associated costs between them. A prime example of this is Elastic Beanstalk, which is hosted on either EC2 instances or S3 buckets (examples of storage services). AWS do not charge for the use of AWS Elastic Beanstalk; customers pay for AWS resources (such as EC2 instances or S3 buckets) created to store and run their applications.

We have seen an increasing number of inconsistencies in claims, such as cloud computing costs included in the R&D tax claims by some advisers. The recent consultation documents indicate that currently these costs are ineligible and therefore including these costs in the claim is incorrect.

The argument for including these costs has been that they are akin to software licences and are services that have directly facilitated the R&D activities, for example using AWS Lambda as a code editor. These businesses also argue that these services have been used in a development environment as opposed to a production environment, which is unlikely to be clear-cut as there are typically more routine or business-as-usual activities within the production environment. In these claims, advisers have apportioned the costs to exclude any hosting or storage costs. This is not easy to do and raises questions over how accurate these apportionments are. The reasons outlined above demonstrate the complexity and inconsistency within the regime and could leave clients claims open to challenge.

It is also interesting to note that while cloud costs have been mentioned in the recent consultation, the legislation only mentions computer software and makes no distinction between enterprise software and cloud or web hosted applications and services.

Our recommendation in response to the recent consultation is that all cloud costs, including hosting and storage costs, should be eligible where they directly contribute to the R&D activities. It would be far too complex for businesses to identify and separate out hosting and storage costs from their PaaS and SaaS costs. The proposed position is likely to result in businesses not claiming for any cloud costs for fear of not being able to calculate it correctly. If all cloud costs become eligible, businesses can take a reasonable apportionment based on their R&D activities, similar to software licences. This will ultimately contribute to increasing R&D investment in the UK as businesses leverage cloud platforms and services for their R&D.

The complexities in this area highlight the depth of technical knowledge required by both claimant companies and their advisers to navigate the R&D regime. Smith & Williamson has R&D specialists with deep expertise in both the technical and financial aspects of R&D tax incentive claims and can help you through the claim process.

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Ref: NTAJ14022211