Disruption has been the name of the game in recent years, and few trends have caused more disruption than organizations migrating en masse to cloud services.
Across industries — including manufacturing, health, education, and professional services, cloud computing boasts a global market of
Why are organizations making this move? For one, the cloud yields reduced dependency on physical infrastructure, making room for both business growth and flexibility to adapt and integrate with innovative technologies. What may be less apparent, though, are the potentially significant tax savings available to companies, regardless of industry and size, that transition to cloud services.
Benefits of the cloud
Cloud-based technology has become a necessity for organizations that want their systems to be flexible enough to not just endure but excel in an increasingly unpredictable future. Businesses need to move to the cloud – and fast. The benefits are plentiful:
- Easier scalability: Scaling up or down is made simple with the cloud's capacity;
- Cost efficiency: Budgets for on-premises data centers and additional computing resources can be eliminated;
- Enhanced data security and protection: Cloud service providers often build this into their offer for improved cybersecurity and data backup measures across applications, infrastructure and development platforms;
- Technology integration: From artificial intelligence to machine learning, emerging technologies can be seamlessly woven into other applications, platforms, services and environments;
- Operational improvements: Reduced dependency on IT support, greater business agility and lower staffing costs.
In addition to these more evident benefits, organizations could see significant tax benefits from cloud migration. Look no further than the research and expenditure credits available to companies leveraging the cloud, for starters.
Cashing in on credits
There's no doubt the transition from tried-and-true systems to brand-new technology can be a costly and challenging investment. However, this is exactly the type of investment that the R&E tax credit was designed to promote.
This dollar-for-dollar tax incentive provided by the federal, and most state governments in the U.S. and certain other countries, exists to incentivize technology development-related activities. For an activity to qualify for the credit, qualitative criteria under Section 41 of the Internal Revenue Code should include questions such as the following:
- Is the cloud-related activity more technical in nature (e.g., rearchitecting on-premise applications for cloud) or is it purely business process focused?
- Did the company strive to make some form of technical improvement as part of their use of the cloud (e.g., functional, performance, scalability improvements, etc.)?
- Did the activities the company undertook, such as integrating with cloud computing services or revamping architecture, pose any technical challenges? For instance, were there challenges associated with converting from a monolithic architecture to a cloud-based microservices architecture?
- In resolving those technical challenges or uncertainties, did the company evaluate different alternatives such as integration methods or conduct a proof of concept? Even review of early design alternatives during early POC phases may potentially qualify.
If the answer to each of these four questions is yes, then the company may see a significant return by claiming their activities under the R&E tax credit. For companies considering a cloud migration, the potential here is huge. In short, an activity counts as research for purposes of claiming the tax credit if it relates to a new or improved product or process, is technological in nature, and if there is a level of technical uncertainty that can be eliminated through a process of experimentation.
Passed the test, what next?
While migration to the cloud is no simple task, once the candidate applications have been identified for cloud migration, the next steps might include:
- Refactor the design for existing applications or entire platforms to be cloud ready;
- Validate operational dependencies;
- Integrate internal applications and infrastructure with external systems;
- Integrate internal systems, migration and security planning; and
- Validate cloud-deployed systems for security, scalability, performance, resilience or vulnerabilities.
These activities generally pass the four-part test above to qualify for the R&E tax credit. Other expenses incurred during product testing and development may also qualify. To claim the R&E credit, it's important to accurately assess the qualifying expenses. This can be a complicated process that requires thorough documentation and a deep knowledge of credit methodology. Seeking the help of a professional advisor can be a good idea.
Savvy organizations know the Tax Code offers an opportunity for organizations migrating to cloud services to significantly enhance their return on investment. And R&E tax credits are a prime example of what efficient tax planning can do to benefit the entire organization. Chief technology, financial and information officers need to work with their heads of tax to evaluate whether their activities meet the four-part criteria or look for a vendor who can provide services to help capitalize on this potentially significant return.
