Processes of Experimentation in Software Development
The preamble to the final regulations states that –
“The final regulations do not provide detailed guidance as to how the regulatory provisions are to be applied to a given factual situation. Rather, the Treasury Department and the IRS have concluded that the application of these provisions will depend on the specific activities being claimed by a taxpayer as qualified research, the nature of the taxpayer’s business and industry, and the uncertainties being addressed by the taxpayer’s research activities.”
T.D. 9104 (January 2, 2004)
Accordingly, some preliminary discussion of the nature of uncertainty in software development is in order. Uncertainty in this context is the software development uncertainty that has been identified concerning a functional aspect of a software business component.
In software development, as with the development of tangible business components, there is a distinction between a software development uncertainty, that is resolved through a process of experimentation, and a software development uncertainty that is resolved by other means. For example, a taxpayer may have to configure a software application, and may be uncertain about which configuration choices to make. This uncertainty, in and of itself, does not indicate that the taxpayer subsequently engaged in a process of experimentation to eliminate the configuration uncertainty. The activities undertaken to eliminate the configuration uncertainty are determinative.
In addition to software development uncertainties, there are other types of uncertainties, namely business and project uncertainties. Business uncertainties could, for example, be whether or not potential customers will react favorably to the new product, and/or whether or not the product will be competitive. Project uncertainties could be whether or not the existing staff is adequately trained to use a technology, and/or whether the project can be completed within a given schedule and budget. Such uncertainties do not meet the requirements of I.R.C. § 41(d).
