Article published in Issue 15, 2009-10 of The Taxpayer, dated 15 Feb 2010
In a nutshell...
Deduct or depreciate your software?
The annual licence fees for both tax and accounting software are outgoings that the Tax Office has
deemed to be allowable deductions under the general deduction provisions, and that the rights to use
such software are not considered to be ‘depreciating assets’.
Generally, buying computer software is considered to be done on capital account. For it to be depreciable
for tax, it must satisfy the definition of ‘in-house’ software. Costs will be held to be met from revenue
account.
And where costs fall within the meaning of ‘in-house’ software, the present effective life is set at four years
using the ‘prime cost’ method (see depreciation details here). The ‘diminishing value’ method does not
apply to in-house software.
The Tax Office holds that the recurring nature of the licence fee in these cases places the outgoings as
bone fide deductions, as it is a repeated and continual cost rather than a once-and-for-all payment.
Where the nature of software costs is unclear, the Tax Office says that the licence agreement with the
software provider may give an indication. These agreements should outline the specific characteristics
for the use of software and whether it indicates ‘capital’ or ‘revenue’ cost (such as recurrence, enduring
benefit, for a particular period).
Which account to fall upon may be influenced also by access to certain concessions, such as the small
business tax concessions, or if the cost can be allocated to a low-value pool (which could boost the
immediate deduction).
...the full article follows
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The Taxpayer
15 February 2010 www.taxpayer.com.au
Issue 15 • 2009/2010
Software licence fee: Depreciating asset or
outright deduction?
By Andy Nguyen
In ATO Interpretative Decision 2010/14: Income Tax: Capital Allowances: Cost – computer software – annual licence
fee, the Commissioner concludes that annual licence fees for both tax and accounting software are outgoings
that the taxpayer can deduct under the general deduction provisions of s8-1 of the Income Tax Assessment Act
1997 (ITAA97), and that the rights to use such software are not considered to be a ‘depreciating asset’ for income
tax purposes. The tax treatment of costs incurred in acquiring computer software and related costs such as
licence fees can sometimes be unclear. This article demystifies the tax treatment of software costs and outlines
the relevant matters to consider in determining whether costs incurred in relation to computer software should
be capitalised or expensed.
How is computer software generally
treated for tax purposes?
In general, the acquisition of computer software is
considered to be on capital account and subject to
treatment under the Uniform Capital Allowance (UCA)
provisions (ie. the tax depreciation rules). In order for
the software to be depreciable for tax purposes, it must
satisfy the definition of ‘in-house software’.
Broadly, this is defined as computer software, or a
right to use computer software, that the taxpayer
acquires, develops or has another entity develop on their
behalf:
• mainly for use by the taxpayer in performing the
functions for which the software was developed,
and
• for which the taxpayer cannot claim a deduction
under another provision of the tax laws (outside
the UCA provisions and the Small Business Entity
(SBE) Concessions).
The former point is important; to the extent that the
taxpayer is able to claim a deduction elsewhere, such
as being entitled to a deduction under the general
deduction provisions, then there is no need to treat
such costs as ‘in-house software’ and therefore, the tax
depreciation rules do not apply.
To ascertain whether a deduction will be available
under the general deduction provisions, consideration
will need to be given as to whether the relevant limbs of
s8-1 ITAA97 are satisfied. In most instances, for business
taxpayers, whether the costs are deductible would be
dependent on whether the costs are considered to be on
capital or revenue account.
If the costs are considered to be on capital account,
notwithstanding that ‘tax depreciation’ deductions are
available over the software’s effective life, other means to
increase or obtain an immediate deduction for particular
types of taxpayers may be available such as:
• if the taxpayer is a SBE taxpayer, they may allocate
in-house software to either a general STS pool (if
the cost is less than $1,000) or a long life STS pool
(which have comparatively higher depreciation
rates than the standard UCA rules)
• non-business individual taxpayers may be entitled
to a deduction where the depreciating asset is less
than $300, and
• business taxpayers may also be able to allocate the
software cost to a low value pool (where the cost
or tax written-down value is less than $1,000) or
under certain conditions, into a project pool.
The tax implications may be different if the software is
treated as trading stock.
NOTE: Where the costs incurred fall within the meaning of
‘in-house software’, the current effective life is four years
using the ‘prime cost method’. The ‘diminishing value
method’ does not apply in determining the deduction for
‘in-house software’. For assets acquired before 13 May
2008, the effective life is 2.5 years.
The facts in ATO ID 2010/14
The decision in ATO ID 2001/14 was determined based
on the following facts.
The taxpayer incurred annual fees under two licence
agreements: one agreement is associated with the use
of tax software and the other is associated with the use
of accounting software. The taxpayer’s outgoings were
incurred to acquire the right to use software which is
used to produce income tax returns for the purpose of
carrying on their business.
Under the licensing agreement with the software
developer, the taxpayer pays an annual licence fee and
acquires the right to use the software for 12 months. All
The Taxpayer 15 February 2010
© Copyright Taxpayers Australia 2009-10
Software: Depreciate or deduct?
proprietary rights in the software remain vested with the
software developer. The taxpayer does not acquire the
software but only the rights to use the software for 12
months.
Payment of the annual licence fee also entitles the
taxpayer to receive updates to the product and unlimited
telephone support throughout the year.
(as defined in subsection 995-1(1) of the ITAA97) and are
not ‘depreciating assets’ (as defined in section 40-30 of
the ITAA97).
Comment: Understand the nature of the
costs incurred
How was the Commissioner’s decision
determined?
The conclusion reached by the Commissioner
in allowing a deduction for annual licence fees for
accounting software is the appropriate treatment in light
of the facts presented.
Using the general principles noted above, in ATO
ID 2010/14 the Commissioner considers whether there
are any other provisions outside of the Uniform Capital
Allowance provisions, under which a deduction may be
available. On this basis, he refers to the general deduction
provisions and whether such costs are incurred in the
taxpayer’s business of providing accounting and tax
services to produce assessable income.
What this ATO ID does point out is that, before we turn
our thoughts to whether the software costs should be
capitalised for tax purposes as a separate depreciating
asset or represent additional costs which form part of
an existing depreciating asset, the first consideration
should be whether a deduction is available under the
general deduction provisions. This requires taxpayers to
understand the nature of the costs incurred.
In this case, the threshold question for the Commissioner
is whether the annual licence fees for the tax software is
on capital or revenue account. The Commissioner in
making his decision relied on the principles contained in
the classic High Court decision in Sun Newspapers Ltd v
Federal Commissioner of Taxation.
Where the nature of software costs incurred is unclear,
consideration should be given to the terms of the
licencing agreement which the taxpayer has in place
with the software vendor. Not all software licences are
the same.
The indicia in distinguishing whether the expenditure
is on capital or revenue based in Sun Newspapers are as
follows:
• the character of the advantage sought, and in this its
lasting qualities may play a part
• the manner in which it is used, relied upon or enjoyed,
and in this... recurrence may play a part; and
• the means adopted to obtain it, that is, by providing
a periodic reward or outlay to cover its use or
enjoyment for a period commensurate with the
payment or by making a provision or payment so as
to secure future use or enjoyment.
In concluding that the outgoings are on revenue
account, the Commissioner considered the following
relevant factors in making his decision:
• the fixed licence period of 12 months applying to
each software product suggests the expenditure
is of a recurrent nature and does not provide any
enduring benefit
• the payment of the licence fee on a year-to-year
basis represents a periodic outlay that covers the
use of the software for the period, and
• each annual licence fee on a year-to-year basis
is a recurrent, repeated or continual cost to the
business rather than a final or ‘once and for all’
payment.
Therefore, the Commissioner states that annual licence
fees are outgoings that the taxpayer can deduct under
the general deduction provisions. Accordingly, the rights
to use the software are not items of ‘in-house software’
Some licences relate to a fully packaged product (such
as those purchased from software retailers), others relate
to volume licencing for multiple users, whilst others
may also attach annual technical support (which may
either form part of the licence or as a separate service
agreement).
Generally, a review of such agreements should outline
the specific characteristics for the use of the software
and whether it demonstrates the ‘capital-revenue’ indicia
(such as its recurrence, enduring benefit or whether it
is commensurate with a particular period) which will
assist in determining whether it is on capital or revenue
account.
In most instances, it would be reasonable to conclude
that annual licencing fees would normally be deductible
as this is a recurring cost with no enduring benefit
after the 12-month period passes. This view is akin to
that contained in ATO ID 2003/931: Income Tax: Capital
Allowances: Cost – enhancement and support fees for
in-house software, whereby the Commissioner considers
monthly fees paid for the supply of enhancements
necessary for in-house software to remain current and
any technical support required should not be capitalised
as part of the cost of software acquired.
Where the software expenditure is considered to be on
capital account, rather than simply applying an effective
life of four years to determine the deduction available,
it may be worthwhile considering the availability of
deductions under some other provision of the tax laws,
such as the SBE concessions, or whether the software
can be allocated to a low value cost pool, which may
maximise the deduction immediately available. n
The Taxpayer 15 February 2010
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