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Ruling

Subject: Deduction-website

Question 1

Is a deduction allowable for the initial costs incurred in the construction of the websites?

Answer: No.

Question 2

Is the expenditure incurred for the construction of the websites deductible under the capital allowance provisions?

Answer: Yes

Question 3

Is the expenditure incurred for the on-going development of the websites that provides additional functionality deductible as in-house software?

Answer: Yes

Question 4

Is a deduction allowable for expenditure incurred on maintenance costs for the operation of the websites?

Answer: Yes

Question 5

Is a deduction allowable for the costs incurred in operating the websites that are used for income producing purposes?

Answer: Yes

Question 6

Is a deduction allowable for the costs incurred in purchasing domain names where the domain names are used for income producing purposes?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You operate a number of websites which provide online directories.

You received fees for providing online space for the directories.

You engaged a software development company to provide the layout and structure for the websites.

You paid domain registration fees for the websites.

You paid the following costs in relation to the websites:

· renewal fees for website application

· the purchasing of images for the websites

· expenditure for engaging a number of entities to write blocs

· search engine optimization fees paid for the websites

You provided the initial blocs for the websites.

· You engaged contractors to update the websites by creating a number of changes.

A review of the websites shows that the websites have a number of functionalities we have outlined.

You pay an annual fee to a hosting company to act as the hosting company for the websites.

You retain legal ownership of the websites and may move the websites, as designed, to another location as required.

You are not in the business of buying and selling commercial websites.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-25(1)

Income Tax Assessment Act 1997 section 40-30.

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 995-1.

Income Tax Assessment Act 1997 subsection 995-1(1).

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, relate to the earning of exempt income or are excluded by another provision of the taxation legislation.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 56 ALR 785; (1949) 8 ATD 431 the High Court stated that:

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

Apportionment of deductible expenses

Expenses may have to be apportioned into deductible and non-deductible parts. The inclusion of the words 'to the extent' in section 8-1 of the ITAA 1997 implies that the apportionment of expenses is contemplated.

Process

The general requirement when apportioning expenditure is to assign a percentage to represent the deductible part of a composite expenditure. There is no universally accepted formula that can be applied. As long as apportionment is reasonable in the circumstances and there is some proof of its determination.

Capital expenses

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155).

Capital expenditure often produces an enduring benefit, that is, the structure of the advantage or asset. Revenue expenditure is often repetitious or recurring in nature and often does not produce assets or advantages of an enduring nature.

Deductibility of the expenditure for the layout and structure of the websites

The classic formulation of the matters to be considered in determining whether a loss or outgoing is of a capital or revenue nature is that of Dixon J in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403 where his Honour said:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

In your case, you engaged a contractor to the design the layout and structure of number of websites. The expenditure incurred in developing a websites secures an enduring benefit for your business.

You have also engaged other contractors to undertake maintenance and changes to the websites on an ongoing basis.

The expenditure that relates to the initial layout and structure to create the websites is capital in nature and not deductible under section 8-1 of the ITAA 1997.

However, a deduction for the decline in value of a depreciating asset may be allowable under Division 40 of the ITAA 1997.

The website

You can deduct an amount equal to the decline in value for an income year of a depreciating asset under subsection 40-25(1) of the ITAA 1997. A depreciating asset is defined in section 40-30 of the ITAA 1997 and excludes an intangible asset unless it is an item of intellectual property or in-house software.

Intellectual property

The definition of 'intellectual property' in subsection 995-1(1) of the ITAA 1997 states that an item of intellectual property consists of the rights an entity has under a Commonwealth law as the owner, or a licensee, of a copyright.

You initially engaged a contractor for the construction of a number of websites. You purchased image for the websites and provided written articles for websites.

The website contractor's services included designing the layout of the information supplied by you. It is considered that you legally own the copyright to the website design and you are free to migrate it to any alternative location.

The engaging of the website contractor's has led to you holding an item of intellectual property, that is, copyright to the website design. Given the facts of this case, however, there is negligible value to the copyright considering that the copyright acquired from the website contractor's is limited to the design of the website, and not the information contained on the site which was supplied by you. The copyright in the website design has no commercial value and is merely ancillary or incidental to the services provided by the website contractor's in constructing and designing the website.

Even though you own the copyright over the website design as a depreciating asset for the purposes of subsection 40-25(1) of the ITAA 1997, the cost of that intellectual property is nil under Subdivision 40-C of the ITAA 1997.

Accordingly, you cannot claim a deduction for the decline in value of the acquired copyright under section 40-25 of the ITAA 1997.

In-house software

Subsection 995-1(1) of the ITAA 1997 states that in-house software is computer software, or a right to use computer software, that you acquire, develop or have another entity develop that is mainly for you to use in performing the functions for which the software was developed.

In determining the extent that a website is made up of software must be determined on a case by case basis. Generally the simplest website consists of little more than the 'marking up' of text and the use of links to other web pages as provided for by basic html. The more sophisticated that a website is may indicate the presence of software as the website often require design, text authoring or transformation, image and graphics acquisition/capture, manipulation and html coding or generation.

In your case, the websites were developed to serve the function of interacting between your business clients and your business activities. The websites have been created from software developed and provided by the software development company. The functionality of the websites is demonstrated through the current websites that were built and is considered in-house software.

Therefore, you can claim a deduction for the cost of the software that provides the functionality of the websites under subsection 40-25(1) of the ITAA 1997.

For further information on in-house software refer to the Guide to depreciating assets 2011 which can be accessed through the ATO website at www.ato.gov.au.

Alterations to the website

Generally where changes result in the addition of new functions to a website they are expenditure of a capital nature (in-house software). Changes that do not create new functions are considered to be maintenance of the website and are deductible under section 8-1 of the ITAA 1997.

You have provided a list of the types of changes that have been made to the websites, as noted above, where expenditure has been incurred which does not affect the functionality of the website, those expenses such as ongoing maintenance and changes to the website layout are deductible under section 8- of the ITAA 1997 as the are a necessary part of your business activities.

Note: Expenses incur to provide additional functionality to the website are capital in nature and such as in-house software costs.

Operating expenses of the website

Generally any asset acquired or held by a business requires ongoing maintenance to ensure it operates in its intended manner. In relation to a website those expenses directed at the website's content and the cost of its creation as a collection of data is deductible as an expense in operating the business.

In addition, annual registration costs of internet service providers and regular domain name registration costs are deductible as part of the ongoing and regular expenses of operating a website.

In your case, the costs operating the websites and the renewal fees connected with the operation of the websites are deductible expenses incurred in operating your business and are deductible under section 8-1 of the ITAA 1997.

Domains

Where internet domains are purchased, the taxpayer as a result of the purchase is acquiring a bundle of rights. The right to use an internet domain is an intangible asset. It is not an intangible asset listed in subsection 40-30(2) of the ITAA 1997. It is also not an item of intellectual property or in- house software as defined in subsection 995-1(1) of the ITAA 1997. Hence, it is not a depreciating asset. Consequently, the expenditure you incurred in respect of acquiring the domains will not be deductible under Division 40 of the ITAA 1997 but may form part of the cost base under the CGT provisions.

Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property, or a legal or equitable right that is not property; therefore, the costs incurred to acquire the internet domain can be included as part of the cost base of a CGT asset under subsection 110-25(2) of the ITAA 1997.

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