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Edited version of your private ruling
Authorisation Number: 1012527993584
Ruling
Subject: Treatment of software licence
Question
Is the cost of purchasing a licence of software which will be used to develop other software capitalised?
Answer
Yes.
This ruling applies for the following period
Year ending 30 June 2014
The scheme commenced on
1 July 2013
Relevant facts and circumstances
You are purchasing a licence of software from a company.
Included in the purchase is the right to develop the software.
The developed software will be sold to external clients.
The licence will be paid for on a yearly basis for the next few years.
At the end of this period, you will own the developed systems in Australia.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 40-25
Income Tax Assessment Act 1997 Subsection 40-30(2)
Income Tax Assessment Act 1997 Subsection 40-72(2)
Income Tax Assessment Act 1997 Subsection 40-95(7)
Income Tax Assessment Act 1997 Section 40-105
Income Tax Assessment Act 1997 Section 40-110
Income Tax Assessment Act 1997 Section 40-450
Income Tax Assessment Act 1997 Section 40-455
Income Tax Assessment Act 1997 Section 995-1
Reasons for decision
Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a taxpayer to claim the cost of a depreciating asset used for taxable purposes over the asset's effective life or a period specified in the legislation.
Subsection 40-30(2) of the ITAA 1997 provides that in-house software, that is not trading stock, is a depreciating asset.
In-house software is defined in section 995-1 of the ITAA 1997 as computer software, or a right to use computer software (ie a licence) that you acquire or develop (or have another entity develop) for your use in performing the functions for which it was developed and for which no amount is deductible outside of Divisions 40 and 328 (trading stock provisions) of the ITAA 1997.
Subsection 40-95(7) of the ITAA 1997 states in-house software has an effective life of four years. It is not possible to self-assess or recalculate the effective life of in-house software. In-house software must be depreciated using the prime cost method of depreciation.
It is recognised that taxpayers may have many software development projects in progress at any one time. If they chose to recognise the depreciating asset that is created by the project, taxpayers will capitalise all expenditure that relates to the particular application being developed. Once the project is completed and the software begins to be used (or held ready for use) in the business, the taxpayers will begin to claim deductions for the decline in value.
However, it may be that the compliance costs of tracking the expenditure and allocating it to each particular item of software is onerous. To overcome this, sections 40-450 and 40-455 of ITAA 1997 were enacted.
Section 40-450 of the ITAA 1997 allows a taxpayer to allocate amounts of expenditure incurred on in-house software in an income year to a software development pool if it is expenditure on developing, or having another entity develop, computer software.
Whilst a note to subsection 40-450(1) of the ITAA 1997 states that the taxpayer cannot allocate expenditure to the software development pool if it is expenditure on acquiring the right to use computer software (ie a licence), this does not apply if the taxpayer is using that licence to develop further applications. It only applies if the related software is being used in its existing state.
Section 40-455 of the ITAA 1997 provides details on how to work out the deduction to be claimed in each financial year. Deductions are calculated as follows:
Income year |
Amount of expenditure you can deduct for that year |
Year 1* |
Nil |
Year 2 |
40% |
Year 3 |
40% |
Year 4 |
20% |
* Year 1 is the year in which the expenditure is incurred.
In your case, you have purchased a licence of software to use and further develop in your business operations. The licence fee will be paid over a X year period. The licence fee and development costs are capitalised as it is not trading stock and will be incurred with the intent of obtaining an enduring benefit. That is, it will be used to develop software which will be sold to external clients.
As the software licence fee is not trading stock and is capital in nature, it is considered to be in-house software for the purposes of the taxation legislation. You may choose to allocate the licence cost (and associated development costs) to a software development pool. Deductions will be calculated in accordance with section 40-455 of the ITAA 1997.
If you choose not to allocate the cost of the licence to a software development pool, once the software development is completed and you begin to use or hold the developed software ready for use, you can depreciate the developed software over its effective life of four years.