Edited version of your private ruling

Authorisation Number: 1012574939509

Ruling

Subject: iPhone app

Question
Are you entitled to a deduction for the costs of developing an iPhone application in an income year where no assessable income was derived from the application?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2010

Relevant facts

You have developed an iPhone application (app).

You have incurred costs in developing the app. Expenses incurred include costs for computers, software and servers.

You started developing the app in the 20WW-XX income year.

You derived income from the app in the 20YY-ZZ income year.

You plan to increase sales of your application by marketing it to the public.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Division 40.

Reasons for decision

Allowable deductions

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 or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it.

The courts have held that, in the absence of special circumstances, expenditure is capital in nature where it is made with the view to bringing into existence an asset or an advantage (tangible or intangible) for an enduring benefit.

In your case, the iPhone app was developed by you to derive assessable income. The copyright in the application provides an enduring benefit. Therefore the expenditure incurred to develop the application would be considered of a capital nature and a deduction is not allowable under section 8-1 of the ITAA 1997 for the cost of developing the application. However, the depreciation provisions in Division 40 of the ITAA 1997 are relevant.

Deductions for capital assets

Taxation Ruling TR 93/12 Income Tax: computer software looks at the income tax implications arising from the development and marketing of computer software.

Paragraphs 11 and 15 of TR 93/12 outline what a computer program is and the treatment for copyright purposes.

'11. A computer program as distinct from its carrying medium is in essence knowledge or information; it is an item of intellectual property. The carrying medium is tangible property, but the computer program is intangible property. It is strictly not the carrying medium but what is stored on the carrying medium (i.e. the computer program) which constitutes software.'

'15. By the Copyright Amendment Act 1984, assented to on 15 June 1984, The Copyright Act 1968 (Cth) (the Copyright Act) was amended to protect computer software as a literary work and to clarify the nature and scope of that protection having regard to the distinctive features of computer software. The amendments specifically include computer programs in the existing copyright category of "literary works" and gives to computer programs the protection applied to literary works.'

As a result of the operation of the Copyright Act, you as creator of the software application automatically become the owner of copyright (an intangible asset) to the software applications you have developed.

Subsection 40-30(2) of the ITAA 1997 specifically includes items of intellectual property as depreciating assets, provided they are not trading stock.

The definition of intellectual property is found within section 995-1 of the ITAA 1997. It includes the rights that an entity has under a Commonwealth Law as the owner, or licensee of a copyright or the equivalent rights under a foreign law.

The creation of a new software application entitles you to the intellectual property rights as owner of the program in which copyright subsists. As an item of intellectual property, copyright (in a computer program or software application) is a depreciating asset (paragraph 40-30(2)(c) of the ITAA 1997).

However a deduction in relation to copyright is only allowable from the year that the copyright is first used for the purpose of producing assessable income. That is, a deduction for the decline in value of a depreciating asset is allowable to the extent the asset is used for a taxable purpose.

In your case, you received your first income from your app in the 2013-14 income year. Before that, the app was being developed and no assessable income was derived from the app. Therefore no deduction under Division 40 of the ITAA 1997 is allowable in the 2012-13 income year or earlier years when the app was being developed.

Business related costs - black hole expenditure

Capital expenditure that is not otherwise deductible and that relates to a business that is, was or is proposed to be carried on for a taxable purpose may be deductible over five years under section 40-880 of the ITAA 1997.

However subsections 40-880(3) to (9) of the ITAA 1997 provide limitations and exceptions. Under paragraph 40-880(5)(a) of the ITAA 1997, you cannot deduct anything under section 40-880 if it forms part of the cost of a depreciating asset that you hold, used to hold or will hold.

As your costs relate to a depreciating asset, you are not entitled to a deduction under section 40-880 of the ITAA 1997.