In our third and final blog entry on software R&D for now, we will look at the issues surrounding the capitalisation of software expenditure.
Some businesses have different policies on when and whether they will capitalise software development costs for accounting and/or for taxation purposes. Even if the expenditure is capitalised in certain contexts, this does not mean you cannot claim the R&D expenditure involved in developing that software.
Accounting treatment of Software
Often a business will choose to capitalise the development of major software products for internal use, sale or to be used as a Software as a Service. Whether it chooses to do this is determined by how it applies the applicable accounting standards based on the size the business and the spread of its ownership. Broadly, most businesses will be bound to the IFRS accounting standards or a subset of these. However, it is critical to note that whether a business capitalises software development costs or not for accounting purposes is irrelevant for taxation purposes.
Taxation treatment of Software – No R&D
The treatment of expenditure on software developed without conducting any R&D activities is covered by the rules on software development in the ordinary provisions of the Income Tax Acts, primarily Div. 40 of the Income Tax Assessment Act 1997 (ITAA97). In this context, software (including interactive websites) may need to be capitalised or pooled to be depreciated. If a business chooses to capitalise an amount for accounting, this has no bearing on whether it must capitalise the amount for taxation because the two issues are covered by different sets of laws and rules.
Taxation treatment of Software – R&D
The treatment of expenditure on software developed in R&D activities is exclusively covered by Div. 355, ITAA97. Section 355-715 prevents any deduction or depreciation under any other provision in the Tax Acts once the expenditure is eligible to be included as R&D expenditure. In other words, the expenditure becomes non-deductible. This applies whether or not the business chooses to include this expenditure as part of the R&D expenditure incurred. This is important because it means that the rules that require an amount of this R&D expenditure to be capitalised rather than immediately deducted are, therefore, exclusively covered by Subdiv. 355-E and not by the ordinary provisions on whether expenditure may or may not be capital in nature unless stated in Div. 355.
This sub-division is very specific about which types of assets must be capitalised and only notionally depreciated in sections 355-225 and 355-305. Paragraph 355-225(1)(b) prevents expenditure on tangible depreciating assets from being included as R&D expenditure when incurred. Instead, paragraph 355-305(1)(b) provides for the inclusion of the attributable tax depreciation (decline in value) of those tangible depreciating assets held by the R&D entity to be added to the R&D expenditure. As software is an intangible depreciating asset, this requirement does not apply to software. There are no provisions in Div. 355 that require software expenditure to be limited to just declines in its value, ie. to only be depreciated.
The end result of this is that whether or not the R&D entity chooses to capitalise software expenditure for accounting or whether they would be required to capitalise it under provisions in the Income Tax Acts, other than Div. 355 ITAA97, is irrelevant. Div. 355 has no such requirement and the whole of the expenditure on software development is notionally deductible as incurred in calculating the value of the R&D expenditure eligible for the R&D Tax Offset.
Still with us?
Next time, we will look at another of the AusIndustry risk areas – the claiming of ‘business as usual’ activities as R&D.