Notice - Income tax treatment of unsuccessful software development
Notice that part of the information in 'Income Tax Treatment of Computer Software' (TIB, 1993) is incorrect and cannot be relied on.
Income Tax Treatment of Computer Software was published in an appendix to Tax Information Bulletin Volume Four, No 10 (May 1993) (the TIB item) provides that the cost of unsuccessful software development can be immediately deducted (whether the software is commissioned or developed in house). The TIB item acknowledges that such software is a capital item but allows a deduction on the basis that ss108K of the Income Tax Act 1976 (now s EE39 of the Income Tax Act 2007) applies. The Commissioner considers that this view is incorrect. Therefore, this part of the item should not be relied on.
Section EE 39 applies to items of depreciable property that have previously been, but are no longer, used in a taxpayer's income earning process. It does not apply to items (such as incomplete software) that have never been used in a taxpayer's income earning process.
The principles relating to the deductibility of expenditure incurred in developing or acquiring a capital asset are set out in the interpretation statement IS 08/02: Deductibility of Feasibility Expenditure (published in Tax Information Bulletin Vol 20, No 6 (July 2008). The following summary assumes that the taxpayer is developing software for use in an existing business or income-earning activity.
- Software developed for use in an income earning process will provide the taxpayer with an enduring benefit, and will generally be a capital asset.
- Expenditure incurred in undertaking feasibility studies to determine whether to develop a capital asset will be prima facie deductible under s DA 1(1) (assuming the asset is to be used in the taxpayer's income earning process). In the context of software development this means that expenditure incurred analysing the feasibility of developing a piece of software for use in a business would be deductible. This is consistent with the position set out in the TIB item, which refers to this as the "pre-development phase".
- Accordingly, expenditure incurred principally for the purpose of placing a taxpayer in a position to make an informed decision about the development of some software will not generally be expenditure incurred in relation to that software. However, once a decision has been made to proceed with the development, any expenditure incurred beyond that point will relate to the acquisition of the software and/or rights in the software. From that point on, expenditure should be capitalised. The rights in the software (if that is what has been obtained) are then able to be depreciated provided they are “depreciable property” and are used or available for use in the taxpayer’s income earning process.
- Consequently, it is possible that certain expenditure may never be deductible. This would occur when the expenditure is capital in nature but not depreciable property because the relevant property never came into existence or was never used in the business (see for example Milburn NZ Ltd v CIR (2001) 20 NZTC 17,017 and Softwood Pulp and Paper Co Ltd v FCT 76 ATC 4,438).
The parts of the TIB item that suggest that a taxpayer is allowed a deduction of expenditure on software development where the software is never implemented or used in the taxpayer’s income earning process should hereby be treated as being withdrawn effective from the beginning of the 2011/12 income year. Taxpayers taking a taxpayer's tax position after that date should not rely on those parts of the item.
The remainder of the TIB item should be used with some care. The TIB item applies the Income Tax Act 1976. Legislative changes inevitably mean that some parts of the item will no longer be applicable. If in doubt, Inland Revenue recommends that advice from a tax advisor is sought. Inland Revenue intends to update this item as part of its review of PIBs and TIB items issued before 1996.