Software Depreciation

The costs of periodic licence fees e.g. an annual licence fee for publicly available software, will generally be deductible under section 8-1. Similarly, periodic payments to a commercial web developer will generally be deductible. However, the cost of acquiring an ‘off-the-shelf’ product which enhances the business structure will generally be capital in nature.

Usage fees such as costs of periodic operating, registration and web hosting are generally exclusively deductible.

The costs of developing or purchasing a website will generally be capital in nature.

The costs of maintaining a website will generally be deductible. ‘Maintenance’ here refers to routine checks or responses to an unexpected event impacting the operation of a website.

The costs of modifications to a website that do any of the following in a significant measure will generally be treated as capital:

• Altering and improving functionality of the website (either back-end or front-end)
• Improving website efficiency and user-experience
• Improving the durability of the website
• Replacing material parts of the website
• Upgrading the website

Modifications involving minor improvements and enhancements will generally remain deductible under section 8-1. Examples include:

• Minor functionality improvements or enhancements.
• Fixed website faults
• Upgrading software to enable functionality on mobile devices
• Routine modifications
• Work to preserve the functionality of the website.

Ultimately, to determine whether the character of the expenditure to modify a website is capital or deductible under section 8-1, a taxpayer will also need to consider and weigh up the following factors:

• The centrality and importance of the website to the business
• The nature of the modification
• The extent of the modification
• The level of preparation to implement the modification
• The level of approval required before the modification was undertaken
• The expected useful life of the modification

Any expenditure on a social media profile is generally deductible under section 8-1 if the profile is trivial and maintained mostly for marketing purposes. Otherwise, any costs to establish a social media presence is generally capital in nature.

Note that if commercial website costs are partly on revenue and capital account, they should be apportioned between the two categories on a reasonable basis. Where commercial website costs are capital in nature and form part of a depreciating asset, the taxpayer may claim a depreciation deduction for relevant costs over time.

If expenditure on software is in-house software and is used for a business or income producing purpose – in the alternative to depreciating the asset over five years under the capital allowance regime – the asset may be added to and depreciated in a ‘software development pool’. There will be a separate software development pool established for each income year and the balance of each pool is deducted over five years. The rate of deduction varies from year to year. In the first year, there is no deduction to the balance of the pool. In the second to fourth years, the balance of the pool is deducted at a rate of 30%. In the final year, the balance of the pool is deducted at a rate of 10%.

For example, Thomas is a sole trader and incurs expenses in developing in-house software for his business costing $10,000 during the 2022/2023 financial year. Thomas will be entitled to deduct the $10,000 as follows:

• $0 in the 2022/23 financial year
• $3,000 in the 2023/24 financial year
• $3,000 in the 2024/25 financial year
• $3,000 in the 2025/26 financial year
• $1,000 in the 2026/27 financial year

Often beneficial to a taxpayer is that eligible software expenditure can be added to the pool and deducted even where the software is not currently used or ready and installed for use (which is a requirement for a depreciation deduction under the capital allowance regime and under the simplified depreciation rules).

Note that once the taxpayer elects to use the pool, all software development expenditure incurred must be allocated to the software development pool. That is, you may not pick and choose which software development expenditure is assigned and depreciated under the pool and which is not. Therefore, taxpayers should carefully consider the decision to utilise the software development pool.

Note that any consideration received based on the disposal of the software, the grant of a licence to use the software etc. will be assessable income to the taxpayer, unless roll-over relief is available.

Where the in-house software costs less than $1,000 or possesses a taxation value of less than $1,000 and is not written-off under another depreciation regime the asset must be allocated to a low-value pool. However, note that the in-house software must be used or installed ready for use before it can be allocated to the pool. A deduction is available to the extent the software is applied for a taxable purpose. The balance of the pool is depreciated at a diminishing value rate of 37.5%. However, the asset added to a pool will be depreciated at a rate of 18.5% in the year it is added to the pool. Adjustments are required for any private use percentage of an asset added to the pool.

For example, take James who runs a sole trader business and incurs $800 on software in 2022/2023 that is immediate used and constitutes ‘in-house’ software. This amount can be added to James’ low value pool and depreciated at the low value pool rates. This is assuming the expenditure is not allocated to a software development pool due to an election.

Note that there are number of depreciating assets that cannot be allocated to a low-value pool. These include: assets for which prime cost method has already been applied; horticultural plants; assets where a deduction is obtained under the simplified depreciation rules; assets costing less than $300 where a low cost write-off is available; certain assets used in carrying on research and development activities that entitle the taxpayer to a tax offset; certain assets that are paid for by the employer or where there is a reimbursement from the employer towards the employee who purchased the asset/s.

A taxpayer may also immediately deduct in-house software which has a GST-inclusive cost of $300, provided the software is not predominantly used to produce business income.