Many businesses and other taxpayers regularly incur expenditure to acquire, develop, maintain or modify a commercial website. Beware, it is best not to assume that these costs are deductible. Remember that section 8-1 of Income Tax Assessment Act 1997 (the general deduction provision) provides that outgoings which are capital (or private) in nature are not deductible. In fact, there will be many instances where particular website expenses will have a ‘capital’ character. Remember that an outgoing will be capital where it is seen to enhance the profit-yielding structure of a business and is not an everyday type of outgoing. Although a capital outgoing is not deductible under the general deduction provision, it is possible that the outgoing may still ultimately be deductible to the taxpayer via another regime. For example, as deductible ‘depreciation’ under the capital allowance regime. In the alternative, an outgoing not subject to deduction under such a regime may simply be an addition to the cost base of a CGT asset. The tax benefit of this being that any future capital gain on that asset will be reduced.
The tax treatment of various forms of website expenses is addressed in Tax Ruling 2016/3 and is broadly summarised below:
The costs of labour that relate to standard website operational matters will generally be deductible under section 8-1. However, costs of labour related to the enhancement of the website will generally be capital in nature.
Off-the-shelf software costs
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.
Developing or purchasing a website
The costs of developing or purchasing a website will generally be capital in nature.
Maintenance & Modification
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
Social media costs
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.
Apportionment & Depreciation
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.
Domain Name Expenses
According to tax law, a website domain name is a separate asset to the website itself. The business domain name registration costs and server hosting fees will usually be deductible when paid. However, any ‘once-and-for-all’ payment to obtain rights to use a domain name will likely be capital in nature and included in the first element of the CGT asset’s cost base. In this case, the right to use the domain name being the CGT asset. The cost base of that right would obviously be nil where there is no cost (other than a registration fee) to acquire the domain name.
The entirety of expenditure on software that is revenue in nature will be deductible under section 8-1 (the general deduction provision) at the time the software expenditure is incurred. As an example, monthly enhancement and support fees for in-house software are revenue in nature and therefore deductible under section 8-1. However, expenditure on software that is capital in nature will not be deductible under section 8-1. As mentioned, a deduction may be allowed (either immediately or over time) under certain regimes for in-house software outgoings which are capital in nature. The operation of these deduction regimes is addressed below.
Note that the tax treatment of expenditure on intellectual property is outside the scope of this article.
What constitutes ‘in-house software’?
‘In-house software’ is computer software, or a right to use computer software, that you acquire, develop or have another entity develop that is mainly for you to use in performing the functions for which the software was developed and which you cannot deduct under a provision of the tax law (except under Division 40 or Division 328 of the ITAA 1997).
The ATO in Taxation Ruling 2016/3 provides that software that is in-house software includes:
- software in a commercial website that enables the website owner to interact with the user, where any independent benefit to the user is no more than incidental to the interaction
- software provided on a commercial website for installation on the user’s device if its purpose is solely to provide a user interface for interacting with the business
- content on a website which is incidental to the website and not an asset having value separate from the website
Conversely, software will not be in-house software where, for example:
- It is installed on a user’s device for offline used independent of the taxpayer’s business
- It is provided mainly for the user’s benefit and not to enable further interactions with the taxpayer
- The software is mainly for sale to customers
You will note that software which has internal use but which is also licenced may still be classified as in-house software provided the internal use is the predominant use.
Remember that if the software is a revenue outgoing that is deductible under section 8-1, there is no need to consider whether the software is in-house software. In this instance, the software expense (regardless of whether in-house software or not) will be an allowable deductible for the taxpayer.
Capital allowance regime
A capital allowance deduction may be available for software which is used for a business or income-producing purpose and meets the definition of in-house software. This is because the capital allowance regime only applies to depreciating assets and the definition of ‘depreciating assets’ excludes ‘intangible assets’ except where that intangible asset is in-house software. For such an asset which is not subject to deduction under section 8-1, the software costs may be depreciated over a period of five years on a straight-line basis commencing from the time the in-house software is first used or installed ready for use.
Note that if in-house software is subjected to depreciation under the capital allowance regime and is disposed, not used or stops being used for a taxable purpose, a ‘balancing adjustment’ event will occur. If the termination value (i.e. sale or disposal proceeds, potentially $nil) exceeds the adjustable value (i.e. the cost of the asset less previous depreciation deductions on the asset), the difference results in assessable income for the taxpayer. In the reverse scenario, the difference is an allowable deduction. Note that any private use of the ‘in-house’ software will impact on the calculation of the balancing adjustment amount.
Software development pool
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.
Low value pool
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.
Immediate write-off for low cost assets under $300 used to produce non-business assessable income
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.
Depreciation options for small business entities
If a taxpayer is a ‘small business entity’ and elects to apply the simplified depreciation rules, there is a separate regime for depreciating ‘depreciable assets’. The rules of the regime must be followed completely. You may not pick and choose which rules of the regime should apply.
The below headings consider the simplified depreciation rules as they operate to taxpayers from 1 July 2023 onwards. There were various additional COVID-related concessions available to taxpayers up until the income year ended 30 June 2023 which have been (largely) retracted for the income year ending 2024. Further retractions appear likely for income year ending 2025.
These below concessions are not to be used where the expenditure is ‘software development expenditure’ that has or is required to have be allocated to a software development pool.
Instant asset write-off
If the taxpayer is a small business entity and elects to apply the simplified depreciation rules, any in-house software under the asset threshold will be immediately deductible in full (even though it is a capital) under the instant asset write off. Remember that the asset must be used predominantly for an income-producing purpose. There is also a $20,000 threshold limit (per asset) on the value of depreciable assets which may be written-off. The asset must be used or installed ready for use before the immediate write-off can be recognised.
General small business pool
Under the simplified depreciation rules, where the value of the in-house software exceeds the instant asset write-off threshold, the asset must be allocated to a general small business pool and a deduction is available to the extent the software is applied for a taxable purpose. The balance of the pool is depreciated at a rate of 30% with a 15% depreciation available for an asset in the first year it is used or installed ready for use.
Software that is not in-house software
As alluded to earlier, if software expenditure is not deductible under section 8-1 nor considered in-house software, the software will likely be treated as a CGT asset with any relevant expenditure being part of the cost base of that asset. If for whatever reasons there is no identifiable CGT asset, the software expenditure may be deductible over five years as a blackhole expense. However, this provision may only be used as a last resort.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.