Are you developing software to generate income from customers using mechanisms such as license fees, rental payments, once-off payments or subscriptions?

Let us help you consider how your expenditure is recognised for accounting and tax purposes, as this may significantly affect your cash flow.

Recognising Costs for Accounting Purposes: Research Stage & Development Stage

Under AASB 138 – Intangible Assets, software costs are either:

  • Capitalised as assets, based on the costs resulting in future economic benefit to the entity and their reliable measure; or
  • Expensed in the year in which they are incurred.

Costs are divided into 2 stages, a research stage and a development stage.

Costs incurred in the research stage of a project are expensed when they come in. This includes activities aimed at gaining knowledge, evaluating alternatives and making selection decisions.

Costs incurred in the development phase are recognised as an intangible asset if an entity can demonstrate all of the following:

  1. Technical feasibility of completing the intangible asset to make it available for use or sale;
  2. Intention to complete the intangible asset and use or sell it;
  3. Ability to use or sell the intangible asset;
  4. Capacity to generate income, for instance by demonstrating the existence of a market for the intangible asset, its output, or its usefulness if used internally;
  5. Availability of adequate technical, financial and other resources to complete the development and use or sell the intangible asset; and
  6. Ability to reliably measure development expenditure attributable to the intangible asset.

If an entity can’t demonstrate all of the above, the costs are expensed.

Treatment for Income Tax Purposes

Software costs will likely be considered deductible under s8-1 ITAA97, or under the creation of a Copyright by depreciating intangible asset with an effective life of 20 years. Otherwise stated, is the expenditure on revenue or capital account.

Complications arise when the Research & Development Tax Incentive is being claimed. In this case, income tax deduction for the expenditure is denied, but a tax offset is granted. It’s, therefore, the expenditure that isn’t eligible for the R&D tax incentive that needs considering.

Generally, in making the distinction between revenue or capital, the following factors should be considered:

  1. The character of the advantage sought, and its lasting qualities may play a part,
  2. The way it’s intended to be used, relied on or enjoyed; and
  3. The means adopted to obtain it – that is, the periodical outlay to cover its use for periods matching the payment, or making a final payment to secure future use.

Ultimately, it needs to be decided whether the expenditure relates to the ‘profit-yielding subject’ or ‘profit-yielding process’.

In doing this, it’s important to consider the traits of the field the business operates in. This includes giving thoughts to the timeframes the software, as well as related expenditure, would provide value to the user in.

The above is intended only to provide a summary and general overview on accounting and tax concepts. Please get in touch to discuss your business’ software expenditure and implications in the context of your organisation.