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Claiming business expenses: Using software packages in your business
If you are using software packages in your business, find out here whether payments are a deductible expense and when you can claim depreciation.
Software purchased for your business
Software purchased for use in a business is a capital expense so is non-deductible. This includes a licence paid for the use of software. You can claim depreciation on the software purchased over its life.
Periodic payments for right to use or access software
When you pay a periodic fee for the right to use or access software for use in a business, these payments are deductible when they are incurred.
United Chemists Ltd runs a chain of pharmacies. They use online account software for financial reporting. They pay a subscription fee of $50 to access the software online. This fee is deductible as a periodic payment to access software.
Software developed in-house
You should not claim any expenditure in developing software until the software is either completed (in use or available for use), or abandoned.
Once the software is completed, you can claim depreciation on the cost of developing the software over its life.
If the software is abandoned, a deduction is allowed for any expenditure that you have not already claimed in the income year it is abandoned.
What's Goodie Ltd sells household goods online. In the 2017 income year they decide to develop new inventory management software. They employed Matthew to undertake this work and purchased a computer. The computer was used 50% of the time by Matthew and 50% for other business purposes.
In total, What's Goodie Ltd incurred expenses of $50,000 developing the software. This includes:
- Matthew's wages
- 50% of the depreciation on the computer for the relevant period, and
- office expenses for Matthew's leased space.
Matthew was never able to make the software work correctly. In the 2018 income year What's Goodie Ltd decides to abandon the development of the software.
The expenses incurred in the 2017 income year are a capital expense and cannot be deducted in that year. This amount can't be depreciated in the 2017 year as there is no completed software available for use.
In 2018, when the development of the software is abandoned, What's Goodie Ltd is entitled to a deduction for all of the expenses incurred in the development of the unsuccessful software.
Software commissioned from a third party
Commissioned software is treated the same as for software developed in-house.
In 2017 Old Bank Ltd contracts XYZ Software Ltd (XYZ) to design and put in place a new phone app for its customers to make banking transactions on their smartphones. The software is completed in the 2019 year. After it is completed XYZ run a training course to teach Old Bank's staff how to use the software. XYZ also provides on-going maintenance services for the app.
The development costs incurred are a capital expense so can be depreciated from 2019 when the software is complete. This is because it is available for use in the business at this time.
The costs of training staff to use the app can be deducted when they are incurred. Once the app is complete any maintenance costs can be deducted in the year they are incurred.
Maintenance versus upgrade
Changes that are made to software allowing it to continue operating as intended are a deductible expense in the year that they are incurred.
If a significant upgrade or improvement is made to the software the cost of this should be added to the value of the software and depreciated.
After the Old Bank's app (in the example above for "Software commissioned from a third party") is in use, a mobile phone provider upgrades their system which means the app no longer works with their phones. Old Bank contract XYZ again to make the minor modifications required for the app to run on the new system. XYZ also fix some minor bugs at the same time.
As these changes do not add new functionality and are intended to keep the app running as designed, they can claim a deduction in the year it is incurred.
The following year Old Bank decides to change the app so that its customers can make payments directly to each other. Again they contract XYZ to make these changes.
As the change adds a new function it is considered an upgrade or improvement so the cost should be added to the value of the software and depreciated.
Find more information in interpretation statement IS 17/04 - Income tax - computer software acquired for use in a taxpayer's business