Tax treatment of computer software acquired for use in a taxpayer’s business

By Ian Fay and Rosalind Li

On 21 October 2015, the Commissioner of Inland Revenue released a draft interpretation statement intended to update and replace the 1993 Policy Statement on computer software published in an Appendix to the Tax Information Bulletin Volume Four Vol 4, No 1 (May 1993). 

Before readers get too excited, the statement is limited to taxpayers who purchase, lease, licence, develop, or commission computer software for use in their business.  

Disappointingly, the statement does not consider the income tax treatment of software that taxpayers develop for sale or licence.  For a long period this has been an area of some uncertainty and confusion for taxpayers (particularly with regard to the interaction/application of the trading stock rules), which hasn’t been helped by subsequent Inland Revenue statements suggesting caution in relying on the 1993 statement, and the fact that the conclusions reached in that document do not fit all circumstances.

The draft interpretation statement says that the intention is to consider this area in a later item so for now it’s “watch this space”.

As the above has been left out of consideration, unsurprisingly the conclusions reached in the draft interpretation statement aren’t too different from the 1993 statement (the stated reason for the issue of the statement is that there have been a number of legislative changes that mean that parts of the 1993 statement are now out of date). 

However, as software and how it is used has come a very long way since 1993 (think cloud software providers as a starting point), under current drafting, the statement does have the potential to confuse rather than assist. For example:

• The statement specifically excludes the application of any specific research and development provisions.  In particular, section DB 34 (which was introduced after the 1993 statement) allows a deduction for expenditure on research and development of intangible assets that are not permitted to be capitalised for financial reporting purposes under IFRS. In its current form, the statement notes that expenditure should be capitalised once a decision has been made to proceed with the development but doesn’t reconcile this comment to the capital override in section DB 34.
• The statement includes comments on “periodic payments for the rights to use software” which appear intended to cover online and cloud based software service providers.  However, in most cases, online and cloud based software service providers will not be providing an end user license for “rights to use software” but instead will be providing a service (which is not a “right to use”). This distinction is very important when considering derivation of income, lease classification and potentially withholding taxes.
• It would also be useful for Inland Revenue to clarify whether the statement applies to “software as a service” providers who do not sell or licence software as noted above.

In addition, the number of examples included in the draft statement has reduced as compared with the 1993 statement and guidance on issues such as post-implementation maintenance and upgrades is limited. The statement also seems to stop short in a number of instances in providing guidance on how to distinguish costs which should be capitalised vs costs which are deductible as ongoing maintenance so there could be room for improvement here.

The draft interpretation statement is open to submission until 2 December 2015.  Please contact your Deloitte tax advisor if you wish to make a submission or would like to discuss this in more detail.