Tax treatment of software in New Zealand

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Prompted by one of our clients, we've been doing a bit of reading and research on how NZ companies should treat the development costs of the products and services that we charge for.

As software has come to form a core part of many businesses now, it's a timely reminder to check and make sure that you're treating the costs correctly for tax and accounting purposes.

Below is our understanding of Inland Reveue's official document on the subject, the exciting and riveting: "INCOME TAX – COMPUTER SOFTWARE ACQUIRED FOR USE IN A TAXPAYER’S BUSINESS". We recommend that you speak to your accountant to get specific guidance for your business and circumstance — please don't take our advice as law.

First up, it's a pretty dry read, so make sure you have plenty of caffeine on board and no tempting distractions such as cute cat gifs anywhere nearby... in fact turn off the internet and lock yourself away. Or ask your accountant to read it — that's what they're designed for.

Tax Treatment of Software Development

For businesses who are not software developers as such, even if developing software for own use, the basic rules are:

  • You must capitalise development post 'feasibility', up to deployment
  • You must capitalise upgrades that add functionality and features
  • You can't expense “maintenance”
  • Depreciation is 50% diminishing value or 40% straight-line, so you'll write it off over 3 - 4 years
  • Capitalisation includes money spent with external developers like us and/or internal costs, ie. wages plus overheads plus hardware etc used.
  • If released in modules, each module must be capitalised and depreciated from the point it is deployed (start of the month in which is available for use.)
  • Any module for application abandoned can be written off (fully expensed)

Defining "Maintenance"

“This would include expenditure such as fixing programming bugs, providing help desk facilities and making minor changes to the software - that is, routine changes that do not materially increase the capacity or performance of the software.”

Other post-development expenditure will usually be deductible (there's some more documentation defining what exactly) but typically these costs could include, for example, producing instruction manuals and staff training.

Alternate “R&D” approach

There might be a case for considering at least some initial development as fully expensible Research and Development, particularly if the outcome is uncertain — if you're trying something new. It's all quite unclear, but our take on it is:

If a company recognises R&D as an expense, based on international financial reporting standards, software development that is regarded as R&D can be expensed.

There is a standard outlined in IRD publication s DB 34(2) except it doesn't seem to answer the critical question, “What is R&D?”.

Digging further we found that "Research” and “development” are both defined in paragraph 8 of the New Zealand Equivalent to International Accounting Standard 38 and essentially boil down to: When there is uncertainty of future benefits (e.g. whether the project will be viable) it’s R&D and therefore an expense. At the point it becomes clear there are benefits to be had from the project, it can be capitalised.

It also seems that larger corporations are generally likely to want to capitalise expenditure if possible because it spreads the big expense and avoids impacting the bottom line so heavily during the period of development. Small companies on the other hand would rather expense outgoings as soon as possible in order to help cashflow (i.e. reduce tax in the short term).

We think most of the planned development we do needs to be capitalised. However the analysis and design phase may be regarded as feasibility because projects don't always go head so perhaps it should be considered “Feasibility Analysis and Design”

One thing is clear from the international standards: Websites for marketing and promotion are fully expensible in the year of development.

Summary

Well there you go. I'm sure there are a number of areas where you might be unsure, again we recommend you talk to your accountant.

If you're looking at developing some custom software for your business then we'd love to chat.