The tax treatment of software and website costs depends on:
- whether they are capital or revenue in nature for tax purposes
- whether or not they are incurred by an incorporated business, and
- if incurred by a company, whether they fall within "the intangible assets" regime
The potential consequences of these issues can be summarised below:
1. Capital or revenue expenditure
This is not the same as treatment for accounts purposes. Whilst the accounting treatment may be persuasive, it doesn’t determine the classification of expenditure for tax purposes. Tax law doesn’t define what is meant by ‘capital’ and ‘revenue’, but several tests have been developed through case law. Two of the key tests for expenditure to be capital in nature are:
a. Has an identifiable asset been acquired, disposed of, or modified?
b. Was the expenditure incurred with a view to providing an ‘enduring benefit’ to the business?
There is no strict time limit which can be applied when considering whether expenditure is capital in nature. However, HMRC will normally accept that expenditure on an asset with a useful economic life of less than two years is revenue in nature as the asset will not bring lasting benefit to the business.
Where software is acquired under licence, whether the expenditure is revenue or capital in nature will depend on:
a. Whether the licence is acquired for a lump sum or regular payments
b. If acquired for a lump sum, what the useful life of the software is
If a software licence is paid for by regular periodic payments akin to a rental, HMRC will normally accept that those payments are revenue in nature. If a lump sum payment is made for a licence it will be necessary to consider whether the licence will have a sufficiently enduring nature to be classed as a capital asset. This requires consideration of both the function of the software and how long it will last.
If businesses develop their own software, the classification of expenditure relating to this (including salaries of in-house IT staff) should be assessed following the same principles. The fact that expenses such as salaries may be recurring does not on its own prevent them from being capital in nature. However, it should be noted that:
a. The salaries of IT staff will not normally be capital expenditure unless some major new project can be identified
b. If staff are making only piecemeal changes or minor improvements to software, their salaries are likely to be revenue costs
1.2 Website costs
Whether website expenditure is capital or revenue in nature will depend upon:
a. The nature of the expenditure
b. The function which the website performs in the business
Design and content development costs should normally be treated as capital expenditure to the extent that an enduring asset is created.
Where a website directly generates sales, subscriptions, advertising or other income this will normally be considered to be an enduring asset. It is, however, also necessary to confirm that the website will have the lifetime normally expected of a capital asset. HMRC’s position is that the following should normally be treated as capital expenditure:
- Application and infrastructure costs
- Domain names
- Operating software that relates to the functionality of the website
However, not all website related costs will be capital in nature. In particular, HMRC will normally accept that the following are revenue costs:
- Initial research and planning costs prior to deciding to proceed with development
- Costs associated with maintaining or updating a website
The corporation tax regime includes specific rules regarding the tax treatment of intangible assets, referred to as the ‘intangible assets regime’, which can be found in Part 8 of CTA 2009.
For companies there are broadly three possible scenarios depending on whether expenditure is revenue or capital for tax purposes and, if capital, how it is treated for accounts purposes:
a. The expenditure is revenue in nature - generally deductible in full at the time it is recognised in the accounts
b. The expenditure is capital in nature and accounted for as a tangible asset - capital allowances may be available if the asset functions as plant or is software
c. The expenditure is capital in nature and accounted for as an intangible asset - the intangible assets regime may apply
Licences and rights over software, website development costs and domain names will often be accounted for as intangible assets, and will therefore fall within the intangible assets regime provided they are created or acquired from an unrelated party on or after 1 April 2002. Where this is the case, the tax relief will follow the accounting treatment with amortisation or impairment of the asset usually deductible for tax purposes as and when recognised in the accounts.
It should also be noted that software is excluded from the intangible assets regime if:
a. it is treated for accounting purposes as part of the related hardware; or
b. the company makes an election under s815 CTA 2009 to exclude it from the regime
An asset will also be completely excluded from the intangible asset regime if it is treated as an intangible asset in the company’s accounts but in a previous accounting period was treated as a tangible asset on which capital allowances were claimed (for example on a change of accounting standards). Where any of the above applies to exclude an asset from the intangible assets regime, it may qualify for capital allowances instead.
It may be beneficial to make an election under s815 CTA 2009 if claiming capital allowances would give relief faster than deducting the amortisation or impairment costs recognised in the accounts (for example, because the Annual Investment Allowance (AIA) will cover the expenditure in full or the intangible asset will be amortised over a long period).
HMRCs capital vs. revenue toolkit:
Any questions, please contact Laurence or Mark.