Replacement Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)Chapter 2 - Increasing the statutory effective life of in-house software
Outline of chapter
2.1 Schedule 2 to the Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to better align the statutory effective life of in-house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.
Context of amendments
Operation of existing law
2.2 Division 40 of the ITAA 1997 provides rules relating to the deductibility of expenditure on depreciating assets - assets with a limited effective life which are reasonably expected to decline in value over the period that they are used. A deduction is generally allowed (under Subdivision 40-B of the ITAA 1997) for the yearly decline in the value of a depreciating asset, until the cost of acquiring the asset has been fully written-off. The amount of the deduction available in each year in respect of an asset depends on a number of circumstances, including the type of asset, its cost, the period in which it was held by the entity seeking to claim the deduction, the extent to which it is used for a taxable purpose and the effective (useful) life of the asset.
Intangible assets and effective life
2.3 For certain intangible assets, including in-house software, the effective life of the asset is set out in the legislation. In most cases the effective life is aligned with the duration of the right or licence underlying the intangible asset.
2.4 For in-house software the ITAA 1997 prescribes an effective life of four years (item 8 in the table in subsection 40-95(7)). Additionally, subsection 40-70(2) of the ITAA 1997 prevents in-house software, amongst other assets, from being depreciated using the diminishing value method. This means that in-house software must be depreciated using the prime cost method, generally resulting in an equal deduction being available over each of the four years of its effective life (assuming it is used exclusively for a taxable purpose and pro-rated for the number of days in the year).
Deduction Pooling
2.5 In some circumstances, taxpayers have the choice of allocating certain assets acquired in an income year to a pool. The pool is then treated as a single item for the purposes of the capital allowance rules. Generally, if a taxpayer decides to create a particular type of pool for expenditure in an income year, all expenditure of that type in the current income year and subsequent income years must be allocated to a pool.
2.6 Expenditure incurred on developing in-house software may be allocated to a pool, referred to as a software development pool (see section 40-450 of the ITAA 1997). Section 40-455 provides that none of the value of the pool is deductible in the year it is created, 40 per cent of the value of a software development pool is deductible in the income year after it is created, 40 per cent is deductible in the following year and the remaining 20 per cent is deductible in the final income year.
2.7 The Government announced this measure in the 2014-15 Mid-Year Economic and Fiscal Outlook (MYEFO) to increase the effective life of in-house software generally from 1 July 2015. The new effective life will align the statutory life of in-house software more closely with its useful life.
Summary of new law
2.8 Schedule 2 to the Bill amends the ITAA 1997 to better align the statutory effective life of in-house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.
Comparison of key features of new law and current law
| New law | Current law |
| In-house software has a statutory effective life of 5 years. | In-house software has a statutory effective life of 4 years. |
| Deductions can be claimed over five years for expenditure allocated to software development pools at the following rates:
Year 1 - Nil
|
Deductions can be claimed over four years for expenditure allocated to software development pools at the following rates:
Year 1 - Nil
|
Detailed explanation of new law
2.9 Schedule 2 to this Bill amends the ITAA 1997 to extend the effective life of in-house software.
Extending the effective life of in-house software
2.10 Presently, item 8 of the table in subsection 40-95(7) of the ITAA 1997 specifies that the effective life of in-house software is four years.
2.11 Schedule 2 amends the statutory effective life to five years. [Schedule 2, item 1, item 8 in the table in subsection 40-95(7) of the ITAA 1997]
2.12 By amending the tax law to extend the statutory life of in-house software from four to five years the Government will better align the statutory effective life of in-house software with the typical useful life of in-house software.
Software development pools
2.13 Section 40-455 of ITAA 1997 sets out the deductions available in each year for expenditure allocated to a software development pool. These deductions will be altered to amend the timing of deductions for software development pools.
2.14 The current deductions for software development pools are as follows:
Year 1 - Nil
Year 2 - 40% of the expenditure allocated to the pool
Year 3 - 40% of the expenditure allocated to the pool
Year 4 - 20% of the expenditure allocated to the pool
2.15 These deductions will be replaced with the following deductions:
Year 1 - Nil
Year 2 - 30% of the expenditure allocated to the pool
Year 3 - 30% of the expenditure allocated to the pool
Year 4 - 30% of the expenditure allocated to the pool
Year 5 - 10% of the expenditure allocated to the pool
[Schedule 2, item 2, the table in section 40-455 of the ITAA 1997]
2.16 This change adjusts the time and rate over which taxpayers may obtain deductions for the value of expenditure assigned to a software development pool. The revised table will provide deductions over five years instead of four years.
2.17 These changes will better align the statutory effective life of in-house software with the typical useful life of in-house software for businesses, consistent with the general change to the effective life of in-house software.
Application and transitional provisions
2.18 The amendments will commence on the day of Royal Assent.
2.19 The amendment to the effective life of in-house software will apply to assets that are first used or first installed ready for use on or after 1 July 2015. [Schedule 2, item 3]
2.20 The amendments to the timing of deductions for software development pools will apply to expenditure incurred in income years commencing on or after 1 July 2015. [Schedule 2, item 3]
STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS
Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011
Increasing the statutory effective life of in-house software
2.21 This schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.
Overview
2.22 Schedule 2 to the Bill amends Income Tax Assessment Act 1997 to better align the statutory effective life of in-house software with the typical useful life of in-house software for businesses by extending the statutory effective life of in-house software from four to five years.
Human rights implications
2.23 This Schedule does not engage any of the applicable rights or freedoms.
Conclusion
2.24 This Schedule is compatible with human rights as it does not raise any human rights issues.