House of Representatives

Explanatory Memorandum

Circulated by the authority of the Treasurer, the Hon Wayne Swan MP

Chapter 3 - Depreciation of computer software - four year statutory effective life

Outline of chapter

3.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to increase the period over which taxpayers write off for tax purposes depreciable in-house software from 21/2 years to four years.

3.2 All references to legislative provisions in this chapter are references to the ITAA 1997.

Context of amendments

3.3 For tax purposes, depreciable assets are generally written off over their effective lives. The Commissioner of Taxation (Commissioner) has set 'safe harbour' effective life depreciation periods for a wide range of assets. For example, the Commissioner's safe harbour effective life for computers is four years. Alternatively, taxpayers can self assess an effective life where they can demonstrate the basis for doing so.

3.4 Certain intangible assets, including in-house software, have a statutory effective life. In the case of in-house software, this effective life is currently 21/2 years.

3.5 In-house software is essentially software that is used in-house, rather than as trading stock, and that is a capital asset, rather than fully deductible in the year of purchase. It includes software, or a right to use software, that the taxpayer has acquired, developed or has had another entity develop.

3.6 Extending the statutory effective life of software to four years aligns the write-off period with other computer equipment (hardware).

3.7 Subsection 40-70(2) precludes certain intangible assets - including in-house software - from being depreciated using the diminishing value method. This means that in-house software must be depreciated on a 'straight line' basis, under the prime cost method. Summary of new law

3.8 Schedule 2 to this Bill increases the statutory effective life for depreciable in-house software from 21/2 years to four years.

3.9 A four year depreciation period for expenditure on in-house software is the same period as the Commissioner's safe harbour effective life for computers generally.

3.10 The new statutory effective life applies from 7:30 pm (by legal time in the Australian Capital Territory) on 13 May 2008, in relation to newly held software assets.

Detailed explanation of new law

3.11 Under section 995-1, in - house software is computer software, or a right to use computer software, that a taxpayer acquires, develops or has another entity develop:

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that is mainly for use in performing the functions for which the software was developed; and

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that is not fully deductible in the year of purchase.

3.12 Paragraph 40-30(2)(d) states that in-house software is an intangible depreciating asset if it is not trading stock.

3.13 Section 40-25 allows taxpayers to deduct an amount equal to the decline in value for an income year of a depreciating asset held for any time during the year.

3.14 In this manner, depreciating assets are generally 'written off' (ie, depreciated) for taxation purposes over their effective lives.

3.15 The table at subsection 40-95(7) prescribes effective lives for certain intangible depreciating assets.

3.16 Item 8 of that table prescribes the effective life for in-house software as 21/2 years.

3.17 This measure changes the figure for that statutory effective life at item 8 from 21/2 to four years. [ Schedule 2, item 1, subsection 40-95(7) ]

3.18 This means that in-house software will be depreciated over four years, rather than 21/2 years, with a commensurately smaller deduction allowed each year.

3.19 In-house software will therefore be depreciated at the same rate as under the Commissioner's safe harbour effective life for computers generally.

3.20 The subsection 40-70(2) requirement that in-house software be depreciated using the prime cost method is unchanged.

Application and transitional provisions

3.21 The new, longer statutory effective life of four years applies from 7:30 pm (by legal time in the Australian Capital Territory) on 13 May 2008, in relation to newly held software assets. That is, the four year write-off period applies to an in-house software asset that a taxpayer starts to:

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hold under a contract after that time;

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develop after that time; or

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hold in some other way after that time.

[ Schedule 2, item 2 ]

3.22 For an in-house software asset held at that time, any further expenditure representing second element cost (in terms of section 40-190 of the ITAA 1997) is depreciated as part of that asset, under the current shorter statutory effective life. In particular, upgrades to such software that do not create new or different depreciating assets will not be affected by this measure, even though that further expenditure occurs after 7:30 pm (by legal time in the Australian Capital Territory) on 13 May 2008.