E-commerce is driving demand as many of us do even the simplest of tasks on the internet. As consumer preferences digitalise, businesses need to ensure they can evolve with it.
Holding fit-for-purpose software is key for businesses to meet customer demands by making their operations more effective and efficient. When upgrading their facilities, one thing that many don’t consider is in-house software depreciation and how it maximises cash flow.
What is depreciation?
Before we go into the intricacies of software depreciation, it’s essential to have a general understanding of what depreciation is and how it works.
Depreciation is the natural wear and tear of a building and its assets over time. Owners of income-producing properties and businesses can claim depreciation as a tax deduction every year.
Business owners can claim software depreciation on the computer software they use for their operations. This is because the software is required for them to earn income. Software depreciation works in a very different way compared to physical items like fixtures and fittings.
What is in-house software?
In-house software can be defined as two things. It is either computer software, or the right to use software that is purchased and developed for a business.
For example, if a business developed a software to store jobs and client details, this would be classed as in-house software.
What type of software can’t be depreciated?
There are several circumstances where a business can’t depreciate the software it holds.
In-house software isn’t what a business has for sale. For example, a computer game for sale in a store can’t be depreciated.
When a business purchases ‘off-the-shelf’ commercial software with the effective life of one year or less, it can’t be depreciated. It’s instead instantly written off in the financial year of purchase. The same applies to periodic software subscription costs.
How does in-house software depreciate?
In-house software can be depreciation in a number of ways depending on the type of business and depreciation method used.
1. Software development pool
Any expenses associated with a business developing in-house software can be placed in a software development pool. Pre-installation expenses are also included, such as software consultant fees or legal expenses.
When a business uses the software development pool all future in-house software expenses must be depreciated using the pool. A new pool is created for each years’ expenses. A common in-house software future development expense includes upgrades or security improvements.
A software development pool depreciates over a five-year period. The table below shows how much a business can depreciate in-house software placed in a pool each year.
2. Business costs
Small businesses can use the simplified depreciation rules for in-house software depreciation.
If eligible, they can either claim it as an instant asset write-off in the year of purchase, or under the general small business pool rules. When the software isn’t physically ready for use and still in the development stages, any business costs can be claimed using the software development pool rules.
But what if the business chooses not to use the simplified rules or the software development pool? If this happens, the business can depreciate the software’s value using the prime cost method. If the software was held on or after 1 July 2015, it will have an effective life of five years and prime cost rate of 20 per cent.
What happens if software development stops?
With the economic climate shifting and changing, businesses need to adapt. This can result in changing business priorities or project realignments.
This sometimes means a software development project may be abandoned after expenses have already been made. Given that the business has already paid out these expenses, they remain in the pool and can be depreciated until the pool total is zero.
|In practice: abandoning in-house software development
A logistics business had started developing a new in-house software tool to track their supply chain that they named ‘TrackABC’.They started developing TrackABC the 2017-18 financial year and allocated $25,000 to the software development pool for the project.
At the start of the next financial year, the business realigned their priorities and decided to develop a different, more versatile in-house software that includes a supply chain tracking feature. This meant they had to abandon their TrackABC software project.
Although TrackABC was never used, the business could still depreciate the $25,000 in expenses already allocated to its software development pool. The deductions worked as follows:
On the other end of the scale, software can be superseded after it’s already been installed and used. This means the business can expect not to need to use it again while it still had depreciable value in the pool. In this scenario, the business can claim an instant deduction for the software’s current cost.
Start depreciating in-house software with the specialist
BMT Tax Depreciation has helped business owners across the country claim thousands in depreciation deductions. BMT can find the depreciable value on any item, from industrial machinery and fishing nets to in-house software.
To learn more about BMT and how they maximise cash flow with depreciation, Request a Quote or call 1300 728 726.