Depreciation of Software Solution

[Petrichor]

I have a question around inhouse software development; if one spends say R100,000 on developing an in-house software solution for your company, are you able to deduct depreciation on this?

If so over how many years would the standard be?

I assume the full cost will be capatalisd to form part of your asset base once the solution has been completed.

[Mark Atkinson]

Hi Petrichor,

Unfortunately, the answer is not as simple as it may seem.

Basically, the statement on Intangible Assets says that all expenses incurred in the development of an intangible asset shall be expensed through profit and loss (not capitalised) in the period in which they occur, unless they meet the all the criteria for the development (not research) of an intangible asset.

Before I delve into the depths of research and development, just clarify, are you developing it in-house? In other words, you are not purchasing the software or having it externally developed?

[Dave A]

There may be additional scope in what Mark is saying as these wear and tear allowances can get complicated, but in terms of SARS Interpretation Note 47 shedule A:

Computer software for mainframes may be depreciated over 3 years if purchased, or over 1 year if self-developed.
Software for PCs may be depreciated over 2 years.

[Petrichor]

Thank you Mark and Dave.

We will make use of external developers to develop the software. However, most of the business analysis, research etc will be done by internal employees. Based on your comments then, would it be correct to say, that only the external development cost could be capatalised and the internal costs be expensed in the period incurred?

[Mark Atkinson]

In a nutshell, yes. Whatever you're paying to the external developer you should be able to capitalise as an intangible asset. For accounting purposes, if memory can recall, if the software has an finite useful life you would amortise (depreciate) the asset over its useful life. If it has an infinite useful life there would be no amortisation at all.

I can look this up further if you would like.

In terms of the tax treatment, Dave would have more experience in practice than I would so I would probably run with that. I can also just check the theoretical tax treatment of intangible assets (computer software) if you like.

Dave I'm not sure if there is a monetary limit applied to that interpretation note?

[Dave A]

Dave I'm not sure if there is a monetary limit applied to that interpretation note?

There is a small item immediate write-off limit of R7 000.00 (provided the asset isn't used to generate rental income - and there's the set issue to consider too when applying this).

At the top end - the sky's the limit.

If you're interested, I've been working on a SARS allowable depreciation page in the wiki - You're welcome to help edit and improve it. I've pretty much put in the bare bones so far.

My concern at this point is obviously those allowances are intended for where the taxpayer is using the software. Different rules might apply for software developed for selling on - as in a software development company situation.

If it's a once off, I would expect the cost could be considered a cost of sale. If it's for repeat sales - it could get interesting and I'd suggest getting a tax ruling.

[Petrichor]

Thanks again, I think the above is more than enough information for what I required at this point in time.

[Nickolai Naydenov]

Software gets outdated just like your computers and equipment. What you can do is get a company owned policy where you invest a certain amount every month, all the contributions are tax deductuble and at the end of the term you have lump sum to buy the necessary equipment.

[mikeytdurbs]

I have a question around inhouse software development; if one spends say R100,000 on developing an in-house software solution for your company, are you able to deduct depreciation on this?

If so over how many years would the standard be?

I assume the full cost will be capatalisd to form part of your asset base once the solution has been completed.

It is quite simple.
Your computer software solution will be recognised as an intangible asset for accounting purposes.

There are 2 categories/phases into which your "R100,000" potentially falls. They are research and development.

Research is expensed in the period incurred (therefore you will not even record an asset so there will be no depreciation).
Delelopment is capitalized (therefore recognition of an asset and future depreciation/ammortisation).

You say you spent the money on "developing" in house software. This gives the impression that your full R 100000 (from the first rand you spent) went into the development of software for which you knew the outcome would be useable software which would benefit your business.
There are 6 formal criteria for recognition as development and it appears the full R 100 000 satisfies them all.
1)Technically feasible to complete the asset.
2)Intention to complete and use the asset.
3)Ability to use the asset once complete.
4)Software once in use will generate future economic benefits.
5)Resources available to complete and use the asset.
6)Expenditure during development can be measured reliably.

So if any of the R 100000 was initially paid to developers "experimentally" to see if they could potentially come up with a solution for you, that experimental amount would be classified under the research phase and can never be capitalised to the asset. Not even at a later stage when it is recognised.

For depreciation you have to choose to depreciate all your intangible assets under either the cost model or the revaluation model. You will be using the cost model.

Once the software is complete and READY FOR USE, it's up to your judgement to decide how long a period you will ammortise it over, hence, how much depreciation you will write off annually. Use how long your previous software lasted as an indicator.

2 questions -
Can you reliably measure the expenditure incurred in developing the software?
When was the expenditure incurred?

FOR TAXATION SARS ALLOWS ALL RESEARCH AND DEVELOPMENT TO BE DEDUCTED IN THE PERIOD INCURRED. Therefore you won't have annual wear and tear.

[Petrichor]

Thank you mikeytdurbs!

This really helps. I would be able to measure exactly how, for what and when the expenditure is incurred, so all is good.

thanks again.