On 25 July 2001, the Australia Tax Office (ATO) issued a final ruling (Ruling) on the deductibility of expenses incurred in establishing, constructing, acquiring and maintaining commercial websites.
The Ruling provides that:
- computer hardware on which a website is hosted will be regarded as a 'unit of plant' for income tax purposes
- expenditure on software (such as wages and fees paid to programmers) will be deductible over a period of two and a half years where the website is used for the purpose of earning assessable income
- website costs which are not expenditure on software will be considered according to normal principles.
Different tax implications will arise from different types of websites. For example, the Ruling distinguishes between:
- simple websites: eg, those made up of basic HTML documents and simple links - which are unlikely to involve the creation of software
- complex websites: eg, those requiring design, text authoring or transformation, image and graphics acquisition/capture, manipulation and html coding or generation - which are more likely to involve expenditure on software.
A copy of the final ruling can be obtained from the ATO
The following article was prepared by Freehills when the ruling was in draft form.
Recent speculation in the press has suggested that the Australian Taxation Office (ATO) is tightening its controversial Draft Taxation Ruling TR 2000/D6 (Draft Ruling) dealing with the tax treatment of expenditure on commercial websites. The Draft Ruling was released in May 2000, and its release in final form is expected shortly.
This article considers the main income tax issues associated with establishing and maintaining a website in a business context. We consider the ATO's current position expressed in the Draft Ruling, and the effects of the rumoured changes. We also examine the changes that will take effect upon the enactment of the New Business Tax System (Capital Allowances) Bill 2001 (Bill), currently before Parliament.
Common website expenditures
Typically, a business will undertake the following types of expenditures when establishing and operating its website:
costs incurred in acquiring, developing or constructing a website
costs incurred in acquiring computer hardware to operate the website
fees paid in order for the website to be hosted on another entity's computer server
subsequent alterations to the functionality of the website
ongoing operating expenses associated with maintaining the website.
Website development expenditures
In its present form, the Draft Ruling considers that costs incurred to acquire, develop or construct a website will generally amount to 'expenditure on software' within the meaning of the Income Tax Assessment Act 1997 (ITAA 97). The main target of this part of the Draft Ruling is expenditure on wages and fees paid for programmers, although other expenses (eg, the price paid to purchase an existing site or a domain name) will also be relevant.
The ATO's view is that this expenditure will not qualify for an immediate deduction in the year in which it is incurred, but will be required to be capitalised and written off over a period of two and a half years, in accordance with the current software capital allowance rules in Div 46 ITAA 97. These rules were introduced in May 1998, in conjunction with an announcement by the Commissioner withdrawing a prior Ruling (IT 26) which had allowed deductions for various expenses associated with acquiring and developing software. The clear intention of these provisions was to require depreciation for many software expenses, rather than to allow immediate deductibility.
Under Division 46, the issue is whether the website is itself 'software'. Industry has argued that these outlays lead to an output which is simply advertising on a website that utilises software, but the expenses are from producing software. The Explanatory Memorandum to the Bill, which introduced the software write-off rules, described software as 'computer programs consisting of encoded instructions designed to cause a computer to perform a particular task or produce a particular result'. The ATO view is that a website comes within that definition. Wages are included in the cost of 'software', and so the expenditure could fall within the ambit of the two-and-a-half-year rule for software.
The relevant provisions will shortly be located in Division 40 ITAA 97 as a result of the Bill. These rules apply to expenditures on 'in-house software' which is defined to include amounts for computer software that a taxpayer acquires, develops or has another entity develop. Taxpayers will have the option of depreciating expenditure on 'in-house software' either on an item-by-item basis over two and a half years, or using a pooling mechanism under Subdivision 40-E ITAA 97 which also affords recovery over two and a half years (although the pooling option does slightly delay the recovery, as no deduction is allowed for expenses in the year they are allocated to the pool).
The speculation in the press is, however, that the Commissioner is proposing to defer the recovery of these expenses even further, apparently by treating them as business-related costs, which under the Bill are depreciable only over five years (or perhaps even treating them in a way that makes them a 'black hole' non-recoverable cost). This new position is possible, but implausible in light of the specific software provisions. What is more difficult is whether the taxpayer is nevertheless entitled to deduct these expenses immediately (as wages etc) despite the ATO view that a website is itself software. Industry has long argued that website expenses are simply another form of advertising expenditure and should be treated accordingly. Our current tax rules invariably allow taxpayers to deduct advertising expenses immediately.
Another plausible challenge to the Draft Ruling will be to distinguish expenditure on website content (which does not so easily fall into the definition of software) from expenditure on the underlying website software and code. At present the Draft acknowledges no such distinction.
The Draft Ruling states that computer hardware on which a website is hosted will be regarded as a 'unit of plant' for income tax purposes. Costs associated with acquiring the hardware will therefore be required to be capitalised and depreciated over the effective life of the hardware. The Commissioner's recommended effective life for computer hardware is currently set at four years (three years for laptop computers).
Under the Bill, this treatment will continue.
It is not understood whether the final version of the Ruling will change this approach, and it is difficult to see how it could.
Fees paid for hosting a website
If a taxpayer's website is hosted on another entity's computer server in return for the payment of a periodic fee, the Draft Ruling states that the fee will be deductible as it is incurred.
Alterations to the website
Most websites are regularly updated with new content or design changes. The Draft Ruling provides that where the alterations result in the addition of new functions, this will also amount to 'expenditure on software' for income tax purposes. This means that this enhancement expenditure will not be deductible in the year in which it is incurred, but will also be required to be written off over a two-and-a-half-year period. Again, under the new Bill, taxpayers can choose whether to allocate these additional expenses to an in-house software pool, or depreciate them on an item-by-item basis.
If a business permanently ceases to use its website, (eg it replaces the website or removes it from operation) a deduction for the balance of the two-and-a-half- years of depreciation will be available in the year that the website ceases operations. The Draft Ruling tries to insist, however, that this final deduction will only be allowed if the taxpayer uninstalls either all or part of the website.
In contrast, the ATO acknowledges that a website can require ongoing maintenance, not amounting to improvements to functionality, to ensure that it is operating in the intended manner. For example, the content of the site might need to be changed, fees will be payable to the site host, and other administrative matters will need to be attended to. The Draft Ruling provides that these costs are part of the regular maintenance of the site and are deductible when incurred. There is obviously a difficult border that the ATO will want to police between (immediately deductible) maintenance costs and (depreciable) enhancement costs.
In addition, the Draft Ruling provides that annual registration costs, the fees of Internet Service Providers and regular Domain Name registration costs will also be deductible when incurred as part of the ongoing and regular expense of operating a website.
There is apparently no plan to change this part of the Draft Ruling.
The Draft Ruling when Final will apply for years commencing both before and after its eventual issue later this year. However, the Draft Ruling does not apply to the extent it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Final Ruling.
In addition, as with all Public Rulings, the Final Ruling will also not apply to the extent it is less favourable to a taxpayer than a previously issued Private Ruling.
If a taxpayer has not previously received a more favourable private ruling from the ATO on the deductibility of website expenditure, or reached a settlement with the ATO on this point, it will need to comply with the Ruling for both past, current and future years of income.
In particular the ATO will expect the following:
if a taxpayer has previously claimed up-front deductions for amounts incurred in developing a business-related website, they will need to apply for an amended assessment for the relevant years of income (for assessments issued up to four years ago for entities that paid tax throughout that period, or potentially longer for entities that were in a tax loss position during that period). However, taxpayers who choose not to amend a prior year's returns will be in jeopardy only if the position taken in their prior returns was not reasonably arguable based on the relevant authorities as they stood at the time of lodgement
a taxpayer will now need to add all website establishment costs to a fixed asset register for tax for the current and future years of income.
This newsletter provides a summary only of the subject matter covered, without the assumption of a duty of care by Freehills. The summary is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.