Private ruling: Income and expenses and software development
Published: April 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you carrying on a business of software application development? | A4: 

Relevant facts and circumstances: You have developed a software application which can be downloaded onto appliances and it may be available to be downloaded onto other appliances in the future. You pay yearly fee for the right to sell the application through stores. You incurred costs to initially develop the application, which included paying developers to create the application. You have other expenses relating to the activity (including expenses in relation to your computer) though they are minimal and you do not keep a record of them. In addition, you state that you required the use of a computer whether you conducted this activity or not. You retain the rights to the application, and receive a licensing fee each time someone purchases the application. The income received from the sale of the application is split. Your share of the income is deposited into your personal bank account. You do not have a business plan in place, however, you did conduct research into the costs of developing the application and identifying a market for the application. You have a website set up for the product that details how to use the application effectively. Buyers of the application are referred to the site for information. You do not intend to make any further applications. You are a full-time university student, and also have a casual employment position. You spend little time devoted to the activity.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 995-1 | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 40-25(1) | Income Tax Assessment Act 1997 subsection 40-30(1) | Income Tax Assessment Act 1997 subsection 40-30(2) | Income Tax Assessment Act 1997 paragraph 40-30(2)(c) | Income Tax Assessment Act 1997 section 40-95 | Income Tax Assessment Act 1997 subsection 40-95(7)

Reasons for decision: Summary: You are not considered to be carrying on a business of software application development. However, as you have created an item of property and earn income from this property, the income is assessable as ordinary income. Accordingly, any on-going costs incurred in earning this income will be deductible expenses. However, initial costs incurred in developing the software itself are capital in nature and therefore you will only be entitled to a deduction over the effective life of 25 years for depreciation for this expenditure. | Detailed Reasoning - Detailed reasoning: Income Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Income from rendering personal services The income received was not from rendering personal services as would be expected from an activity where you are considered an employee and are paid in the form of salary and wages. Income from carrying on a business The income received is not from carrying on a business. Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The courts have developed a series of indicators that can be applied to your circumstances to determine whether you are carrying on a business. Taxation Ruling TR 97/11 provides a list of these indicators. No one indicator is decisive. The indicators must be considered in combination and as a whole. In applying the business indicators to your circumstances, we make the following observations: · you have not invested a large amount of capital into the operation. · you do not intend to make further applications. · you do not intend to make a large profit from the activity. · the income from the activity is not received at regular intervals. · your only recurring expense for the activity consists of an annual fee to have your product located in the store. · the activity is conducted on a small scale as you only have one application and only make occasional sales. · you do not have a business plan or any system in place to ensure the activity succeeds. · you spend little time devoted to the activity. Therefore, the large and general impression gained, after examining the activity against the business indicators identified in TR 97/11, is that your software application development activity does not amount to the carrying on of a business. Income from property Taxation Ruling TR 93/12, Income Tax: computer software, looks at the income tax implications arising from the development and marketing of computer software. Paragraphs 11 and 15 of TR 93/12 outline what a computer program is and the treatment for copyright purposes. '11. A computer program as distinct from its carrying medium is in essence knowledge or information; it is an item of intellectual property. The carrying medium is tangible property, but the computer program is intangible property. It is strictly not the carrying medium but what is stored on the carrying medium (i.e. the computer program) which constitutes software.' '15. By the Copyright Amendment Act 1984, assented to on 15 June 1984, The Copyright Act 1968 (Cth) (the Copyright Act) was amended to protect computer software as a literary work and to clarify the nature and scope of that protection having regard to the distinctive features of computer software. The amendments specifically include computer programs in the existing copyright category of "literary works" and gives to computer programs the protection applied to literary works.' As a result of the operation of the Copyright Act, you as creator of the software application automatically become the owner of copyright (an intangible asset) to the software application you have developed. Intellectual property is defined within section 995-1 of the ITAA 1997 and includes the rights that an entity has under a Commonwealth Law as the owner, or licensee of a copyright or the equivalent rights under a foreign law. As you have developed a software application in which you derive assessable income by exploiting the copyright in the application so as to derive license fees, you are considered to be deriving income from property. Accordingly, the licensing fees you receive from the property are income according to ordinary concepts and are assessable under section 6-5 of the ITAA 1997. Expenses Deduction for on-going expenditure Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. In your case, you have incurred costs to market your product on a website. These costs are considered to be incurred in gaining or producing the income you receive from the sale of the application. Accordingly, these costs will be deductible expenses under section 8-1 of the ITAA 1997. Deduction for capital expenditure (initial set-up costs) The courts have held that, in the absence of special circumstances, expenditure is capital in nature where it is made with the view to bringing into existence an asset or an advantage (tangible or intangible) for an enduring benefit. It is the nature of the advantage sought by the taxpayer that is relevant. In your case, the software applications were developed by you to derive assessable income by exploiting the copyright in the application so as to derive licence fees, and not to use the software in your own operations. The copyright in the applications provides an enduring benefit. Therefore the expenditures directly incurred to develop the content of the applications would be considered of a capital nature. Therefore a deduction is not allowable under section 8-1 of the ITAA 1997 for the cost of developing the applications, but the expenses may be deductible under Division 40 of the ITAA 1997. You can deduct an amount equal to the decline in value for an income year of a depreciating asset under subsection 40-25(1) of the ITAA 1997. A depreciating asset is, broadly, defined in subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. While intangible assets are generally excluded from the definition, subsection 40-30(2) specifically includes items of intellectual property as depreciating assets, provided they are not trading stock. As the creation of the copyright necessarily entails bringing into existence the subject matter which it protects, the cost of copyright includes capital amounts incurred directly in creating the subject matter which the copyright protects. In your case, this will include amounts paid to developers and programmers to create the iPhone application for you. Section 40-95 of the ITAA 1997 outlines the choices available of determining the effective life for depreciating assets. There is an exception for intangible depreciating assets in subsection 40-95(7) of the ITAA 1997. The effective life of copyright is shown at item 5 in the table as the shorter of 25 years or the period until the copyright ends. This means that you do not have the option to determine your own effective life for copyright. You will be able to claim a deduction for the capital expenses incurred in developing the copyright in the applications under Division 40 of the ITAA 1997 based on an effective life of 25 years.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Is the income you receive from conducting the activity, assessable income? | Are you entitled to claim a deduction for the on-going expenses incurred in conducting the activity? | Are you entitled to claim a deduction for depreciation for the initial set-up costs incurred in developing the software?