Many businesses now use cloud-based software technologies and services in their business operations – commonly known as a Software as a Service (SaaS) arrangement. Such an arrangement allows the business to access the provider’s software that runs on the provider’s cloud infrastructure.

As part of the integration process, a business may require additional features or functions to optimise its use of the SaaS arrangement. These additional features or functions are generally referred to as configuration and customisation (C&C) costs and are typically borne by the SaaS user.

The question that arises is whether the C&C costs are deductible or depreciable for income tax purposes, or do they fall into a black hole?

Guidance from Inland Revenue

Inland Revenue has issued Interpretation Guideline IG 23/01: Deductibility of software as a service (SaaS) configuration and customisation costs. 

In summary, Inland Revenue’s position is:

• It is likely that SaaS C&C costs will be deductible for tax purposes, but the capital limitation must be considered.
• An immediate deduction may be allowed if the SaaS C&C costs meet the definition of “internally generated” research or development costs and expensed for accounting purposes under paragraph 68(a) of accounting standard NZ IAS 38 Intangible Assets.
• In other cases, the SaaS C&C costs should be capitalised and depreciated as depreciable intangible property (listed in Schedule 14 – a right to use software) or fixed life intangible property (legal life of the SaaS arrangement equals its estimated useful life).
• The estimated useful life of a SaaS arrangement is 4 years.  Therefore, if the legal life of the SaaS arrangement is longer than 4 years, the SaaS C&C costs will be depreciated as depreciable intangible property. 

Read the full Interpretation Guidelines.

As there are quite a few steps to take in determining the correct tax treatment of SaaS C&C costs, each SaaS arrangement should be considered separately as they are not all the same. The Interpretation Guideline includes flowcharts to help navigate the complex path.

Depreciation treatment most likely

While the Interpretation Guideline indicates a deduction may be available for SaaS C&C costs, for many businesses this will not be so. This is because they would not be required to compile financial statements that follow the specific accounting standard referred to; nor would they be doing so voluntarily. As a result, an immediate deduction for SaaS C&C costs may be available for only a small group. Others, in particular, small-to-medium enterprises, will be required to go down the depreciation route.

Missing pieces

CA ANZ supports the publication of the Interpretation Guideline and note that the approach adopted therein will likely reduce the incidence of ‘black hole’ expenditure. However, as we outline in our submission, more needs to be done.

The practical implications outlined above highlights shortcomings with the current law, including unnecessary complexity, inconsistent outcomes between ‘small’ and ‘large’ taxpayers, and high compliance costs. Furthermore, the limited scope of the Interpretation Guideline and omission of a broad framework to assess the tax treatment of cloud-based software solutions means that uncertainty in this area will rise again in future.