HMRC internal manual

Business Income Manual

BIM35810 - Capital/revenue divide: computer software: general considerations

Periodical payments for licences

Unless you can show that periodical payments are instalments of a capital sum (see below for what constitutes capital expenditure in this context) such payments are deductible. The timing of relief follows generally acceptable accounting practice whereby expenditure is charged against profits over the shorter of the useful life of the asset or the term of the licence (see BIM31030). The central role of accountancy in timing matters was re-affirmed by the Court Of Appeal in Gallagher v Jones [1993] 66TC77 - (see BIM35201).

You are most likely to encounter difficulties where the payment profile under a licence is front-end loaded and it is argued that, for tax at least, the expenditure should not be spread over the shorter of the useful life of the software or the length of the licence.

BIM35805 explains that the treatment of a single payment for a software licence as capital expenditure or revenue depends on the role in economic terms that the software plays in the business concerned. Lord Wilberforce’s judgment in Strick v Regent Oil Co Ltd [1965] 43TC1 (on page 55C - see BIM35560) is authority for this approach.


Lump sum payments for licences

On this view it would be wrong to place too great an emphasis on the intangible nature of software (as a set of instructions in digital form and therefore as intellectual property). What the software achieves for the business concerned should be the central consideration. For most businesses (apart of course from those dealing in items of this kind) the software functions as a tool of the trade in the same way as the computer hardware itself. Neither can function without the other.

It follows from Lord Wilberforce’s approach that decided cases involving expenditure on the acquisition of legal rights (such as Bolam v Regent Oil Co Ltd [1956] 37TC56 - see BIM35555) are of very limited relevance. Rather, a lump sum payment for a licence can reasonably be viewed as analogous to a premium for a lease of a tangible capital asset like land. Such a payment is itself capital on the authority of MacTaggart v B & E Strump [1925] 10TC17.


Do not contend that software with less than a two-year life is capital

You should not contend that software with an expected useful life of less than two years is capital. But you should not accept that a particular piece of software has such a limited life solely because updates appear at frequent intervals. The issue is whether the business concerned in fact trades up to the new versions at intervals, which are short enough to give a particular version only a transitory value to that business.

In selecting for challenge cases where expenditure is charged immediately to revenue, you should bear in mind that the advantage obtained is wholly one of timing.


Software owned outright

The treatment of expenditure on software owned outright (often developed in-house) follows that on licences. In the case of software developed in-house the fact that the expenditure may take the form of such recurring items as salaries paid to computer programmers does not stop it from being capital. In McVeigh v Arthur Sanderson & Sons Ltd [1968] 45TC273 it was clear that part of the salaries of staff engaged in producing wallpaper and fabric designs was attributable to the capital cost of the physical piece of plant (the printing etc blocks). These staff costs are broadly comparable with the salaries of staff producing software. Where the nature of the advantage obtained by the expenditure makes it borderline, the recurring nature of the expenditure may tip the balance towards revenue treatment - see Lord Wilberforce’s comments in Strick v Regent Oil Co Ltd [1965] 43TC1 on page 56C (see BIM35560).

In the normal way the ordinary recurring expenditure of a concern’s computer services department will not be capital unless some major new project can be identified. Expenditure on salaries etc of staff engaged on making changes to computer systems, which can at most be viewed as piecemeal improvements, is unlikely to be capital.

The treatment of expenditure in a trader’s accounts as capital or revenue is only of marginal relevance to the tax treatment. But, where the expenditure is revenue, the accounting treatment is central to the timing of relief - see regular payments for licences above. In particular where expenditure has been capitalised in the accounts in accordance with GAAP the contention that a deduction should be given in the tax computation for expenditure as it is incurred should be resisted. Instead you should argue that the trade deduction should be equal to the charge for the amortised expenditure in the trader’s accounts.