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How upcoming changes to tax depreciation rules will benefit owners and acquirers of intangible assets

If you own or are planning to acquire a business that has software, copyright, patents or registered designs, the upcoming changes to tax depreciation rules could benefit you.

The change From 1 July 2023, taxpayers will be able to self-assess the period over which certain intangible assets can be depreciated for tax purposes1. Self-assessment will apply to assets developed or acquired from this date, but not to assets already held. By contrast, tax lives of intangible assets are currently determined by statute. Accordingly, the resultant tax deductions are often spread over a period that is much longer than the economic life of the intangible asset.
The impact Where the self-assessed (economic useful) life is less than the statutory life, there will be quicker access to tax deductions and associated cash benefits. Shorter asset lives may also mean higher valuations for some intangible assets, as the net present value of future tax deductions will increase due to the benefits being realised earlier.
General benefits The greatest benefit will arise where the difference between the economic useful (self-assessed) life and statutory life are greatest. This is likely to be relevant for intangible assets with the longest statutory lives, being copyright (25 years), standard patents (20 years) and registered designs (15 years).
Software assets Currently, software that is “used mainly” by the taxpayer is considered to be in-house software, and has a statutory life of 5 years from when it is acquired or installed ready for use.  By contrast, software that is used mainly by customers or suppliers of a business, is often treated as copyright, and therefore subject to a statutory tax life of the shorter of 25 years from when the copyright is acquired or the period until the copyright ends. The distinction between in-house and outside-use does not correlate with the underlying economic life of software assets, and often causes a delay in accessing tax deductions. Given the crucial and widespread use of software in the modern economy, we expect software assets (copyright and in-house software) to be a common area for self-assessment.

Note: 1. Under section 40-105 of the Income Tax Assessment Act 1997, the tax effective life of an asset is the estimated period over which the asset can be used by any entity. For the purpose of this article, we have taken this to be consistent with the concept of economic useful life.

Case study – software treated as copyright (current versus new rules)

Background

  • Scalable Software Solutions Pty Ltd (“SSS”) has developed and licences a cloud-based software platform that enables businesses to better engage with their customers.
  • The software was developed five years ago and is used mainly by SSS’ customers, rather than within the business itself.
  • SSS’ tax advisors have previously determined that the copyright in respect of the software is depreciable over the statutory life of 25 years from when the copyright was first created.
  • The remaining economic life of the software is five years.
  • SSS was recently acquired by AAA Scalable Software Pty Ltd (“AAA”).  The value attributed to the copyright was $10 million and the remaining life of the copyright was 20 years.

Tax deductibility under the current rules

  • The $10 million market value of the copyright at the time of acquisition by AAA is deductible over the remaining 20 year statutory effective life of the copyright, resulting in a tax benefit of $150,000 per annum.
  • The net present value of the tax benefit (assuming a required return of 15% per annum) is around $900,000.

Tax deductibility under the new rules

  • If the new rules applied at the time of the transaction, the $10 million market value of the copyright would have been deductible over the self-assessed (economic) life of the software, being five years, resulting in a tax benefit of $600,000 per annum.
  • The net present value of the tax benefit (assuming a required return of 15% per annum) is around $2 million.
Tax benefit from new rules ($million)
DurationAnnual tax deductionTax rateAnnual tax benefitNPV of tax benefit1

Under the current rules

(Years 1 to 20)

0.530%0.150.9

Under the new rules

(Years 1 to 5)

2.030%0.602.0
Benefit from new rules   1.1

1 – Net present value (NPV) assumes a required rate of return of 15%.

The incremental net present value of nearer term tax deductibility under the new rules is around $1.1 million ($2 million less $900,000), or 2.2 times the benefit!

As demonstrated above, significant and defensible tax benefits can be obtained by ensuring a robust valuation of your intangible assets, combined with determining appropriate tax effective lives.

Contact us for assistance 

Should you require assistance with valuing intangible assets or in determining their useful lives, contact us.

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