Finalised Inland Revenue guidance on deductibility of SaaS-related costs
Tax Alert - November 2023
By Alex Kingston & Troy Andrews
In the April 2023 Tax Alert, we discussed the ins and outs of Inland Revenue’s proposed guidance on the deductibility of software-as-a-service (SaaS) configuration and customisation (C&C) costs. The guidance has now been finalised as Interpretation Guideline IG 23/01, largely in line with what was expected and with only some minor tweaks and helpful clarifications.
Big picture, there is not a material shift from Inland Revenue’s draft position. There is a clear path to taking a deduction for C&C costs (and avoiding “blackhole” expenditure), with the main consideration being over what term a deduction may arise – either immediately or spread over a period of up to four years under the depreciation rules.
A recap on the tax treatment
As discussed in our earlier article, Inland Revenue accepts it is highly likely SaaS C&C costs will have the necessary nexus with income to be deductible, but that in most cases expenditure will be capital in nature. Despite being capital in nature, an immediate deduction may be allowed for expenditure incurred on R&D (as defined) that is expensed for accounting purposes, when applying particular parts of NZ IAS 38 (a “DB 34 deduction”). Failing that, the depreciation rules should kick in to provide a deduction over time.
The Guidance now includes a simple flowchart outlining this approach.
Key changes from the draft Guidance
Some of the relevant changes/clarifications made by Inland Revenue from the draft Guidance include:
- A broadening of the guidance on determining the capital/revenue nature of certain costs. For example, Inland Revenue acknowledges that SaaS C&C expenditure may be revenue in nature in some circumstances (but does not give specific examples of when this may be the case). Further, the Guidance acknowledges that wider costs incurred as part of a SaaS integration project (such as data migration, testing and support) will need to be assessed for their capital/revenue nature based on the activity that the costs are incurred on. Again, this is less prescriptive than the draft Guidance which suggested that any activities related to the SaaS project should always be viewed as a single project from a capital/revenue perspective.
- Similarly, there has been a broadening in the wording of how to determine whether costs are incurred on an “internally generated” intangible item, which in Inland Revenue’s view is required to claim a DB 34 deduction. The Guidance does not dismiss the ability for costs incurred on work undertaken by the SaaS provider (in addition to third-party consultants) to potentially qualify for a DB 34 deduction (but again, there is no discussion or specific example of when this may be the case).
- Inland Revenue has clarified its position that a SaaS contract length (or legal life) of less than four years will be fixed life intangible property (FLIP); whereas a contract length of greater than four years will not be FLIP, so the usual software depreciation rates (of 40% straight line or 50% diminishing value) should apply. This effectively creates a four-year “brightline” in terms of tax treatment. The Guidance also lists some relevant factors to consider when assessing the legal life, e.g., fixed or minimum terms, and rights of renewal, and also acknowledges that a contract may have an indefinite legal life (e.g., where it runs indefinitely, subject to the cancellation by the parties with appropriate notice).
What isn’t covered?
The Guidance explicitly doesn’t cover SaaS C&C costs incurred by a non-resident party that charges a portion to a New Zealand entity. Withholding tax needs to be considered where there are payments being made to non-residents (e.g., non-resident contractors’ tax) and, in a related party context, it can be complex to work through how transfer pricing rules should apply.
The Guidance is also relatively quiet on how to treat the costs of abandoned SaaS projects, or costs incurred that may ultimately not contribute to the final SaaS arrangement entered into, e.g., where a decision has been made mid-project to change SaaS product or implementation partner or abandon certain modules. While there are tax rules that provide some relief from blackhole expenditure arising in these circumstances, it is not clear that these rules would always apply to abandoned SaaS projects, particularly where the SaaS contract would not have met the definition of FLIP (i.e., contracts of more than four years’ length). This is an area that may warrant some legislative amendments, as we expect the intention would be for tax relief to be allowed in these situations.
Final comment
The Guidance is true to its title – it is very much a guide. While some of the changes to the Guidance from its earlier draft should be seen as taxpayer-friendly, the downside is that they do leave more points open to interpretation, so the devil will be in the detail of the underlying SaaS arrangements and the nature of the activities/costs being analysed. We expect that where DB 34 deduction positions are taken there could be additional scrutiny from Inland Revenue, so it will be very important to maintain robust documentation on all positions taken when it comes to SaaS-related costs. If you have any questions about cost deductibility, contact your usual Deloitte advisor.
November 2023 - Tax Alerts
