Tax benefits of buying software
AM writes: We are a small company considering an investment in software that will cost a total of £20,000, a significant sum for us. What tax benefits will the investment give, and what should we consider in terms of finance?
Computer software is capitalised on the balance sheet as a tangible fixed asset and is depreciated over a period of time — its useful life or licence period, whichever is shorter, writes Jon Sutcliffe, partner at Kingston Smith LLP.
Implementation costs are generally treated differently. Costs such as training, data migration and set-up are usually charged direct to the profit and loss account in the year they are incurred.
For tax purposes, software will attract capital allowances. In the year to March 31, businesses can claim an annual investment allowance (AIA) of up to £100,000 in respect of capital spending on most plant and machinery. This means you can claim the full cost of the first £100,000 as a tax deduction and, above this limit, there is an annual writing down allowance of 20%. From April 1, the rules are changing to reduce the AIA to £25,000 and the writing down allowance to 18%. If your accounting period spans these dates, the thresholds are pro rata. It may be tax efficient to buy the software before April.
When considering the financing options, think about spreading the cost over a period of time, which may be better suited to your cashflow, as the efficiency savings may not arise immediately. In assessing whether you have sufficient cashflow to pay for the software up front, allow for the implementation costs, and also (if the company is profitable) the corporation tax savings that will be generated. If you are still unsure about the investment, consider the impact on your business if you don't invest in the software.