Senior tax lawyers disagree about the consequences for honest software sellers after a court found against software investors in a scheme devised by Actonz.
Last month’s Wellington High Court judgment signals a need for companies to think carefully about how they describe software and software-related assets in order to qualify for depreciation, says PricewaterhouseCoopers tax partner Kathryn Roberts. But it is unlikely, she says, to create problems for honest dealers wanting to depreciate software.
The rules are appropriately spelled out in Schedule 17 of the Tax Administration Act. That schedule defines “intangible” property as, in general, not depreciable, but creates a class of “depreciable intangible property”. “The copyright in software, the right to use the copyright in software or the right to use software” are specifically included in this depreciable class; but the act is silent on source code itself.
Judge Ronald Young, who was ruling on a bid by Actonz for cancellation of an IRD assessment, concluded that source code is intangible, but does not come within the special class of intangible depreciable assets.
KPMG tax partner Ian Kowalski disagrees with Roberts, saying IRD needs to clarify the issue. It has separated source code (not depreciable) from copyright (depreciable). This, he says, will create uncertainty, particularly “when software — that includes copyright — is acquired, but no specific value is attributed directly to the copyright inherent in the software”.
Actonz created a scheme in 1996 whereby investors were invited to sink money into acquiring the source code of a number of applications, some of which the judge found to be insubstantial or overvalued enough for the alleged sale to constitute a “sham”.
The investors attempted to claim income tax and GST losses on the price paid for the software.
Quite apart from the “sham” aspect, however, the software and the rights related to it had been described and valued in a way that would not have allowed the depreciation claimed even if the software was worth the cost claimed for it, Roberts says.
Kowalski acknowledges that Actonz did value the copyright — at $1 — to gain a GST advantage, and that this piece of “bad drafting” lost it the case quite apart from the avoidance aspect. In valuing the assets for sale to the investors, Actonz put virtually all of the cost (hundreds of millions of dollars) in the source code, judged not depreciable.
He agrees with Roberts that this signals a need for software traders to word their terms carefully. But it would be clearer for IRD simply to declare software as a whole depreciable, he says.
“If [the Actonz finding] were extended to inhouse software developments, this could have particularly adverse implications where a significant percentage of the cost of developing the inhouse software relates to writing the source code.”
If software in general were declared depreciable, could the Actonz investors come back and win? No, says Kowalski; the tax avoidance aspect of the judgment would still hold.
Actonz managing director Scott Anderson, facing a potential multimillion-dollar penalty himself for allegedly assisting the investors to avoid tax, says he will appeal the case “on the basis of errors in fact and law”. It is difficult to read that the intent of Parliament in framing the act was not to make source code depreciable, he says.
On the value of the software, the judge also erred, Anderson submits. “It can’t be right that investors who followed advice from gold-plated firms [including PricewaterhouseCoopers] and on investment sales materials [issued under the auspices of Actonz] on the value of the software can face such extreme penalties.”
No date has yet been set for the appeal.