A difference between capital and revenue expenditures must be made in order to evaluate whether and how tax relief is given. It might be challenging to distinguish between expenditures that are revenue or capital. The classification will depend on the context as well as the type of spending; for example, revenue expenditure in one business may be classified as capital expenditure in another.
Since most organisations spend money on software, it is important to know whether this spending counts as revenue or as capital. We consider the elements that determine which side of the capital or revenue the expenditure belongs.
The fact that most software is purchased under licence may have an impact on how expenses are handled.
License payments for software in the form of rental payments are revenue payments rather than capital payments. The licencing fees are therefore deductible in determining the client's earnings as long as they are incurred entirely and solely for the purposes of the client's trade.
According to HMRC, recurring payments paid for a licence are considered revenue and are so deductible for tax purposes, unless they represent instalments of a capital sum.
The treatment of licences purchased with a single payment is determined by the economic contribution that the software makes to the company. The main factor, according to HMRC, is what the software accomplishes for the business and not how much emphasis is put on the intangible character of software. It's common for the firm to anticipate that the software will serve as a useful tool for a long time.
As a general rule, licenced software should be treated as a capital asset and the licence fee as a capital expense when its projected useful life exceeds two years. Therefore, relief is provided through the capital allowances system, with the expenditure qualifying for plant and machinery allowances, rather than deducting the cost of the licence when calculating taxable profits.