Practice Note No. 2/2020: Claiming CA under the Income Tax Rules 2019

Practice Note No. 2/2020: Claiming capital allowance on the development cost for customized computer software under the Income Tax Rules 2019

In Budget 2018, the Government proposed that expenditure incurred on consultation fees, licensing and incidental fees for the development of customized software would qualify for capital allowance (CA) claims, effective from the year of assessment (YA) 2018 (see Special Tax Alert: Highlights of 2018 Budget – Part I).

The proposal was subsequently legislated via the Income Tax (Capital Allowance) (Development Cost for Customised Computer Software) Rules 2019 [P.U.(A) 274] (“Rules”). The Rules provide that a Malaysian resident who has incurred development cost for customized computer software (i.e. consultation fee, payment for rights of software ownership and incidental fee relating to the development of customized computer software) in the basis period for a YA would qualify for CA claims at the rate of 20% initial allowance (IA) and 20% annual allowance (AA), from YA 2018 (see Tax Alert No. 19/2019).

The Inland Revenue Board (IRB) has now issued a two-page Practice Note No. 2/2020 (PN) dated 16 March 2020, titled “Claiming Capital Allowance on the Development Cost for Customised Computer Software under the Income Tax Rules 2019” to provide further guidance on the application of the Rules.

The PN clarifies that the “development cost for customized computer software” refers to expenditure incurred in the production of new software or the improvement of existing software, used for business purposes. The costs consist of the following:

(a)  Consultation fees*

Consultation fees incurred for the development of software specifically for the purpose of developing a new software system, as well as modification or modernization of existing software. Consultation fees related to the initial procedure or planning stages (e.g. feasibility study or preliminary study) are excluded and will not qualify for capital allowances.

(b)  Payments for the rights of software ownership*

Payments for the right to use the software exclusively.

(c)   Incidental fees*

Payments incurred to enable the use of the software in the business and are capitalized (e.g.  costs relating to changes / updates to software requirements)

*The PN highlights that these payments to non-residents may be subject to withholding tax under Section 109 or 109B of the Income Tax Act 1967 (ITA), depending on the relevant facts.

In addition to the above, the PN stipulates that CA can be claimed from the YA in which the customized computer software is capable of being used for the purpose of the business.

The following examples have been provided in the PN: