Depreciation on Software as per Income Tax Act: A CA’s Guide for FY 2025-26

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In the digital age, software is often as expensive as the hardware it runs on. For businesses, correctly claiming depreciation on software is not just about compliance; it is a significant tax-saving tool. However, the Income Tax Act, 1961, often leaves taxpayers confused: Is software a “computer” (40%) or an “intangible asset” (25%)?

As a Chartered Accountant, I see this error frequently during tax audits.

1. The Applicable Rate: 40% or 25%?

For FY 2025-26, the general depreciation rate for “Computers including computer software” is 40% under the Written Down Value (WDV) method.

However, the classification depends on how you purchased the software:

Software TypeClassificationRateReasoning
Shrink-Wrapped Software (e.g., Tally, MS Office, Antivirus)Tangible Asset (Plant & Machinery – Computers)40%Treated as “goods” or standard “computer software” integral to hardware usage.
Customized Software / ERP (e.g., SAP, Oracle implementation)Tangible Asset (Plant & Machinery – Computers)40%Courts have consistently ruled that functional software is “part of the computer system.”
Software Licenses / IPR (e.g., buying a Copyright or Patent)Intangible Asset25%If you acquire the rights (IP) rather than just the usage, it may fall under “Intangible Assets.”

CA’s Pro Tip: Most business software (subscription or perpetual license) falls under the 40% block. Do not mistakenly classify standard software licenses under “Intangible Assets” (25%), or you will lose out on a significant deduction.

2. The “Block of Assets” Concept

Under Section 32 of the Income Tax Act, you do not calculate depreciation on individual software. You add it to the “Computers” Block.

  • Block Name: Plant & Machinery (Computers including Computer Software)
  • Rate: 40%

Why does this matter?

If you sell old software or scrap it, you don’t book a “profit/loss” immediately. The sale value simply reduces the WDV (Written Down Value) of the entire block.

3. The “180 Days” Rule (Crucial for Year-End Buys)

If you purchased software during the year, the date of “Put to Use” determines your claim amount.

  • Put to use for 180 days or more (before Oct 4th): You can claim full 40% depreciation.
  • Put to use for LESS than 180 days (on or after Oct 4th): You can claim only 50% of the rate (i.e., 20%).

Example Calculation:

ScenarioPurchase DateCostDepreciation RateAmount Deductible
Scenario A10th July 2025₹1,00,00040%₹40,000
Scenario B1st Nov 2025₹1,00,00020% (Half of 40%)₹20,000

4. “Put to Use” vs. “Purchase Date”

For software, “Put to Use” is often debated.

  • Ready to Use: If you bought Tally but didn’t enter data until next year, can you claim depreciation?
  • The Law: The asset must be ready and available for use. For software, installation usually equals “Put to Use.” Active data entry is not mandatory to start the claim.

5. Software vs. SaaS (Subscription Models)

This is a modern confusion.

  • Perpetual License (One-time purchase): Capitalize it and claim 40% depreciation.
  • SaaS (e.g., Monthly Zoom/Adobe Cloud subscription): Do NOT depreciate. Treat this as a Revenue Expenditure. You can claim the entire amount as a business expense in the P&L account in the same year. This is often more beneficial than depreciation.

6. Compliance Checklist for Tax Audit

If your business is liable for a Tax Audit (Form 3CD), ensure the following:

  1. Invoice Description: Ensure the vendor invoice clearly states “Software License” or “Software Product” and not “Consultancy Charges” (which attracts TDS u/s 194J but no depreciation).
  2. TDS Compliance: If you bought software from a foreign vendor, ensure you deducted TDS (usually 10% + surcharge), or the expense might be disallowed.
  3. Fixed Asset Register: Maintain a record of the software license keys and installation dates to substantiate the “Put to Use” date during scrutiny.

Summary Table for Quick Reference

Nature of ExpenseTax TreatmentRate
Buying Software (CD/Digital)Capitalize (Fixed Asset)40% Depreciation
Annual Maintenance (AMC)Revenue Expense100% Deduction
Cloud Subscription (SaaS)Revenue Expense100% Deduction
Website DevelopmentCapitalize (Intangible/Software)25% or 40% (Litigative; 25% is safer for websites)

Disclaimer: Tax laws are subject to amendments. While the rate for ‘Computers & Software’ is 40% for FY 25-26, always consult your CA for specific high-value transactions.

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INTEGRATED ACCOUNTING & BUSINESS SERVICES PRIVATE LIMITED

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