How to recognise expenditures on production of a computer game in income taxes? | In Principle

For the costs of developing a computer game to be tax-deductible, they must meet certain criteria. Tax-deductible costs are costs incurred for the purpose of earning revenue from a source of revenue or retaining or securing a source of revenue, except for costs expressly excluded from tax-deductible costs. The method of accounting for these costs depends on whether work on the creation of a new game can be regarded as development work.

For income tax purposes, the definition of “development work” in Art. 4(3) of the Higher Education and Science Act is adopted. Thus development work is an activity involving acquiring, combining, shaping and using currently existing knowledge and skills, including IT tools or software, to plan production or design and develop modified, improved or new products, processes or services, excluding activities involving routine and periodic changes, even if such changes are improvements.

Therefore, in order for the expenditure incurred to be recognised as tax-deductible work development costs, the work must relate to a product (e.g. a computer game) or technology with an economic and utilitarian purpose. It must also lead to the manufacture of a completely new product or application of a first-to-market technology in production.

In most cases, it appears that work on a new computer game or new elements in computer games meets the conditions for being classified as development work. The tax authorities (e.g. in interpretation no. 0114-KDIP2-1.4010.166.2019.3.PW/SP) have counted as development works such activities as:

• Development of initial components of a technology and the finished product
• Development of all models to validate the technology assumptions
• Creation of graphic elements and character models
• Creation of programming elements, including animation management systems, player-game environment interactions, combat systems, progression handling, user interface, and basic elements of technical support of the project and the engine used to create a game
• Creation of game levels
• Creation of animations, films, music, and special effects.

Work on developing new features for games, such as changing weather conditions or new objects, have also been accepted as development work (interpretation no. 0111-KDIB1-3.4010.165.2017.2.APO).

However, activities such as creating and releasing game patches to fix bugs found after the release, e.g. problems with logging in or lack of updates to player equipment (interpretation no. 0111-KDIB1-3.4010.165.2017.2.APO) and adding support for additional hardware (e.g. new graphics cards) (interpretation no. 0114-KDIP2-1.4010.166.2019.3.PW/SP) do not constitute development work.

If work on a computer game does not meet the definition of development work, expenses incurred on production of the game should be qualified as tax deductible when incurred.

However, if work on the production of a computer game meets the definition of development work, the taxpayer conducting the development work may choose one of three methods for tax recognition of such costs:

• On an ongoing basis in the month in which they were incurred, or starting from that month in equal parts over a period of no longer than 12 months
• Once in the tax year in which the development work is completed
• Through depreciation write-offs on intangible assets in the form of development work, for a period of not less than 12 months.

Making depreciation deductions requires that all of the following conditions be met:

• The development work has been completed with a positive result (i.e. it has resulted in achievement of the intended, favourable effect, deserving of positive evaluation, which in the case of a computer game generally means that the game has been created and can be used, although not necessarily in full accordance with the original assumptions, i.e. modifications to these assumptions are permitted).
• The product (computer game) is precisely defined and the work development costs relating to it are reliably determined.
• The technical suitability of the product (computer game) has been adequately documented by the taxpayer, and on that basis the taxpayer has decided to manufacture the product or apply the technology.
• The documentation concerning the development work indicates that the costs of the development work will be covered by the expected sale income from such product or application of the technology.

Hence, based on tax law, there is no single model for settling expenses incurred for development works. Therefore, the choice of the method of accounting for development costs for tax purposes may take into account the individual situation of the given taxpayer. For example, startups usually settle the costs of development works under depreciation deductions, which allows the costs to be shifted to subsequent periods when the computer game produced as part of development works starts to generate revenues. On the other hand, for entities with an established market position incurring development costs for a subsequent game, it may be more advantageous from a tax perspective to settle these costs in the year in which they are incurred.

As a result, development work may be accounted for differently for accounting purposes (where it is required to meet the conditions set forth in the Accounting Act and International Accounting Standards) and differently for tax purposes.

For tax purposes, proper documentation of expenditures incurred on development works is required. Significantly, a taxpayer who wishes to account for development costs through depreciation deductions is required to “reliably determine the costs of the product or technology.” Hence, a proper record of the incurred expenses is vital.

Additionally, it should be noted that since computer games are created as a result of development works, taxpayers creating them may consider applying tax credits under the Innovation Box (aka the IP Box) or R&D relief.

The IP Box enables revenues obtained from granting licences for the use of computer games to be taxed at a preferential income tax rate of 5%.

R&D relief allows the taxpayer to take an additional deduction from the tax base for qualified expenses previously recognised as tax-deductible costs incurred for development work (creation or improvement of a computer game).

Joanna Prokurat, tax adviser, Tax practice, Wardyński & Partners