It’s 8 a.m. and I’m standing in line at the Starbucks down the street, fixated on my iPhone. I give the barista my order, Caramel Macchiato, and go back to checking my email and surfing the internet. If I look up, I’ll see smart phones in hands and customers sipping lattes, glued to their laptops and tablets. Looks like it’s time to pay. No problem. I have the Starbucks application (app) on my cell phone. The cashier scans the barcode on my app, and the drink is charged to my prepaid Starbucks account.
With the added efficiency and convenience for customers, it’s no surprise so many restaurants have decided to implement smart phone apps into their business plans to improve overall customer experience. Customers can pay for their orders, do a GPS-integrated search for restaurants, look at menus, save their favorite orders, select take-out or delivery, and even earn rewards. App development can be pivotal for restaurants, and app customization decisions will affect the tax treatment of revenue and certain costs. For restaurants that do decide to jump on the bandwagon and implement apps, three key tax issues surface: taxation of deferred revenue, state income sourcing, and cost recovery treatment of software and web development costs.
Many mobile restaurant apps allow a customer to prepay an account for future use. The apps save credit card information to aid customers in quickly adding funds to their accounts and also allow them to add gift cards to their account balances. Generally, for tax purposes, restaurants are required to recognize revenue when received or earned. This would typically mean immediate revenue recognition upon payment receipt. However, if an advanced payment method is adopted, the restaurant may defer recognition of advance payments for one year.
A number of restaurant businesses and franchises operate in multiple states and, as a result, will run into state revenue apportionment issues. For example, a customer receives a gift card that was purchased in Georgia and loads it on her restaurant app. She then travels through South Carolina and North Carolina, redeeming her account along the way. The issue that arises is whether that revenue is sourced in Georgia where the gift card was purchased or is it sourced in the two states where redemptions are made. Restaurant owners must determine the correct state(s) for sourcing their gift card and advanced payment revenue. This outcome will have an impact on the company’s overall tax liability in each state it does business.
A multi-state restaurant business that is taxed as a pass-through entity will need to consider state tax issues that affect its partners, members, or shareholders. For instance, restaurants organized as S Corporations or multi-member LLCs may potentially need to deliberate the impact of state nonresident taxes on its shareholders or members. States that impose entity level taxes on the income of pass-through businesses (Tennessee and Texas, for instance) must also be considered.
The tax treatment of the costs incurred to develop, purchase or license web and mobile-app software must also be considered. Software that is developed internally is treated like a research and development cost. This means the cost must be treated consistently and either is deducted in the current period or amortized over 60 months or 36 months, as applicable. If the software is licensed from a third party, the cost is deducted ratably over the license term. Purchased software (acquired separately from any hardware) is amortized over 36 months. Some restaurants will also encounter additional software and Point of Sale interface costs on top of initial software development/acquisition costs, and a determination about whether these costs should be expensed or capitalized must be made.
In some cases, a restaurant’s smart phone app will require website development, but the Internal Revenue Service (IRS) has not specifically addressed the tax treatment of developing and maintaining a web site. Certain taxpayers may want to deduct the web development costs as advertising expenses; however, the IRS argues that many times the life of such expenses extends beyond a year, and thus the costs should be capitalized. Advertising expenses are distinguished from capital expenditures in that their benefit does not extend beyond a year and they are recurring in nature. The IRS has unofficially taken the position that web site costs should be treated like software costs and amortized over 36 months. Taxpayers are then able to recover web site development costs that may otherwise be unrecoverable. Potentially, web development costs could be expensed as software development costs which could be treated as research and development, but that definition should be established on a case-by-case basis.
Restaurant owners who do decide to utilize apps have many options for tailoring their unique software, but they must consider the tax efficiency of these decisions. An understanding of these key tax areas will help restaurant owners optimize their investment return of mobile-based apps.
For more information on tax strategies restaurant applications, please contact Jeff Eischeid or Tim Watt by calling (770) 396- 2200.