Edited version of your private ruling

Authorisation Number: 1012429565575

Ruling

Subject: The acquisition of an exclusive business license and associated rights

Issue 1

Question 1

Are you entitled to an input tax credit on the acquisition of the exclusive license?

Answer

No, you are not entitled to an input tax credit on the acquisition of the license.

Issue 2

Question 1

Are you entitled to an income tax deduction under section 8-1 of the Income Tax Assessment Act 1997 (the ITAA 1997) for the purchase price of the exclusive license, or any part thereof?

Answer

No.

Issue 3

Question 1

Are you entitled to an income tax deduction under Division 40 of the ITAA 1997 for the purchase price, or any part thereof, of the exclusive license? If an income tax deduction is available under Division 40 of the ITAA, at what rate is the amount deductible?

Answer

No.

This ruling applies for the following periods:

1 July 2011 to 30 June 2014.

The scheme commences on:

11 June 2012

Relevant facts and circumstances

The Agreements

You are registered for GST. You account for GST on an accrual basis.

You entered into an agreement with ABC Pty Ltd in its capacity as trustee for the Trust. It is registered for GST.

The trust is a global master licensor of a unique retail concept.

The trust holds a 10 year franchise to be the exclusive franchisor for the concept.

As advised, your purchase of the exclusive license occurred by way of execution of a Heads of Agreement (HoA).

The exclusive license provides you with the exclusive rights for the franchising and development of the business concept

The relevant agreements you entered into and other relevant matters are discussed in greater detail below.

The Heads of Agreement

The HoA provides that the purchase price will be paid to the trust under a different agreement. The HoA provides that the purchase price is only payable by you from distributable EBIT and that you have no liability to the trust to pay the purchase price other than from distributable EBIT, except for the provisions of the performance security.

Distributable EBIT is defined as the total amount of money you receive from sales associated with the Rights in a Payment Period less Reasonable Costs to be agreed between the parties.

The HoA provides that X% of the purchase price is payable upon execution of the HoA and rendering of a tax invoice. Y% of the purchase price, excluding GST, will be paid upon execution of the agreement concurrently with the execution of the vendor finance agreement, rendering of a tax invoice and the performance security.

The Purchase Agreement

A series of relevant recitals and clauses were provided to the ATO.

The Vendor Finance Agreement

A series of relevant recitals and clauses were provided to the ATO.

The Performance Security

A series of relevant clauses were provided to the ATO.

The Tax Invoice

A tax invoice was provided to the ATO.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 9-10, 9-15, 11-5, 11-10, 11-20, 29-10, 195-1; Income Tax Assessment Act 1997 Section 8-1, Division 40, Sub-division 40B, Section 40-30, 40-880 and section 995-1.

Reasons for decision

Providing consideration for the supply

Section 11-20 of the A New Tax System (Goods and Services Tax) Act 1999 ('GST Act') provides that you are entitled to the input tax credit for any creditable acquisition that you make. Section 11-5 of the GST Act defines creditable acquisition. It states:

You make a creditable acquisition if:

(a) you acquire anything solely or partly for a *creditable purpose; and

(b) the supply of the thing to you is a *taxable supply; and

(c) you provide, or are liable to provide, *consideration for the supply; and

(d) you are *registered, or *required to be registered.

(Items marked with an asterisk (*) are defined in the Dictionary at section 195-1 of the GST Act)

Subsection 11-10(1) of the GST Act defines acquisition as any form of acquisition whatsoever. Without limiting subsection 11-10(1), paragraph 11-10(2)(e) of the GST Act provides that an acquisition also includes an acceptance of a grant, transfer, assignment or surrender of any right.

Consideration is defined in section 9-15 of the GST Act to include any payment, or any act of forbearance, in connection with a supply of anything.

Supply is defined in subsection 9-10(1) of the GST Act to include any form of supply whatsoever. Without limiting subsection 9-10(1), paragraph 9-10(2)(e) of the GST Act provides that a supply also includes a creation, grant, transfer, assignment or surrender of any right.

You entered into an agreement for the supply of rights to a business concept. You are registered for GST. For the purposes of this private ruling, it is assumed that you have acquired the rights for a creditable purpose.

Accordingly, in determining whether you have made a creditable acquisition within the meaning of section 11-5 of the GST Act, the key questions at issue are whether:

the supply of the thing to you is a taxable supply; and

you provide, or are liable to provide, consideration for the supply.

For the acquisition of the rights to be a taxable supply to you, the supply of that thing (rights) must, amongst other things, be a supply for consideration. For present purposes, the supply of the rights will only be for consideration if it can be shown that you provide, or are liable to provide, consideration for the supply.

The various documents provided to us state that you are liable to pay the purchase price for the rights and licenses to the business concept.

According to the various documents, this will be extinguished by the obligation to pay a deposit of X% on execution of the HoA, with the balance being satisfied by 'vendor finance'. Thereafter, the obligation to pay relates to the vendor finance amount and is done in accordance with the documents provided to us. These documents also provide that the deposit 'is payable subject to the application for a Private Tax Ruling from the Australian Taxation Office', and, as such, it is not clear from the documents mentioned when the deposit is payable, if at all.

Taken as a whole, the agreements show that you have not provided, nor are liable to provide, any consideration for the supply of the rights to you. For you to be liable to provide consideration, you must have a presently existing liability to pay such an amount.

The terms of the Vendor Finance Agreement (VFA) are such that any payment is contingent on a future event, namely you achieving a particular distributable EBIT result from the exploitation of the rights that you've acquired.

That is, until that future event occurs, there is no presently existing obligation for you to pay (or repay) anything.

The deposit as consideration

For a variety of reasons, we do not consider that you have provided or are liable to provide any consideration by way of a X% deposit of the purchase price for the supply of rights by the trust to you.

The performance security as consideration

When the agreements are read together, there is considerable doubt about whether the performance security referred to in the documents can, or is, intended to have any legal effect.

Even if it has its intended effect, the performance security is merely a means of securing performance under the agreements. As such, the security does not enjoy separate identity or economic value from the consideration payable under the agreements such that it could be (part) consideration for the supply of the rights.

Eligibility for an input tax credit

For the reasons explained above, we consider that you have not provided any consideration, nor are you liable to provide consideration, for the supply of rights by the trust to you. Accordingly, the supply of the rights to you is not a supply for consideration and therefore not a taxable supply to you within the meaning of paragraph 11-5(b). Paragraph 11-5(c) of the GST Act is also not satisfied. Thus, you do not make a creditable acquisition and are not entitled to an input tax credit for the acquisition of rights by you from the trust.

Attribution on the basis of the tax invoice

Even if it could be said that you were entitled to an input tax credit (which is not conceded), there is an issue as to whether you are entitled to attribute the credit to the relevant tax period (the tax period in which you received the document purporting to be a tax invoice).

Subsection 29-10(1) of the GST Act provides that an input tax credit to which you are entitled for a creditable acquisition is attributable to:

(a) the tax period in which you provide any of the *consideration for the acquisition; or

(b) if, before you provide any of the consideration, an *invoice is issued relating to the acquisition - the tax period in which the invoice is issued.

(Items marked with an asterisk (*) are defined in the Dictionary at section 195-1 of the GST Act)

Invoice is defined in section 195-1 of the GST Act as a document notifying an obligation to make a payment.

We consider the words 'liable' and 'obligation' refer to circumstances in which crysallisation of an obligation to pay an amount is not so remote as to be uncertain or improbable during the tax period in question.

According to paragraph 25 of Goods and Services Tax Ruling GSTR 2000/34 Goods and services tax: what is an invoice for the purposes of the A New Tax System (Goods and Services Tax) Act 1999? (GSTR 2000/34), a party can only be regarded as under an obligation to make a payment if there is a requirement for either an actual payment or, at least, a present obligation to pay a sum certain at some future date. Paragraph 31 of GSTR 2000/34 provides that it is not enough that an invoiced amount might become payable in the future upon the happening of some contingency.

The purported tax invoice you provided is for the full purchase price. Consistent with our reasoning in relation to paragraphs 11-5(b) and (c), we do not consider this to be an invoice as there was no presently existing obligation on you to pay anything at the time of issue of the purported tax invoice. The agreements, when construed together, provide that the obligation to make payment will only crystallize upon exploitation of the rights acquired by you, as evidenced through the receipt of distributable EBIT. In accordance with GSTR 2000/34, it is not enough that you might be liable to pay some amount via distributable EBIT, that is, if you earn any distributable EBIT in future.

Accordingly, even if you were entitled to an input tax credit for the acquisition of the rights, you are not entitled to attribute such credit to the relevant tax period as you have neither provided any consideration, nor been issued with an invoice in relation to the acquisition, within the meaning of sub-section 29-10(1) of the GST Act.

Disclaimer on Division 165

We note that you have not asked us to rule on the application of Division 165 of the GST Act to your circumstances. Accordingly, we have not considered the application of the anti-avoidance provisions.

If you want us to rule on whether Division 165 applies in your circumstances, contact your contact officer to find out what details we will need to make the ruling.

Sham

Sham refers to steps that take the form of a legally effective transaction but that the parties intend should not have the apparent, or any, legal consequences. We have ruled on the basis that the documentation is intended to have its legal efficacy.

Issue 2 Question 1

Subsection 8-1(1) of the ITAA 1997 provides that you can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection 8-1(2) provides that you cannot deduct a loss or outgoing under section 8-1 to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or …

Positive limbs of section 8-1

For expenditure to constitute allowable deductions, it must be shown that a loss or outgoing has been incurred. In addition, the loss or outgoing must be referrable to a year of income, and must be incidental or relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. FC of T (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

In determining whether a deduction for the outgoing is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190 (Hallstroms)). The nature or character of the expenditure follows the advantage that is sought to be gained by incurring the expenditure. Paragraph 8-1(2)(a) of the ITAA 1997 precludes a taxpayer from claiming a deduction where the loss or outgoing can be characterised as being capital in nature. This negative limb of section 8-1 is discussed later.

Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions outlines the Commissioner's view of the meaning of the term 'incurred'. Paragraph 5 of TR 97/7 states that you incur an outgoing at the time you owe a present money debt that you cannot escape. The courts have further developed various propositions that outline the scope of the meaning of the term 'incurred'.

The following general rules as to whether and when a loss or outgoing has been incurred have been settled by case law and are outlined at paragraph 6 of TR 97/7:

(a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;

(b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;

(c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);

(d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;

(e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.

Paragraphs 22-25 of TR 97/7 discuss the relevance of accounting practices and principles in relation to whether an outgoing has been incurred and consider that accounting evidence is significant in determining the period to which the outgoing is referrable, but not whether it is incurred.

Paragraph 22 discusses the relevance of jurisprudential analysis in determining whether there is a presently existing pecuniary liability, having regard to the terms of the contract and other arrangements giving rise to that liability, rather than a commercial view of the arrangements - refer James Flood (CLR at 506); Nilsen Development Laboratories (CLR at 624); and see also FC of T v. Citibank Ltd & Ors 93 ATC 4691 at 4699; (1993) 26 ATR 423 at 432-433 ( Citibank Ltd & Ors ); Ogilvy and Mather Pty Ltd v. FC of T 90 ATC 4836 at 4842; (1990) 21 ATR 841 at 848; Coles Myer (ATC at 4221; ATR at 103).

You entered into an agreement to acquire rights to a business concept. For the purposes of this ruling, it is assumed that you are involved in an activity for the gaining or producing of assessable income or are carrying on a business for the purpose of gaining or producing assessable income.

In determining whether you have a presently existing liability to the trust for the purchase of the licence, the following facts are considered relevant:

1. Documents provided to the ATO state that you are liable to pay the purchase price for the rights and licenses to the business concept.

2. The documents provide that a deposit of X% of the purchase price is payable on execution and rendering of a tax invoice. It also provides that a percentage of the purchase price will be paid on execution of the agreements, rendering of a tax invoice and performance security. The documents provides that a deposit is payable in consequence of entering into the agreement.

3. The documents provide that a deposit 'is payable subject to the application for a Private Tax Ruling from the Australian Taxation Office' and provides the terms under which the remaining percentage will be paid.

4. The documents state that the vendor will lend the loan amount to you and the purchase price shall be treated as paid in full. They also provide that all of your obligations in respect thereof will be discharged, and that your obligations to pay any outstanding loan amount and to pay interest on the loan cease on the end date.

It is not clear from the documents provided when the deposit is payable. Further, other documents state that the lender will lend monies to the borrower, subject to the payment of the deposit. You have not provided any evidence that the deposit has been paid, and as the loan from the vendor is subject to the payment of the deposit, there is no evidence that the loan for the purchase price has been executed or advanced. As the loan is the means by which your liability for payment of the purchase price is discharged, you do not appear to have a presently existing liability to pay the purchase price.

For a loss or outgoing to be incurred, it is not necessary for you to have paid any money as long as you are definitely committed to the outgoing in the year of income. A presently existing liability is required for the outgoing to be considered to be incurred, and the liability must be more than impending, threatened or expected. This may be the case, even where the amount of the liability cannot be precisely determined. It follows that you do not have a presently existing liability if it is contingent.

The documents provide that the trust has limited recourse against you if you do not pay back the loan. The terms of the loan agreement are such that repayment, being based on a percentage of distributable EBIT, is contingent on a future event. There is no requirement for you to pay a minimum amount of distributable EBIT at any time. The rate of repayment is vague. These terms indicate that you are not liable to pay a percentage of the purchase price and that your liability for payment of the purchase price for the rights offered by the trust is contingent on a future event (that is, attaining distributable EBIT).

The documents provide that the trust has no recourse for the outstanding loan amount at the end of the term. The clear intention of the agreement between you and the trust taken as a whole is that you are not definitely committed or completely subjected to the loss or outgoing for the purchase of the rights supplied.

You do not have a presently existing liability to pay the purchase price. The amount has not been incurred and you are therefore not entitled to an income tax deduction under subsection 8-1(1) of the ITAA 1997. In addition, whether a loss or outgoing is deductible under subsection 8-1(1) is subject to the tests within subsection 8-1(2) of the ITAA 1997, discussed below.

Negative limbs of section 8-1

Paragraph 8-1(2)(a) of the ITAA 1997 precludes a taxpayer from claiming a deduction where the loss or outgoing can be characterised as being capital in nature.

This is determined by reference to the various principles that have been established through the case law. The judgment of Dixon J in Sun Newspapers & Anor v. Federal Commissioner of Taxation (1938) 61 CLR 337 at page 363 ( Sun Newspapers ) provides the leading distinction for characterising expenditure as revenue or capital in nature. Essentially, after reviewing the existing authorities Dixon J observed that the distinction should be determined by reference to certain practical business considerations, described in the following terms:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

The agreement provides you with rights for the franchising and development of the business concept. The business concept and associated rights can reasonably be characterised as forming the core assets to be used and relied upon by you for gaining or producing your assessable income over the term of the business agreement. Your outgoings can reasonably be regarded as once-off in regard to securing the right to develop the business concept. This is notwithstanding the previous discussion on whether the outgoing has been incurred.

The acquisition of the rights associated with the agreement can reasonably be characterised as part of your business structure or its 'profit-yielding subject'. This was articulated by Dixon J in his judgment in Sun Newspapers at pages CLR 359 to 360:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested... But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a "profit-yielding subject " the phrase of Lord Blackburn in United Collieries Ltd. v. Inland Revenue Commissioners' [(1930) SC 215, at p. 220; (1929) 12 Tax Cas. 1248, at p. 1254]

The business agreement and associated rights are an integral part of your business structure. Therefore, the outgoing (if it had been incurred) for the acquisition of the business concept and the associated rights goes to the 'profit-yielding subject' of the business, and is properly characterised as capital in nature.

Issue 3 Question 1

Division 40 of the ITAA 1997 provides for deductions for the decline in value of a depreciating asset, to the extent that an asset that you hold is used for a taxable purpose. Section 40-30 of the ITAA 1997 describes the assets that are considered to be depreciating assets for the purposes of Division 40.

Section 30-30(1) provides:

A depreciating asset is an asset that has a limited ^*effective life and can reasonably be expected to decline in value over the time it is used, except:

(a) land; or

(b) an item of ^*trading stock; or

(c) an intangible asset, unless it is mentioned in subsection (2).

Section 40-30(2) provides:

These intangible assets are depreciating assets if they are not ^*trading stock:

(a) ^*mining, quarrying or prospecting rights;

(b) ^*mining, quarrying or prospecting information;

(c) items of ^*intellectual property;…

Subsection 995-1(1) provides that an item of intellectual property consists of the rights (including equitable rights) that an entity holds under a Commonwealth law as:

(a) the patentee, or a licensee, of a patent;

(b) the owner, or a licensee, of a registered design; or

(c) the owner, or a licensee, of copyright;

or of equivalent rights held under a *foreign law.

The agreement provides you with the exclusive rights for the franchising and development of the business concept, with patents pending and intellectual property.

You have advised that patents are pending for certain operational aspects of the business. You have acquired a license from the vendor that gives you the rights to exclusively sell and develop the franchises associated with the business concept.

The information that you have provided does not indicate that you are the holder of an item of intellectual property under a Commonwealth Law as either the patentee or licensee of a patent, the owner or licensee of a registered design, or the owner or licensee of a copyright. The patents pending that are associated with the concept will be held as intellectual property of ABC Pty Ltd when registered and will be supplied to the venues leased by ABC Pty Ltd.

The asset you have purchased consists of the rights to sell and franchise the business concepts and systems. You do not hold intellectual property under a Commonwealth Law that would enable you to claim deductions for the decline in value of a depreciating asset, including an intangible asset that satisfies the definition of intellectual property under the ITAA 1997. You are therefore not entitled to any deductions under sub-division 40-B in relation to the agreement.

Section 40-880 provides an income tax deduction for certain business related capital expenditure that you incur for a business that you carry on, or propose to carry on, for a taxable purpose.

The issue of whether you have 'incurred' an outgoing has been considered at Issue 2, Question 1 of this ruling. The principles that have been established in relation to the meaning of 'incurred' under section 8-1 also apply to section 40-880. That is, you incur expenditure or an outgoing at the time that you owe a present money debt that you cannot avoid paying.

As we have already determined that you have not incurred the outgoing or expenditure in relation to the agreement, you are not entitled to deduct an amount of capital expenditure under section 40-880.

Does Part IVA, or any other anti-avoidance provision, apply to this ruling?

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Other relevant comments

The Commissioner has issued Taxation Ruling TR 2002/19 Income tax: license arrangements for intellectual property - Division 40 - tax avoidance schemes, which examines tax avoidance schemes connected with intellectual property. This ruling examines arrangements whereby taxpayers, with little or no financial exposure to the success or failure of the commercialisation of intellectual property, obtain the benefit of deductions under Division 40. We do not have sufficient facts to consider the application of this ruling to the taxpayer's circumstances, should capital allowance deductions be claimed in the future.

Special rules operate to prevent taxpayers from obtaining deductions for certain capital expenditure in excess of the amounts actually outlaid if the property was acquired under a limited recourse financing arrangement. Division 243 operates to include an additional amount in assessable income at the termination of a limited recourse debt arrangement where capital allowance deductions have been obtained for expenditure that was funded by the limited recourse finance arrangements and the debt has not been paid in full when the arrangement is terminated.

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