Edited version of your written advice

Authorisation Number: 1012950960997

Date of advice: 18 February 2016

Ruling

Subject: Copyright, Division 40 and Consolidation

Question 1

Is PH Co entitled to a deduction for the decline in value of the copyright (if any) that subsists in the Databases under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997), as modified by subsection 701-55(2) of the ITAA 1997?

Answer

Yes.

Question 2

To the extent that an Allocable Cost Amount (ACA) exists as determined by Division 705 of the ITAA 1997 (as modified by Subdivision 719-C of the ITAA 1997), is the market value of the copyright (if any) in each Database at the joining time the amount which should be used under section 705-35 of the ITAA 1997 in allocating the residual ACA (after allocation of the ACA to retained cost base assets) to reset cost base assets in proportion to their market values?

Answer

Yes.

This ruling applies for the following periods:

Income tax year ended 30 June 2015

Income tax year ended 30 June 2016

Income tax year ended 30 June 2017

Income tax year ended 30 June 2018

Income tax year ended 30 June 2019

Income tax year ended 30 June 2020

Income tax year ended 30 June 2021

Income tax year ended 30 June 2022

Relevant facts and circumstances

PH Co MEC Group

PH Co and ET1 Co are wholly owned Australian resident subsidiaries and eligible tier-1 companies of Top Co. Top Co is a non-resident company listed on an overseas stock exchange.

PH Co and ET1 Co recently formed a Multiple Entry Consolidated Group (PH Co MEC Group) with PH Co as the provisional head company and Top Co as the top company.

Acquisition of Sub Co 1

Pursuant to the Share Purchase Agreement, PH Co acquired 100% of the issued shares in Sub Co 1 for cash consideration (which included an amount which was paid into an escrow account).

PH Co and the former shareholders of Sub Co 1 were non-related parties and acted at arm's length in relation to the acquisition of Sub Co 1.

Immediately prior to the acquisition by PH Co, Sub Co 1 was the head company of an income tax consolidated group (Former Sub Co 1 Tax Group). As a result of the acquisition, the Former Sub Co 1 Tax Group ceased to be an income tax consolidated group and all members of the group joined the PH Co MEC Group with effect from the joining time.

Acquisition of Sub Co 2

Sub Co 2 became a wholly owned subsidiary of PH Co as a result of the acquisition by ET1 Co of 100% of the issued shares in Sub Co 2. The acquisition was undertaken by a scheme of arrangement whereby 100% of the issued shares in Sub Co 2 were acquired for cash consideration,

ET1 Co and the former shareholders of Sub Co 2 were non-related parties and acted at arm's length in relation to the acquisition of Sub Co 2.

Immediately prior to the acquisition by ET1 Co, Sub Co 2 was listed on the Australian Securities Exchange and was the head company of an income tax consolidated group (Former Sub Co 2 Tax Group). As a result of the acquisition, the Former Sub Co 2 Tax Group ceased to be an income tax consolidated group and all members of the group joined the PH Co MEC Group with effect from the joining time.

Sub Co 1 Database and Sub Co 2 Database (Databases)

As a result of the acquisition by the PH Co MEC Group of both Sub Co 1 and Sub Co 2 (via PH Co and ET1 Co) respectively, the PH Co MEC Group has acquired Databases previously owned by Sub Co 1 and Sub Co 2. The Databases consist of compilations of electronic records relating to the PH Co MEC Group's core business.

Both Sub Co 1 and Sub Co 2 had previously utilised the copyright in the Databases to perform acts described in section 31 of the Copyright Act 1968.

Since acquisition, members of the PH Co MEC Group have used the copyright that subsists in the Databases to perform the acts described in section 31 of the Copyright Act 1968 and to derive assessable income.

Legal opinion has been obtained by PH Co confirming that copyright subsists in the Databases, that PH Co owns the copyright subsisting in the Sub Co 1 Database, that ET1 Co owns the copyright subsisting in the Sub Co 2 Database and that the value of each Database is a measure of the value of the copyright subsisting in them.

The adjustable value as defined by reference to subsection 40-85(1) of the ITAA 1997 of the Sub Co 1 Database as at the valuation date was approximately $20,000,000. PH Co obtained a valuation report of the value of the copyright subsisting in the Sub Co 1 Database. That report states that the indicative fair value of the Database was approximately $30,000,000.

The adjustable value as defined by reference to subsection 40-85(1) of the ITAA 1997 of the Sub Co 2 Database as at the valuation date was approximately $13,000,000. PH Co obtained a valuation report of the value of the copyright subsisting in the Sub Co 2 Database. The valuation report of the value of the copyright subsisting in the Sub Co 2 Database at that time was approximately $50,000,000.

The ACA calculations undertaken by PH Co indicate that upon joining the PH Co MEC Group the tax cost setting amounts subsisting in both the Sub Co 1 and Sub Co 2 Databases exceeded their respective terminating values as determined by subsection 705-30(3) of the ITAA 1997.

Relevant legislative provisions

Copyright Act 1968 section 31

Copyright Act 1968 subsection 31(1)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 subsection 40-25(1)

Income Tax Assessment Act 1997 subsection 40-25(2)

Income Tax Assessment Act 1997 subsection 40-25(7)

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 subsection 40-30(1)

Income Tax Assessment Act 1997 subsection 40-30(2)

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 section 40-60

Income Tax Assessment Act 1997 paragraph 40-70(2)(b)

Income Tax Assessment Act 1997 subsection 40-85(1)

Income Tax Assessment Act 1997 subsection 40-95(1)

Income Tax Assessment Act 1997 subsection 40-95(3)

Income Tax Assessment Act 1997 subsection 40-95(7)

Income Tax Assessment Act 1997 Division 701

Income Tax Assessment Act 1997 section 701-5

Income Tax Assessment Act 1997 section 701-10

Income Tax Assessment Act 1997 subsection 701-10(4)

Income Tax Assessment Act 1997 section 701-55

Income Tax Assessment Act 1997 subsection 701-55(2)

Income Tax Assessment Act 1997 paragraph 701-55(2)(a)

Income Tax Assessment Act 1997 paragraph 701-55(2)(b)

Income Tax Assessment Act 1997 paragraph 701-55(2)(c)

Income Tax Assessment Act 1997 paragraph 701-55(2)(d)

Income Tax Assessment Act 1997 section 701-60

Income Tax Assessment Act 1997 Division 703

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 Subdivision 705-A

Income Tax Assessment Act 1997 subsection 705-25(5)

Income Tax Assessment Act 1997 subsection 705-30(3)

Income Tax Assessment Act 1997 section 705-35

Income Tax Assessment Act 1997 paragraph 705-35(1)(a)

Income Tax Assessment Act 1997 paragraph 705-35(1)(b)

Income Tax Assessment Act 1997 paragraph 705-35(1)(c)

Income Tax Assessment Act 1997 section 705-40

Income Tax Assessment Act 1997 subsection 705-40(1)

Income Tax Assessment Act 1997 subsection 705-40(3)

Income Tax Assessment Act 1997 section 705-60

Income Tax Assessment Act 1997 Subdivision 705-C

Income Tax Assessment Act 1997 section 705-170

Income Tax Assessment Act 1997 section 705-180

Income Tax Assessment Act 1997 subsection 705-180(1)

Income Tax Assessment Act 1997 subsection 705-180(2)

Income Tax Assessment Act 1997 subsection 705-185(1)

Income Tax Assessment Act 1997 Division 719

Income Tax Assessment Act 1997 Subdivision 719-C

Income Tax Assessment Act 1997 subsection 719-2(1)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997, unless specified otherwise.

Question 1

Division 40 contains capital allowance provisions which enable a deduction for the decline in value of depreciating assets to the extent they are used for a taxable purpose.

Copyright as a depreciating asset and subsistence of copyright in relation to compilations and databases

Subsection 40-30(1) provides that a depreciating asset has a limited effective life and can reasonably be expected to decline in value over the time it is used.

Subsection 40-30(2) identifies a number of intangible assets which can be depreciating assets, provided they are not trading stock. Intellectual property is an intangible asset which can be a depreciating asset.

Subsection 995-1(1) defines intellectual property as including the rights, including equitable rights, which an entity has under a Commonwealth law as the owner, or a licensee, of a copyright.

PH Co (as head company of the PH Co MEC Group) has acquired the Databases of Sub Co 1 and Sub Co 2 that record a considerable amount of information relating to the PH Co MEC Group's core business.

A compilation that consists of various pieces of information and which has been gathered, sorted and presented may be considered the original literary work of an author or authors and may be protected by copyright law in Australia.

The current state of the law in relation to the copyright which may subsist in a compilation of records is less than clear and has been considered in a number of recent authorities. The High Court of Australia considered copyright in relation to television program guides and databases in IceTV Pty Ltd v Nine Network Australia Pty Ltd [2009] HCA 14 (IceTV).

The Federal Court of Australia also considered copyright in relation to databases in the context of the telephone directory in Telstra Corporation Ltd v Phone Directories Company Pty Ltd [2010] FCA 44 (Telstra), and a compatibility table for computer printer cartridges in Dynamic Supplies Pty Limited v Tonnex International Pty Limited [2011] FCA 362 (Dynamic).

The recent authorities highlight the difficulties which surround the recognition of copyright in compilations and databases. In IceTV and Telstra it was determined that copyright did not subsist in the relevant compilations, respectively being television programming schedules and telephone directories. In Dynamic it was determined that copyright subsisted in the original CSV file developed by Dynamic in 2008 only - not the subsequent iterations.

The authorities place great emphasis on satisfying the requirements of originality and authorship in determining whether copyright subsists in original literary works which are either compilations or databases. As noted at paragraph 84 of Dynamic:

The cases make clear that originality, for copyright purposes, is a matter of degree depending on the amount of skill, judgment or labour that has been involved in making the compilation. … Whilst negligible skill and labour will not suffice to sustain a claim of originality, I am satisfied in the present case that, cumulatively, the skill and labour employed by Mr Campbell in creating the compatibility chart in the form of the March 2008 CSV file was more than negligible and that that work was, accordingly, an original literary work for copyright purposes.

The emphasis that is placed on the concepts of originality and authorship in the authorities is reinforced in the Copyright Act 1968.

Subsection 31(1) of the Copyright Act 1968 provides that the owner of a copyright in an original literary work possesses certain exclusive rights, such as the right to: reproduce the work in a material form; publish the work; perform the work in public; communicate the work to the public; and make an adaptation of the work. They also have the exclusive right to reproduce, publish, perform or communicate any adaptation of the work. They also have the exclusive right to enter into a commercial rental arrangement in respect of the work reproduced in a sound recording. It would be both reasonable and logical that the use which could be made of a copyright asset for tax purposes would relate to the exclusive rights which vest in the owner of a copyright by virtue of subsection 31(1) of the Copyright Act 1968.

Any copyright that subsists in each of the Databases as original literary works is intellectual property. Intellectual property is recognised as being an intangible asset and a depreciating asset under section 40-30 (hereinafter referred to as intangible copyright assets).

Deductions for decline in value of depreciating assets under Division 40

Subsection 40-25(1) provides that you can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year. Section 40-40 provides that a depreciating asset is 'held' by the owner of the asset.

Subsection 40-25(2) provides that any deduction must be reduced by any part of the decline in value that is attributable to use of the asset, or having it installed ready for use, for a purpose other than a taxable purpose.

Subsection 40-25(7) defines a taxable purpose as being: producing assessable income; exploration or prospecting; mining site rehabilitation; or environment protection activities.

Subsection 40-30(1) provides that 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.

Section 40-60 provides that a depreciating asset starts to decline in value from when its start time occurs and that the start time is the time the asset is first used or installed ready for use, for any purpose.

Subsection 995-1(1) defines installed ready for use as meaning installed ready for use and held in reserve.

PH Co (as head company of the PH Co MEC Group) acquired ownership of the Databases when the respective subsidiaries, namely Sub Co 1 and Sub Co 2, were acquired by the PH Co MEC Group.

Prior to PH Co's acquisition of the Former Sub Co 1 Tax Group, Sub Co 1 used the Database to perform acts described in section 31 of the Copyright Act 1968.

Similarly, prior to ET1 Co's acquisition of the Former Sub Co 2 Tax Group, Sub Co 2 used the Database to perform acts described in section 31 of the Copyright Act 1968.

Since acquiring the Databases, PH Co has used the intangible copyright assets, embodied in those Databases, to perform acts described in section 31 of the Copyright Act 1968.

Further, since acquiring the Databases PH Co has used them for the purposes of subsection 40-30(1) in operating their core businesses by virtue of the Databases being accessible for the input, analysis and retrieval of information and the subsidiaries also used the Databases in this manner before they were acquired by PH Co and ET1 Co (respectively), via the PH Co MEC Group.

Cost, method of depreciation and effective life of the Databases

Part 3-90 contains section 701-55, which operates in relation to assets which are held by consolidated groups and modifies Division 40.

Paragraph 701-55(2)(a) provides that PH Co (as head company of the PH Co MEC Group) acquired the Databases at the time that Sub Co 1 and Sub Co 2 joined the PH Co MEC Group (the joining time). The joining time provides the start time for when the Databases began to decline in value for the purposes of section 40-60.

Cost

Paragraph 701-55(2)(a) also provides that the PH Co MEC Group is taken to have acquired each intangible copyright asset for a payment equal to its tax cost setting amount. The entry history rule in section 701-5 is overridden by subsections 705-180(1) and 705-180(2), such that the terminating value for the assets just before the joining time is not attributed to the PH Co MEC Group. PH Co (as head company of the PH Co MEC Group) will therefore use the tax cost setting amount as the first element of the cost of the intangible copyright assets in calculating the decline in the value for the purposes of subsections 40-25(1) and 40-25(2).

Method of depreciation

Paragraph 701-55(2)(b) requires that the same method for working out the decline in value for an asset is chosen that applied to it just before the joining time. Whilst section 701-55 provides rules for determining the choice of method in working out the decline in value and the effective life of assets acquired by consolidated groups, paragraph 40-70(2)(b) provides that the prime cost method is the only method of depreciation that can be applied in calculating depreciation in relation to intellectual property (except for copyright in film).

Accordingly, PH Co (as head company of the PH Co MEC Group) will utilise the prime cost method of depreciation. As such, paragraph 701-55(2)(b) is satisfied as PH Co will use the same method of working out the decline in value as that which would have applied to the copyright in the Databases before the joining time.

Effective life

PH Co (as head company of the PH Co MEC Group) will determine the effective life for the intangible copyright assets in accordance with paragraph 701-55(2)(d).

As the tax cost setting amounts for the intangible copyright assets exceeds the terminating values of the Sub Co 1 and Sub Co 2 Databases, PH Co will choose an effective life of the intangible copyright assets in accordance with subsections 40-95(1) and 40-95(3). However, subsection 40-95(7) provides an exception to subsections 40-95(1) in relation to intangible assets and specifies that the effective life for an intangible asset consisting of a copyright is the shorter of 25 years from when the copyright is acquired or the period until the copyright ends.

PH Co (as head company of the PH Co MEC Group) is therefore entitled to a deduction for the decline in value of any copyright that subsists in the Databases under Division 40 as modified by subsection 701-55(2) with cost, method of depreciation and effective life determined as detailed above.

Question 2

Acquisition of a consolidated group by a MEC Group

Division 719 modifies the application of Part 3-90 to MEC groups. Specifically, subsection 719-2(1) provides that:

[this Part 3-90] (other than Division 703 and this Division) has effect in relation to a *MEC group in the same way in which it has effect in relation to a *consolidated group.

More specifically Subdivision 719-C contains specific cost setting rules in relation to MEC Groups.

The effect of Subdivision 719-C is that for the purposes of cost setting, other than Divisions 703 and 719, Part 3-90 applies to consolidated and MEC Groups in an equivalent way. Consequently, when PH Co acquires Sub Co 1, and ET1 Co acquires Sub Co 2, the tax cost setting amounts are worked out in accordance with Subdivision 705-C (as modified by Subdivision 719-C). As stated in section 705-170:

When a consolidated group is acquired by another consolidated group, modifications are made to the operation of Division 701 (the core rules) and Subdivision 705-A (tax cost setting amount where a single entity joins a consolidated group) basically to ensure that the tax cost setting amount for assets of the acquired group that become those of the acquiring group reflects the cost to the latter group of acquiring the former.

Modification to Division 701

As discussed in Question 1 (above), Subdivision 705-C modifies Division 701. The modifications to Division 701 are set out in section 705-180. Specifically, the head company core purposes, entity core purposes and entry history rule in Division 701 are overridden and modified by subsections 705-180(1) and 705-180(2) respectively.

Therefore, when PH Co acquires Sub Co 1 and ET1 Co acquires Sub Co 2, Division 701 operates subject to the overriding of the head company core purposes and entity core purposes, and to the modification of the entry history rule.

This means that subsection 701-10(4) provides that the tax cost of each asset of Sub Co 1 and Sub Co 2 is set at the time that the entity (and their subsidiaries) becomes a subsidiary member of the PH Co MEC Group These will be the assets' tax cost setting amounts. Section 701-60 establishes how the tax cost setting amount is worked out and provides that the cost to a head company of assets of a joining entity is the amount worked out under Division 705.

Modification to Subdivision 705-A

Division 705 provides for the determination of tax cost setting amounts for assets where entities become subsidiary members of a consolidated group. Where one consolidated group is acquired by another Subdivision 705-C modifies the usual application of Subdivision 705-A. Subsection 705-185(1) in Subdivision 705-C provides:

Subdivision 705-A has effect in relation to the acquiring group for the head company core purposes set out in subsection 701-1(2) as if:

(a) the only *member of the acquired group that is a joining entity of the acquiring group were the entity that, just before the acquisition time, was the *head company of the acquired group; and

(b) the operation of this Part for the head company core purposes in relation to the head company and the entities that were *subsidiary members of the acquired group continued to have effect for the purposes of Subdivision 705-A.

This means that the assets of all of the subsidiaries within the Former Tax Groups will be treated as assets of Sub Co 1 and Sub Co 2 (respectively). This is explained in Note 1 to section 705-185, which states:

This means that for Subdivision 705-A purposes the subsidiary members of the acquired group are treated as part of the head company of that group, and as a result their assets (other than e.g. internal membership interests) have their tax costs set at the acquisition time.

In applying Subdivision 705-C, the intangible copyright assets, namely the Databases, will be reset cost base assets as they do not satisfy the definition of a retained cost base asset as defined in subsection 705-25(5).

Section 705-35 sets out the method for calculating the tax cost setting amount for reset cost base assets. Paragraphs 705-35(1)(a)-(c) provide that the tax cost setting amount is worked out by:

(a) first working out the joined group's allocable cost amount for the joining entity in accordance with section 705-60; and

(b) then reducing that amount by the total of the tax cost setting amounts for each retained cost base asset (but not below zero); and

(c) finally, allocating the result to each of the joining entity's reset cost base assets (other than excluded assets) in proportion to their market values.

To the extent that an allocable cost amount exists under section 705-60, the tax cost setting amount of the copyright in the Databases, as reset cost base assets, will be determined through the application of section 705-35.

Pursuant to paragraph 705-35(1)(c) it is the market value of the intangible copyright assets at the joining time which should be used for the purposes of section 705-35. To the extent that there is a residual allocable cost amount (after allocation to retained cost base assets) it should be allocated to the reset cost base assets (other than excluded assets) in proportion to their market values.

However, subsection 705-40(1) stipulates that the tax cost setting amount for a reset cost base asset that is a depreciating asset must not exceed the greater of either the asset's market value or the joining entity's terminating value.

As such the tax cost setting amount allocated under section 705-35 will be limited by subsection 705-40(1).

Note: The Commissioner expresses no opinion as to the existence or ownership of copyright in the Databases. The Commissioner also expresses no opinion as to the correctness of either the methodology used or the quantum of the indicative fair values as expressed in the valuation reports obtained by Recruit which were utilised in the acquisition of Sub Co 1 and Sub Co 2 by PH Co and ET1 Co respectively.

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