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Edited version of your written advice

Authorisation Number: 1013027337901

Date of advice: 9 June 2016

Ruling

Subject: Capital gains tax - capital proceeds

Question 1

Are proceeds received by company A of capital nature and accordingly assessable under Part 3-1 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following periods:

30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Company A is in the business of software development.

Company A has three main products, product A, product B and product C, that are provided to users on a subscription basis only.

The company initially distributed product A through a distribution agreement with company B.

The company distributed product B and product C directly to the clients.

Company B approached the company offering to purchase product A. Company B, in negotiations advised that if the company did not accept, company B would prevent the company from accessing the company B database, effectively destroying product A as a saleable product to company B users.

Prior to this offer, company A had no intention of selling but due to the commercial pressure decided that they would sell their product A client base to company B, grant company B a non-exclusive licence to the product A code base at the agreed value, and concentrate on building their income stream from product B and product C.

Company A and company B entered into a Deed of Agreement in the relevant financial year.

The purchase price per the Deed of Agreement was $X.

The Deed of Agreement terminated the distribution agreement between company A and company, and resulted in the transfer of ownership of current product A clients and income streams to company B, along with a non-exclusive code-base licence.

Company A continues to develop and offer subscriptions to product B and product C to company B clients.

The Deed of Agreement states that upon the completion date, all existing agreements are hereby terminated by mutual consent.

The Deed of Agreement states that company A grants to company B a perpetual, irrevocable (under any circumstances), worldwide, royalty free, license to use, copy, adapt, translate, sub-license or otherwise transfer, and in any other way exploit and commercialise product A.

The Deed of Agreement assigns to company B, all right, title and interest in all intellectual property rights in the marks, free from any encumbrance of any type.

The Deed of Agreement states that after the completion date all intellectual property rights in any adaptations, translation or modifications that are made to product A by company B, vest in or are assigned to the Company B. Company B has no obligation to provide copies of any such intellectual property rights to company A. While after the completion date all intellectual property rights in any adaptations, translations or other modifications that are made to product A by company A, vest in company A. Company A has no obligation to provide copies of any such intellectual property rights to company B.

The Deed of Agreement states that company A shall not, and shall not permit any third party to, directly or indirectly, market, promote or license product A in competition with purchaser or use the source code to create any software or program that may be used in competition with product A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 section 6-10,

Income Tax Assessment Act 1997 section 10-5 and

Income Tax Assessment Act 1997 Part 3-1.

Reasons for decision

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states:

Further, subsection 6-10(1) of the ITAA 1997 states:

Your assessable income also includes some amounts that are not ordinary income.

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in the present circumstances. Therefore the amount received by company A will not be assessable income under section 6-10. The amount received will only be included in the assessable income of company A if it is assessable income under section 6-5.

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts which is called ordinary income. The classic definition of ordinary income in Australian law was given in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 by Jordan CJ:

The leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). It was said in that case that:

In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. It was further stated at page 138 that:

Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

In your circumstances the Deed of Agreement states that that company A grants to company B a perpetual, irrevocable (under any circumstances), worldwide, royalty free, license to use, copy, adapt, translate, sub-license or otherwise transfer, and in any other way exploit and commercialise product A. Furthermore the Deed of Agreement assigns to company B, all right, title and interest in all intellectual property rights in the marks, free from any encumbrance of any type.

Therefore the licence obtained by company B under the Deed of Agreement will permit company B to perform acts and do things that would normally infringe upon the rights of company A as the owner of various copyrights under the Copyright Act 1968.

However under of the Deed of Agreement, after the completion date all intellectual property rights in any adaptations, translation or modifications that are made to product A by company B, vest in or are assigned to company B. Company B has no obligation to provide copies of any such intellectual property rights to company A. While after the completion date all intellectual property rights in any adaptations, translations or other modifications that are made to product A by company A, vest in company A. Company A has no obligation to provide copies of any such intellectual property rights to company B.

Furthermore there is also a restraint on company A under the agreement which states that it shall not, and shall not permit any third party to, directly or indirectly, market, promote or license product A in competition with purchaser or use the source code to create any software or program that may be used in competition with product A.

The nature of a payment for a licence has been the subject of some judicial consideration in the United Kingdom and Australia. Lord Denning provided a good description of how amounts received for the granting of a licence are generally viewed in Murray (Inspector of Taxes) v Imperial Chemical Industries Ltd [1967] 2 ALL ER 980 (Imperial). Lord Denning in Imperial at 982-983 stated in the context of an assignment of patent rights:

The observations of Lord Denning in Murray were referred to in Kwikspan Purlin System Pty Ltd v Commissioner of Taxation (Cth) (1984) 71 FLR 154 (Kwikspan) by Campbell J at 159. In Kwikspan it was determined that certain lump sum receipts received for the grant of exclusive licences to use a patented invention in different parts of Australia were not part of a profit-making undertaking or scheme and therefore were capital in nature. Furthermore as the company in question was not in the business of dealing in patents, the receipts were not on income account.

Under the Deed of Agreement company B will pay the purchase price for the licence in one single amount to company A. Under the Deed of Agreement, company B acknowledges that it has the right to use the intellectual property, but company B remains free to exploit the same intellectual property. However company A is restricted from marketing, promoting or licensing product A in competition with company B and is unable use the source code to create any software program that may be used in competition with product A. Furthermore the licence obtained by company B is perpetual and irrevocable. The purchase price for the licence was based on calculating the present value of the current income stream received from product A.

Company A is in the business of developing software. Company A is not in the business of dealing in copyrights.

On the basis of the above it is determined that the purchase price for the licence paid by company B to company A under the Deed of Agreement is capital in nature and accordingly will be assessable under Part 3-1 of the ITAA 1997.


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