Edited version of private ruling

Authorisation Number: 1011675432746

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Ruling

Subject: Deductibility of copyright in databases

Notice of private ruling

Question 1

Will the Commissioner of Taxation confirm that the taxpayer is entitled to a deduction for the decline in value of the copyright 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

Will the Commissioner of Taxation confirm that the copyright in the databases can be brought into the taxpayer group and the tax value of the copyright in the databases will be reset to the greater of the market value of the asset and the joining entities' termination value of the asset where the ACA (Allocable Cost Amount) is sufficient to apportion over the reset cost base assets?

Answer

Yes.

Question 3

To the extent that an Allocable Cost Amount exists as determined by Subdivision 705-A of the ITAA 1997, is the market value of the copyright in the databases at the joining time the amount which should be used under section 705-35 of the ITAA 1997 in allocating the residual Allocable Cost Amount (after allocation to retained cost base assets) to reset cost base assets (except excluded assets) in proportion to their market values?

Answer

Yes. However, the restrictions under section 705-40 of the ITAA 1997 on revenue assets will apply to acquired copyright and the tax cost setting amount cannot exceed the higher of an asset's market value or terminating value.

This ruling applies for the following periods:

Year ending 30 June 2005

Year ending 30 June 2006

Year ending 30 June 2007

Year ending 30 June 2008

Year ending 30 June 2009

The scheme commenced on:

1 July 2004

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer is the head company of a consolidated group for income tax purposes. The taxpayer relevantly acquired a number of companies at arm's length.

Each of the acquired entities joined the taxpayer consolidated group immediately upon acquisition. The taxpayer advises that at the date when each company joined the consolidated group the difference between the net assets on the balance sheet of each of the entities and the purchase price of each of the entities was incorrectly identified as goodwill and the taxpayer failed to recognise certain identifiable intangible assets.

The identifiable intangible assets that were previously unrecognised included copyright in the compilation of the databases of the acquired entities joining the taxpayer consolidated group. The compilation of the databases involved the selection of various details relating to the taxpayer's business. The taxpayer advises that the compilation of details in the database is protected under copyright law as a 'compilation' as that term is understood in the definition of 'literary work' in subsection 10(1) of the Copyright Act 1968 (Commonwealth). Copyright in each 'compilation' protected for each database is a distinct asset, separate from other assets of the subsidiaries. Each of the acquired subsidiaries is the owner of copyright in the 'compilation' protected for each database of the acquired subsidiaries.

Each 'compilation' protected by copyright was recorded electronically and developed into an electronic database system using off-the-shelf database management systems. The systems were not developed by the subsidiaries and were operated under a licence agreement from the owners of the software (including the right to use any copyright in the computer software). A database management system is a software environment that structures and manipulates data and ensures data security, recovery and integrity.

The taxpayer advises that not all new details of the business were added to the database and the selection of appropriate details to be added to the databases was part of the skills required by consultants. The taxpayer advises that it can identify the authors of the database compilation, although, given the number of authors involved it would be extremely onerous to do so.

The taxpayer advises that the copyright in each protected 'compilation' has been used, before and after the relevant joining time, to perform acts described in section 31 of the Copyright Act 1968 (Commonwealth).

A valuation report prepared for the taxpayer by an independent third party valuer values each of the relevant assets, being the copyright in the 'compilation' protected for each database at the time of consolidation. These values have not been verified by the Commissioner of Taxation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-30,

Income Tax Assessment Act 1997 Section 40-60,

Income Tax Assessment Act 1997 Section 40-70,

Income Tax Assessment Act 1997 Section 40-75,

Income Tax Assessment Act 1997 Section 40-95,

Income Tax Assessment Act 1997 Section 40-215,

Income Tax Assessment Act 1997 Section 701-10,

Income Tax Assessment Act 1997 Section 701-55,

Income Tax Assessment Act 1997 Section 705-25,

Income Tax Assessment Act 1997 Section 705-30,

Income Tax Assessment Act 1997 Section 705-35,

Income Tax Assessment Act 1997 Section 705-40,

Income Tax Assessment Act 1997 Section 705-60,

Income Tax Assessment Act 1997 Section 995-1,

Copyright Act 1968 (Commonwealth) Section 10 and

Copyright Act 1968 (Commonwealth) Section 31.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) 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 of the ITAA 1936 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 of the ITAA 1936 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.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Section 40-25 of the ITAA 1997 states that you can deduct an amount equal to the decline in value for an income year (as worked out under this Division) of a depreciating asset that you held for any time during the year. Depreciating assets are defined in section 40-30 of the ITAA 1997 to be assets with a limited effective life that are reasonably expected to decline in value, subject to some exceptions. 'Asset' is not defined in the ITAA 1997 and takes its ordinary meaning, shaped by the context in which it appears. In the Division 40 context, the meaning of 'asset' given in the Macquarie Dictionary (2001, revised third edition, Macquarie Library Pty Ltd) is appropriate - an asset is 'a useful thing or quality; an item of property; an economic resource'. An intangible asset will not be a depreciating asset unless it is listed in subsection 40-30(2). Among the list of intangible assets in paragraph 40-30(2)(c) that are depreciating assets are items of intellectual property.

Intellectual property has a specific meaning for the purposes of the ITAA 1997. As far as the definition in subsection 995-1(1) is relevant, an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as the owner, or the licensee, of a copyright.

A database is generally formed by compiling material and facts that are selected and coordinated in a specific way. The resulting work as a whole may be considered as being an original literary work of the author in certain circumstances and the compilation may be protected by copyright. In this case, the taxpayer has confirmed in writing that copyright subsists in the databases and that the consolidated group both owns and uses the copyright in the databases. The taxpayer has obtained independent valuations of the databases but has not sought confirmation of these values in the Private Binding Ruling.

Use of copyright

A depreciating asset starts to decline in value for the purposes of section 40-60 of the ITAA 1997 when it is used or installed ready for use for any purpose. Subsection 40-60(1) provides that a depreciating asset starts to decline in value from when its start time occurs. For a holder of a depreciating asset, the start time of the asset under subsection 40-60(2) is when the holder first uses the asset, or has it installed ready for use, for any purpose.

The use of a depreciating asset requires exploitation of the asset in such a way that it can reasonably be expected to decline in value over the time it is so employed (see the definition in subsection 40-30(1) of the ITAA 1997). Accordingly, the nature of the exploitation that is required to constitute use will depend to a certain extent on the nature of the asset and the purpose for which it was acquired.

The phrase 'installed ready for use' is defined in subsection 995-1(1) of the ITAA 1997 and requires not only that the relevant thing be installed ready for use but also that it be 'held in reserve'. This latter phrase was also used in the former depreciation provisions that Division 40 replaced (namely, former section 54 of the ITAA 1936 and former Division 42).

In this case, the taxpayer has confirmed in writing that the subsidiaries used the copyright in the databases in their business before the joining time.

For Division 40 purposes, paragraph 701-55(2)(a) of the ITAA 1997 operates so that the taxpayer is taken to have acquired the copyright in each of the databases with a cost equal to the tax cost setting amount. This allows the taxpayer to start claiming deductions for the decline in value of the copyright in the databases based on this amount. The entry history rule in section 701-5 of the ITAA 1997 is overridden so that the terminating value for the copyright in the databases just before the joining time is not attributed to the taxpayer.

Subsections 701-55(1) and (2) of the ITAA 1936 state that:

701-55(1) This section states the meaning of the expression an asset's tax cost is set at a particular time at the asset's *tax cost setting amount.

701-55(2) If any of Subdivisions 40-A to 40-D, sections 40-425 to 40-445 and Subdivision 328-D, and sections 73BA and 73BF of the Income Tax Assessment Act 1936, is to apply in relation to the asset, the expression means that the provisions apply as if:

(a) the asset were *acquired at the particular time for a payment equal to its *tax cost setting amount; and

(b) at that time the same method of working out the decline in value were chosen for the asset as applied to it just before that time; and

(c) where just before that time the prime cost method applied for working out the asset's decline in value and the asset's tax cost setting amount does not exceed the joining entity's *terminating value for the asset - at that time an *effective life were chosen for the asset equal to the remainder of the effective life of the asset just before that time; and

(d) where just before that time the prime cost method applied for working out the asset's decline in value and the asset's tax cost setting amount exceeds the joining entity's *terminating value for the asset - the *head company were required to choose at that time an effective life for the asset in accordance with subsections 40-95(1) and (3) and any choice of an effective life determined by the Commissioner were limited to one in force at that time; and

(e) where neither paragraph (c) nor (d) applies - at that time an effective life were chosen for the asset equal to the asset's effective life just before that time.

The copyright in the databases were internally generated assets of the subsidiaries prior to the time that the taxpayer acquired the subsidiaries and these assets were not recognised by the subsidiaries for tax purposes. If the subsidiaries had recognised copyright in the databases as a depreciating asset, they would not have been entitled to a positive amount for decline in value as the copyright had a nil cost because all amounts incurred in creating the asset (that is, labour costs) were deducted and not able to be included in the asset's cost pursuant to section 40-215 of the ITAA 1997.

The copyright in each of the databases is an item of intellectual property and is an intangible asset for which only the prime cost method applies for working out the decline in value. Specifically, paragraph 40-70(2)(b) of the ITAA 1997 lists an item of intellectual property (except copyright in a film) as an asset for which the diminishing value method cannot be used. Items of intellectual property are included in the list of intangible assets in subsection 40-30(2) of the ITAA 1997 which are depreciating assets.

Prior to the joining time, the subsidiaries each held the copyright in the databases for which the decline in value could only be worked out using the prime cost method. As stated above, the subsidiaries were using the copyright in the databases in their business before the joining time which provides a 'start time' under subsection 40-60(2) of the ITAA 1997 when the copyright in each database starts to decline in value.

The copyright in each of the databases qualifies as a depreciating asset and is subject to the capital allowance provisions in Division 40 notwithstanding that the cost of the copyright in each database for Division 40 purposes to the subsidiaries may be nil. All the elements in the formula in subsection 40-75(1) of the ITAA 1997 are present for working out the decline in value under the prime cost method before the joining time; namely asset's cost, days held and effective life. Therefore, an amount for the decline in value could be determined before the joining time, noting that the definition of 'amount' in subsection 995-1(1) of the ITAA 1997 includes a nil amount.

As the subsidiaries held and used the copyright in the databases prior to the joining time, the prime cost method is taken to have applied for working out the decline in value just before the joining time for the purposes of subsection 701-55(2) of the ITAA 1997.

Pursuant to paragraph 701-55(2)(b) of the ITAA 1997, the taxpayer will use the prime cost method when it works out the decline in value of the copyright in each database. Division 40 is modified by subsection 701-55(2) in respect of the taxpayer's entitlement to deductions for decline in value under the prime cost method as follows:

§ the 'start time' for the taxpayer will be determined having regard to its holding of the copyright in each database. The taxpayer will be taken to first hold the copyright in each database at the joining time as paragraph 701-55(2)(a) deems that the taxpayer is taken to have acquired the copyright in each database at that time.

§ the first element of the 'cost' is the tax cost setting amount as paragraph 701-55(2)(a) deems that the taxpayer is taken to have acquired the copyright in each database for a payment equal to the tax cost setting amount.

§ the effective life is determined under either paragraph 701-55(2)(c) or (d) of the ITAA 1997. Where the tax cost setting amount exceeds the subsidiaries' terminating value of the copyright, paragraph 701-55(2)(d) applies. This paragraph refers to an effective life in accordance with subsections 40-95(1) and (3) of the ITAA 1997. However, there is a statutory effective life for copyright under subsection 40-95(7). The effective life will therefore be the shorter of 25 years from the joining time, when the taxpayer is taken to have acquired the copyright for Division 40 purposes, and the period until the copyright ends.

Questions 2 and 3

Section 701-10 of the ITAA 1997 sets out the how an asset of a subsidiary is treated when a subsidiary joins a consolidated group. Subsection 701-10(4) provides that each asset's tax cost is set at the time the entity becomes a subsidiary at the asset's tax cost setting amount. Section 701-60 provides that the tax cost setting amount set by section 701-10 is worked out under Division 705.

The copyright in each of the databases will be a reset cost base asset as it is not a retained cost base asset as defined in section 705-25 of the ITAA 1997.

Section 705-35 of the ITAA 1997 sets out the method of calculating the tax cost setting amount for reset cost base assets. The section provides that for each asset of the joining entity that is not a retained cost base asset, a reset cost base asset or an excluded asset, the asset's 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 in accordance with section 705-25 for each retained cost base asset (but not below zero); and

c) finally, allocating the result to each of the joining entity's rest 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 of the ITAA 1997, the tax cost setting amount of the copyright in the databases will be determined under section 705-35 of the ITAA 1997.

Pursuant to paragraph 705-35(1)(c) of the ITAA 1997, the market value of the copyright in the databases at the joining time is the amount which should be used under section 705-35 of the ITAA 1997 in allocating the residual allocable cost amount (after allocation to retained cost base assets) to reset cost base assets (except excluded assets) in proportion to their market values. In this case, the taxpayer has obtained a valuation report in relation to the values of the copyright in the databases, however confirmation of the market value of the databases has not been sought in this Ruling.

The application of section 705-35 of the ITAA 1997 is limited by the operation of section 705-40. Section 705-40 provides that the tax cost setting amount for a reset cost base asset that is a depreciating asset must not exceed the greater of the asset's market value and the joining entity's terminating value.

Subsection 705-30(3) of the ITAA 1997 has application to a depreciating asset to which Division 40 applies and provides that the joining entity's terminating value for the asset is equal to the asset's adjustable value just before the joining time.

Accordingly, where the allocable cost amount (as defined in section 705-60 of the ITAA 1997) is sufficient to apportion over the reset cost base assets, the tax value of the copyright in the databases will be reset to the greater of the market value of the asset and the joining entities termination value of the asset.