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Ruling

Subject: Deductibility of copyright assets under Division 40 of the Income Tax Assessment Act 1997

Question 1

Is Entity A entitled to a deduction for the decline in value of the copyright in certain acquired 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 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 ACA (after allocation of the ACA to retained cost base assets) to reset cost base assets (except excluded assets) in proportion to their market values?

Answer

Yes

This ruling applies for the following periods:

Income tax year ending 30 June 2007

Income tax year ending 30 June 2008

Income tax year ending 30 June 2009

Income tax year ending 30 June 2010

The scheme commences on:

1 July 2006

Relevant facts and circumstances

Entity A is a listed Australian company and is the head company of an Australian tax consolidated group.

Entity A acquired the following entities:

· Entity B

· Entity C and Entity D (together referred to as Entity C)

Entity A appointed an independent valuer who identified the various intangible assets of the entities joining the tax consolidated group. Entity A did not seek a legal opinion, as they were not advised to do so. Entity A worked out the ACA for the joining entities and assigned a tax cost amount to each of the various identified intangible assets.

Entity B and Entity C developed and operated a number of databases prior to acquisition. Entity B and Entity C did not previously recognise the databases for tax purposes.

The relevant (certain acquired) databases (collectively referred to as the Databases) are:

1. Database A held by Entity B

2. Database B held by Entity B.

3. Database C held by Entity B.

4. Database D held by Entity C.

Entity A subsequently obtained legal advice in relation to the subsistence of copyright within the Databases as well as the ownership, use and value of this copyright. Entity A submits that copyright exists in the various Databases and that those copyrights are previously unidentified assets of the joining entities which could have been assigned a tax cost amount.

Entity A have obtained a valuation report which attributes value to the Databases. The aggregated market value attributed to the Databases on acquisition was $10,000,000.

Entity A submit that had a tax cost amount been assigned to the newly identified copyright assets in the Databases they would not have been able to assign an amount equal to the market value of the assets as they would not have had a sufficient ACA.

Entity A were asked to confirm and did confirm a number of facts which are relied upon in the provision of this private binding ruling:

· That Entity B, prior to acquisition, had developed, owned and operated databases, namely: Database A, Database B and Database C (Entity B Databases).

· That Entity C, prior to acquisition, had developed, owned and operated a database, namely Database D (Entity C Database).

· That the Entity B Databases and Entity C Database contain records which are protected under copyright law as 'compilations' as that term is understood in the definition of 'literary work' in subsection 10(1) of the Copyright Act 1968.

· That Entity B, prior to acquisition, used the copyright in the Entity B Databases to perform acts described in section 31 of the Copyright Act 1968.

· That Entity C, prior to acquisition, used the copyright in the Entity C Database to perform acts described in section 31 of the Copyright Act 1968.

· That the copyright in the Entity B Databases and Entity C Database are separate and distinct assets from any of the other assets of Entity B and Entity C.

· That they own the copyright in the Entity B Databases and Entity C Database either directly or indirectly by reason of their acquisition of Entity B and Entity C

· That they have used the copyright in the Entity B Databases and Entity C Database to perform acts described in section 31 of the Copyright Act 1968.

· That they are not seeking confirmation of the valuations obtained for the Entity B Databases and Entity C Database.

Relevant legislative provisions

Copyright Act 1988 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 subsection 40-30(1)

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

Income Tax Assessment Act 1997 section 40-60

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

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

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

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

Income Tax Assessment Act 1997 subsection 40-215(1)

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 sub-section 701-10(4)

Income Tax Assessment Act 1997 section 701-55

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 705

Income Tax Assessment Act 1997 subdivision 705-A

Income Tax Assessment Act 1997 section 705-5

Income Tax Assessment Act 1997 section 705-25

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 section 705-60

Income Tax Assessment Act 1997 paragraph 705-60(1)(c)

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

Reasons for decision

Question 1

Division 40 of the ITAA 1997 contains capital allowance provisions which enable a deduction for the decline in value of a depreciating asset to the extent that it is used for a taxable purpose.

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

Subsection 40-30(1) of the ITAA 1997 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.

Subsection 40-30(2) of the ITAA 1997 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) of the ITAA 1997 defines an item of intellectual property as being the rights, including equitable rights, that an entity has under a Commonwealth law as the owner, or a licensee, of a copyright.

Entity A acquired the Databases which consist of a number of records. A compilation which consists of various pieces of information 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.

Entity A have advised that copyright subsists in each of the identified databases described above as compilations which are original literary works and which satisfy the requirements of subsection 10(1) of the Copyright Act 1968.

The copyright in each of the databases is intellectual property. Intellectual property is recognised as being an intangible asset and a depreciating asset under section 40-30 of the ITAA 1997 (hereinafter referred to as intangible copyright assets).

Deductions for decline in value of depreciating assets under Division 40 of the ITAA 1997

Subsection 40-25(1) of the ITAA 1997 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 of the ITAA 1997 provides that a depreciating asset is 'held' by the owner of the asset.

Subsection 40-25(2) of the ITAA 1997 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) of the ITAA 1997 defines a taxable purpose as being: producing assessable income; exploration or prospecting; mining site rehabilitation; or environment protection activities.

Subsection 40-30(1) of the ITAA 1997 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 of the ITAA 1997 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) of the ITAA 1997 defines installed ready for use as meaning installed ready for use and held in reserve.

Section 701-55 of the ITAA 1997 operates in relation to assets which are held by a tax consolidated group and modifies the operation of Division 40 of the ITAA 1997.

Paragraph 701-55(2)(a) of the ITAA 1997 operates so Division 40 of the ITAA 1997 applies as if Entity A acquired the intangible copyright assets at the time the subsidiaries joined the tax consolidated group (the joining time). The joining time provides the start time for when the intangible copyright assets began to decline in value for the purposes of section 40-60 of the ITAA 1997.

Paragraph 701-55(2)(a) of the ITAA 1997 also operates so Division 40 of the ITAA 1997 applies as if Entity A acquired each intangible copyright asset for a payment equal to its tax cost setting amount. Section 701-5 of the ITAA 1997 which contains the entry history rule is overridden so that the terminating value for the assets just before the joining time is not attributed to Entity A. Entity A 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) of the ITAA 1997.

Paragraphs 701-55(2)(b) to (e) provide rules for determining the choice of method in working out the decline in value and the effective life of assets acquired by tax consolidated groups. Prior to applying these rules it is necessary to identify how the intangible copyright assets would have been treated by the subsidiaries prior to joining the tax consolidated group.

Method of depreciation that would have been used by subsidiaries

Entity A have advised that the subsidiaries were not deducting any amount for the decline in value of the intangible copyright assets just prior to joining the consolidated group as the Databases and any copyright which subsists within them were internally generated assets of the subsidiaries. Amounts incurred by the subsidiaries in creating the intangible copyright assets would therefore have been deducted under section 8-1 of the ITAA 1997 and would not have been able to be included in working out the cost of the intangible copyright assets, as depreciating assets, due to the operation of subsection 40-215(1) of the ITAA 1997.

Despite the fact that the subsidiaries did not or could not claim an amount as a deduction for the decline in value of the intangible copyright assets the assets would still have qualified as depreciating assets for the purposes of Division 40 of the ITAA 1997. That is so even though the cost of the intangible copyright assets for the subsidiaries would have effectively been nil for the purposes of Division 40 of the ITAA 1997. The definition of the word 'amount' includes a nil amount in subsection 995-1(1) of the ITAA 1997.

Entity A advises that the subsidiaries owned the intangible copyright assets just prior to joining the consolidated group. Entity A has also advised that the subsidiaries were using the Databases prior to joining the consolidated group in operating their respective businesses. This provides the start time for use of the intangible copyright assets by the subsidiaries for the purposes of section 40-60 of the ITAA 1997.

The subsidiaries could have deducted an amount, even though that amount would have been nil, for the decline in value of the intangible copyright assets. The only method of depreciation that could have applied to the intangible copyright assets in calculating depreciation would have been the prime cost method. The diminishing value method cannot be used in relation to intellectual property, except for copyright in film, due to paragraph 40-70(2)(b) of the ITAA 1997.

Cost, method of depreciation and effective life of the intangible copyright assets for Entity A

Entity A have advised that they own the intangible copyright assets either directly or indirectly by reason of their acquisition of the subsidiaries. Entity A therefore hold the intangible copyright assets for the purposes of sub-section 40-25(1) of the ITAA 1997.

Entity A have advised that since acquiring the intangible copyright assets they have used them in operating their businesses by virtue of the Databases being accessible for the input, analysis and retrieval of information. Entity A have advised that they have used the intangible copyright assets to perform acts described in section 31 of the Copyright Act 1968.

Entity A is entitled to a deduction for the decline in value of the copyright in the Databases under Division 40 of the ITAA 1997 as modified by subsection 701-55(2) of the ITAA 1997.

Entity A will determine the cost, method of depreciation and effective life of the intangible copyright assets as follows:

1. Entity A is taken to have acquired the intangible copyright assets for a payment which is equal to the tax cost setting amount due to paragraph 701-55(2)(a) of the ITAA 1997. This provides the first element of the cost for calculating the decline in value for the purposes of subsections 40-25(1) and 40-25(2) of the ITAA 1997.

2. Entity A is taken to have chosen to apply the same method for working out the decline in value as applied to the intangible copyright assets just before the joining time due to paragraph 701-55(2)(b) of the ITAA 1997. This would be the prime cost method as that was the only method which could have been used by the subsidiaries in relation to intellectual property consisting of copyright due to paragraph 40-70(2)(b) of the ITAA 1997.

3. Entity A will not determine the effective life for the intangible copyright assets under paragraph 701-55(2)(c) of the ITAA 1997. That is because although the prime cost method would have applied for working out the assets decline in value the assets tax cost setting amount will exceed the joining entities terminating value for the assets, which was a nil amount.

4. Entity A will determine the effective life for the intangible copyright assets under paragraph 701-55(2)(d) of the ITAA 1997. That is because the prime cost method applied for determining the assets decline in value and the tax cost setting amount would exceed the joining entities terminating value for the assets, which was a nil amount. Entity A can therefore choose an effective life for the assets in accordance with subsections 40-95(1) or 40-95(3) of the ITAA 1997. However, subsection 40-95(7) of the ITAA 1997 provides an exception to subsections 40-95(1) and 40-95(3) of the ITAA 1997. Subsection 40-95(7) of the ITAA 1997 provides that in relation to intangible assets consisting of a copyright the effective life is the shorter of 25 years from when the copyright is acquired or the period until the copyright ends.

Question 2

Section 701-10 of the ITAA 1997 establishes how the assets of an entity which joins a tax consolidated group are treated by the head company. Sub-section 701-10(4) of the ITAA 1997 provides that the tax cost of each asset is set at the time that the entity becomes a subsidiary member of the tax consolidated group at the assets tax cost setting amount.

Section 701-60 of the ITAA 1997 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 of the ITAA 1997.

Section 705-5 of the ITAA 1997 provides that when an entity becomes a subsidiary member of an existing tax consolidated group, the tax cost setting amount for its assets reflects the cost to the group of acquiring the entity.

The intangible copyright assets will be reset cost base assets as they do not satisfy the definition of a retained cost base asset in subsection 705-25(5) of the ITAA 1997.

Subsection 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 of the ITAA 1997; 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 ACA exists under section 705-60 of the ITAA 1997, the tax cost setting amount of the intangible copyright assets, as reset cost base assets, will be determined through the application of section 705-35 of the ITAA 1997.

Pursuant to paragraph 705-35(1)(c) of the ITAA 1997, to the extent that there is a residual ACA after allocation to retained cost base assets, it should be allocated to reset cost base assets in proportion to their market value.