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Ruling

Subject: deduction for the decline in value of a copyright

Question 1

Is Company A entitled to a deduction for the decline in value of the copyright in an acquired database (Database) 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 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 the 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 period:

1 July 2010 to 30 June 2015

Relevant facts and circumstances

Company A is the head company of an Australian tax consolidated group (the A Group) and derives assessable income by operating a business.

On X April 20XX, Company A completed the acquisition of Company B and its subsidiaries. On the same day, Company B joined the A Group.

Among the assets of Company B that were acquired by the A Group was a database containing extensive information (the Database).

The creation of the Database by the staff of Company B involved compiling material and facts including reports and assessments as well as selecting and coordinating this information.

The Database was used by Company B and is used by Company A in its business. It enables particular forms of retrieval and analysis of information used in the business from which it derives its assessable income.

The applicant has confirmed the following facts in relation to the Database which are relied upon in the provision of this private ruling:

· that before its acquisition by Company A as the head company of the tax consolidated A Group, Company B had developed, owned and operated the Database;

· that the Database contains records that 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 and also as individual works in some instances such as reports, assessments and letters;

· that Company B prior to its acquisition used the copyright in the Database to perform acts described in section 31 of the Copyright Act 1968;

· that the copyright in the Database was a separate and distinct asset from any of the other assets of Company B;

· that Company A owns the copyright in the Database either directly or indirectly by reason of its acquisition of Company B;

· that Company A uses the copyright in the Database to perform acts described in section 31 of the Copyright Act 1968;

· that Company A is not seeking confirmation of the valuation obtained for the copyright in the Database; and

· that the adjustable value of the copyright in the Database was nil at the time Company B joined the A Group.

Company A has obtained legal advice in relation to the subsistence of copyright within the Database and the ownership, use and value of this copyright.

Company A obtained a valuation report from an independent valuer, which attributes a market value of $X million to the copyright in the Database.

Upon joining the A Group, the tax cost amount of the copyright in the Database was set at $X million.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-25

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 subsection 40-70(2)

Income Tax Assessment Act 1997 section 40-75

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 701(1)

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 subsection 701-55(2)

Income Tax Assessment Act 1997 section 701-60

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 section 705-5

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 subsection 705-35(1)

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

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

Income Tax Assessment Act 1997 section 705-60

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

Reasons for decision

Question 1

Copyright as a depreciating asset

Under subsection 40-30(1) of the ITAA 1997, an asset is a depreciating asset if it 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 includes items of intellectual property as depreciating assets (provided they are not trading stock).

'Intellectual property' is defined in subsection 995-1(1) of the ITAA 1997 as consisting, inter alia, of the rights that an entity has under a Commonwealth law as the owner or licensee of a copyright.

The Database acquired by Company A from Company B includes a compilation of material and facts as well as individual works such as reports, assessments and letters.

Company A has confirmed that that it considers that copyright subsists in the Database as a compilation that is a 'literary work' as that term is defined in subsection 10(1) of the Copyright Act 1968 and also as individual works in some instances.

The copyright in the Database is intellectual property within the meaning of subsection 40-30(2) of the ITAA 1997 and therefore is a depreciating asset under section 40-30 of the ITAA 1997.

Deduction under Division 40

Subsection 40-25(1) of the ITAA 1997 allows a deduction for the decline in value of a depreciating asset that was held during the year. By virtue of section 40-40 of the ITAA 1997, a depreciating asset is held by the person who owns it. The applicant has advised that Company A is the owner of the copyright in the Database by virtue of its acquisition of Company B and the operation of the single entity rule in subsection 701-1(1) of the ITAA 1997.

Any deduction must be reduced where any part of the asset's decline in value is attributable to use for other than a taxable purpose (subsection 40-25(2) of the ITAA 1997). A taxable purpose is defined, inter alia, as being a purpose of producing assessable income (subsection 40-25(7) of the ITAA 1997). The applicant has advised that Company A uses the copyright in the Database in its business to produce assessable income.

By virtue of subsection 40-60 of the ITAA 1997, a depreciating asset starts to decline in value at its start time which occurs when it is first used or installed ready for use. The start time for the decline in value of the copyright in the Database is determined by the time that Company B was acquired by Company A and became a member of the tax consolidated group (the joining time)

As the copyright in the Database is held by a tax consolidated group, the A Group, subsection 701-55(2) of the ITAA 1997 modifies the operation of Division 40 of the ITAA 1997.

Paragraph 701-55(2)(a) of the ITAA 1997 provides that where an asset is acquired at a particular time, it is taken to be have been acquired at that time for an amount 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 asset just before the joining time is not attributed to Company A. Company A will therefore use the tax cost setting amount as the first element of the cost of the copyright in the Database in calculating the decline in value for the purposes of subsections 40-25(1) and 40-25(2) of the ITAA 1997.

Method of depreciation

Division 40 of the ITAA 1997 allows two methods for calculating the decline in value of a depreciating asset, the diminishing value method and the prime cost method. However, paragraph 40-70(2)(b) of the ITAA 1997 states that the diminishing value method cannot be used for items of intellectual property (other than film copyright). As noted above the copyright in the Database is intellectual property and therefore Company A can only use the prime cost method for calculating the amount that can be deducted under section 40-25 of the ITAA 1997 for the decline in value of the copyright in the Database.

This is so regardless of whether Company B was deducting any amount for decline in value of the copyright in the Database before acquisition by Company A. The copyright in the Database would still have qualified as a depreciating asset for the purposes of Division 40 of the ITAA 1997. The only method available to Company B by virtue of paragraph 40-70(2)(b) of the ITAA 1997 would have been the prime cost method. As such, paragraph 701-55(2)(b) of the ITAA 1997 is satisfied as Company A will use the same method of working out decline in value as that which applied to the copyright in the Database before the joining time.

Effective life of the copyright in the Database

Section 40-75 of the ITAA 1997 sets out the method for working out the decline of the value of a depreciating asset under the prime cost method. One of the factors used in determining the decline is the effective life of the asset.

Subsection 40-95(7) of the ITAA 1997 contains a table that prescribes the effective life of the intangible depreciating assets listed in the table. Item 5 of the table provides that the effective life of a copyright (other than a film copyright) is the shorter 25 years from when the copyright was acquired and the period until the copyright ends.

As noted above, subsection 701-55(2) of the ITAA 1997 modifies the operation of Division 40 of the ITAA 1997 in certain respects. The effect of paragraphs 701-55(2)(a) and (b) of the ITAA 1997 in relation to the tax cost setting amount and the method of depreciation respectively has already been discussed.

Paragraphs (c) and (d) of subsection 701-55(2) of the ITAA 1997 also modify Division 40 of the ITAA 1997 as follows:

Paragraph (c)

Company A will not determine the effective life for the intangible copyright assets under paragraph 701-55(2)(c) of the ITAA 1997. Paragraph 701-55(2)(c) will only apply where the prime cost method would have 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.

Company A has advised that the adjustable value of the copyright in the Database was nil at the time Company B joined the A Group. In accordance with subsection 705-30(3) of the ITAA 1997, the terminating value for a depreciating asset of a joining entity is equal to its adjustable value just before the joining time. Therefore, the terminating value of the copyright in the Database was nil and since the copyright in the Database has been allocated a tax cost setting amount of $X million, paragraph 701-55(2)(c) of the ITAA 1997 cannot apply.

Paragraph (d)

Company A will determine the effective life for the copyright in the Database under paragraph 701-55(2)(d) of the ITAA 1997. That is because the prime cost method applies for determining the asset's decline in value and the tax cost setting amount exceeded the terminating value for the copyright in the Database, which, as noted above, was a nil amount. Company A can therefore choose an effective life for the assets in accordance with subsections 40-95(1) and 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 1997and states that in relation to intangible assets consisting of a copyright (other than a film copyright), the effective life is the shorter of 25 years from when the copyright is acquired or the period until the copyright ends.

Accordingly, Company A will determine the decline in value of the copyright in the Database, and therefore the amount of the deduction under section 40-25 of the ITAA 1997, using the prime cost method with an effective life determined in accordance with subsection 40-95(7) of the ITAA 1997.

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 asset's 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 the assets of a joining entity is the amount worked out under Division 705 of the ITAA 1997.

Section 705-5 of the ITAA 1997 states 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 definition of a retained cost base asset is set out in subsection 705-25(5) of the ITAA 1997. The copyright in the Database does not satisfy that definition and is, therefore, a reset cost base asset.

Subsection 705-35(1) of the ITAA 1997 sets out the method for calculating the tax cost setting amount for reset cost base assets. Subsection 705-35(1) of the ITAA 1997 stipulates that the tax cost setting amount is worked out by:

· first working out the joined group's ACA for the joining entity in accordance with section 705-60 of the ITAA 1997; and

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

· 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.

However, subsection 705-40(1) of the ITAA 1997 limits the tax cost setting amount for a reset cost base asset that is, inter alia, a depreciating asset to the greater of

· the asset's market value; and

· the joining entity's terminating value for the asset.

In accordance with subsection 705-30(3) of the ITAA 1997 Company B's terminating value for the copyright in the Database was its adjustable value just before the time it joined the A Group. However, Company A has advised that the adjustable value of the copyright in the Database was nil and consequently in accordance with subsection 705-30(3) of the ITAA 1997, its terminating value was nil. Therefore, the tax cost setting amount of the copyright in the Database cannot exceed its market value. The applicant has advised that the market value of the copyright in the Database as determined by an independent valuer is $X million.

To the extent that Company A has an ACA under section 705-60 of the ITAA 1997 in relation to its acquisition of Company B, the tax cost setting amount of the copyright in the Database, as a reset cost base asset, will be determined through the application of section 705-35 of the ITAA 1997 (as limited by subsection 705-40(1) 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.