Edited version of your private ruling

Authorisation Number: 1012552067264

Ruling

Subject: Capital gains tax and licence agreement

Question 1

Will the licence fees received under the licence agreement be considered 'royalties' and assessable under section 15-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No

Question 2

Will the licence fees received under the licence agreement be considered 'royalties' and assessable under section 6-5 of the ITAA 1997?

Answer: No

Question 3

Will the licence fees received under the licence agreement be considered proceeds received from the outright sale of the registered trade marks (and associated property) owned by the trust and assessed under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer: Yes

Question 4

Will entering into the licence agreement for the outright sale of the registered trade marks (and associated property) constitute CGT event B1?

Answer: Yes

This ruling applies for the following period(s)

Year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

Company A as the trustee for Trust A (the trust) is the owner of the registered trademark (RT) and associated intellectual property (the property).

Mr A is a beneficiary of the trust, and a director and majority shareholder of Company A. Mr A formerly conducted a business of RT branded products.

In the 2013-14 financial year, the trust and Company Z entered into a licence agreement. The key terms of the licence agreement are as follows;

· The trust has granted an exclusive licence to Company Z to use, commercialise and exploit the RT brand and intellectual property. This includes the right to modify, improve, add to or update that brand and intellectual property. It also includes the right to sub-licence Company Z's licence to use, commercialise and exploit the RT brand.

· Company Z will pay a total of $XXXX to the trust in consideration for the grant of the exclusive licence. The total fee will be paid in instalments each month. The amount of the monthly instalment will depend on the total revenue (not merely revenue generated from RT property) of Company Z.

· The term of the licence agreement will be between three to five years, depending on the time taken for Company Z to pay the total $XXXX consideration.

· The exclusive licence granted to Company Z applies worldwide.

· Upon expiry of the licence agreement, the trust will transfer all of its right, title and interest in the RT and intellectual property to Company Z. No further consideration will be paid for the transfer.

· Within 5 days of the date of the agreement, the licensor (the trust) must not use a logo, mark or name which includes the RT in the Territory (being worldwide) in relation to any goods or services. Further, the licensor must not use a logo, mark or name that is substantially the same as or deceptively similar to any of the licensor intellectual property.

· Schedule 1 to the licence agreement provides that the 'licensor intellectual property' referred to include;

o registered trademarks for logo and brand name, and

o domain names

As a consequence of the licence agreement, Company Z now stocks and sells RT branded products in addition to the various other brands stocked by Company Z.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1997 Section 15-20

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-15

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 118-25

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 118-24

Income Tax Assessment Act 1997 Section 40-30

Income Tax Assessment Act 1997 Section 118-20

Reasons for decision

Detailed reasoning

Royalties

Taxation Ruling IT 2660 discusses the definition of royalties. Paragraph 9 of IT 2660 states:

The ordinary meaning of a royalty has been considered by the Courts on many occasions. In Stanton v. F.C. of T. (1955) 92 CLR 630; 11 ATD 1 the Full Court of the High Court of Australia described the essence of a royalty. The Court said at CLR page 641 (ATD page 4) that :

"... the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken".

Paragraph 10 of IT 2660 provides that a common law royalty will normally have all of the following features:

a) It is a payment made in return for the right to exercise a beneficial privilege or right (e.g. to remove minerals or natural resources such as timber, to use a copyright, or to produce a play).

b) The payment is made to the person who owns the right to confer that beneficial privilege or right

c) The consideration payable is determined on the basis of the amount of use made of the right acquired

d) The consideration payable will usually be paid as and when the right acquired is exercised

Section 15-20 of the Income Tax Assessment Act 1997 (ITAA 1997) includes in assessable income an amount received by a taxpayer as or by way of royalty. However, a royalty is only assessable under this section if it:

· falls within the ordinary meaning of the term 'royalty'

· is not assessable as ordinary income under section 6-5 of the ITAA 1997, and

· is not a payment to which sections 15-22 or 15-23 of the ITAA 1997 applies. (those provisions deal with payments from copyright collecting societies or from the visual artists resale royalty collecting society).

Section 995-1 of the ITAA 1997 explains that a 'royalty' has the meaning given by subsection 6(1) Income Tax Assessment Act 1936 (ITAA 1936). Subsection 6(1) of the ITAA 1936 expands the meaning of a 'royalty' and states that a royalty, or royalties, includes any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for (among other things) the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark, or other like property or right.

An amount that is a 'royalty' by reason only of the extended definition of that term in section 995-1 of the ITAA 1997 (a statutory royalty) is not included in assessable income under section 15-20 of the ITAA 1997. A statutory royalty that falls within the concept of ordinary income, however, is assessable under section 6-5 of the ITAA 1997.

Taxation Ruling TR 2008/7 discusses royalties and the assignment of copyright. While the ruling focuses on the exploitation of copyright in the case of a tax treaty with a foreign country, it is considered that the ruling has relevance in this situation as the use of a copyright can be considered similar to the use of a trademark. Accordingly, the Commissioner's view on the use or outright sale of a copyright can be extended to include the use or outright sale of a trademark.

Paragraphs 13 and 14 of TR 2008/7 provide the following explanation:

…in light of the definition of 'royalties', and having regard to all relevant facts and circumstances, whether the payment is to be regarded as a payment for the sale of property consisting of the copyright or as a payment for the use of, or the right to use, that property. It is necessary to carefully construe the terms of the agreement between the parties and characterise the consideration by reference to the substance of the arrangement.

The Commissioner accepts that an assignment of copyright amounts to an outright sale if:

· it is for the full remaining life of the copyright; and

· it extends geographically over an entire country or several entire countries; and

· it is not limited as to the class of acts that the copyright assignee has the exclusive right to do; and

· the amount and the timing of the payment or payments for the assignment are not dependent on the extent of exploitation of the copyright by the assignee.

Based on the information provided:

· the agreement entered into allows for the exclusive use of the RT property by Company Z, in fact, the licensor (the trust) will no longer be able to use the RT property in relation to any goods or services.

· The payments received under the agreement are calculated with reference to the total monthly revenue of Company Z, it is not calculated by reference to any actual use by Company Z of the RT property.

· The expected term of the agreement is between three to five years, however this will be dependent on the time taken for Company Z to pay the total agreed amount.

· Upon expiry of the licence agreement (once the total price agreed upon has been paid in full), all of the trust's rights, title and interest in the RT property will be transferred to Company Z

· The territory covered under the licence agreement extends worldwide

· The agreement allows Company Z to deal with the property as it wishes including making modifications, improvements and adding to or updating the property

· The agreement allows Company Z to sub-licence the property to any third party

Accordingly, as all factors point to the assignment being comparable to an outright sale rather than merely a right to use the property, the fees received will not be royalties.

CGT assets

Subsection 108-5(1) of the ITAA 1997 states that a CGT asset is:

a) any kind of property; or

b) a legal or equitable right that is not property.

ATO Interpretative Decision ATOID 2002/958 discusses the definition of property and states:

The ordinary meaning of the word property would include, for example a right such as a chose in action. A chose in action being anything that is recoverable by action as opposed to something which is enjoyed by possession. There are many rights which are recognised at law as clearly falling within the definition of a chose in action. Halsbury's laws of England 4th edn classification adopts five broad categories:

· Debts, debentures, negotiable instruments, annuities and similar obligations

· The benefit of a contract, an option to purchase land or shares, rights to be issued, shares in a company etc

· Recognised subjects of property, such as shares in a company, listed securities of all kinds, policies of insurance, copyrights patents, trademarks etc

· Equity rights to property, such as beneficial interests under trust, a share in a partnership, a mortgage or right to the supply on the exercise by mortgage of his power of sale

· Miscellaneous rights which include rights of action arising under contract and tort, the right of a discretionary object under a trust to force the trustee to carry out his duties, the right to indemnity and other enforceable rights.'

A domain name is a unique name registered by a domain name registrar in the register of names in a domain, for example .com or .com.au, and listed or capable of being listed on domain name servers as being associated with a particular internet address. The registrant of a domain name holds a licence to use the domain name. The licence to use a domain name is a CGT asset as defined in sub-section 108-5(1) of the ITAA 1997.

Further, according to ATO Interpretative Decision ATO ID 2009/3, the rights in relation to trade marks, business names and domain names are CGT assets pursuant to paragraph 108-5(1)(b) of the ITAA 1997.

Accordingly, the property referred to as the 'licensor intellectual property' in the licence agreement, being the registered logo and trade/business name along with the domain names, are CGT assets.

CGT event B1

Section 104-15 of the ITAA 1997 explains that CGT event B1 happens if you enter into an agreement with another entity under which:

a) the right to the use and enjoyment of a CGT asset you own passes to the other entity; and

b) title in the asset will or may pass to the other entity at or before the end of the agreement.

The time of the event is when the other entity first obtains the use and enjoyment of the asset. You make a capital gain if the capital proceeds from the agreement are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

CGT event B1 effectively brings forward the time of a disposal (and the time of a capital gain or loss) under such an agreement from the time when the actual disposal takes place to the time when the use and enjoyment of the asset changes hands. In other words, the asset is treated as if it was disposed of when the use and enjoyment of the asset changes rather than waiting until the time when there is an actual disposal.

Even though CGT event B1 happens at the time the agreement commences, there is also an actual disposal when the title in the relevant asset passes at or before the end of the agreement. As a result of the actual disposal, CGT event A1 (section 104-10 of the ITAA 1997) happens.

Subsection 102-25(1) of the ITAA 1997 explains that if more than one event can apply to your situation, the one that you use is the one that is most specific to the situation. Clearly, where both CGT events A1 and B1 arise from this kind of agreement, CGT event B1 is the more specific. Accordingly, only the rules relevant to CGT event B1 are appropriate for working out any capital gain or loss that arises.

In your case, on entering into the licence agreement, the right to the use and enjoyment of a CGT asset you own, being the 'licensor intellectual property' referred to in the agreement, passes to Company Z. Then, on the expiry of the agreement, that is, when the full payment of the agreed amount is received, the title to the assets will pass to Company Z. Accordingly, CGT event B1 will happen.

Exclusions to the capital gains tax provisions applying

Trading Stock

Section 118-25 of the ITAA 1997 explains that a capital gain or capital loss you make from a CGT asset is disregarded if, at the time of the CGT event, the asset is:

(a) your trading stock; or

(b) if you are a partner, trading stock of the partnership; or

(c) if you are absolutely entitled to the asset as against the trustee of a trust (disregarding any legal disability), trading stock of the trustee.

Subsection 70-10(1) of the ITAA 1997 states that trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and

(b) live stock.

Accordingly, neither a trademark nor a domain name is considered to be trading stock.

Depreciating asset

Section 118-24 of the ITAA 1997 provides that a capital gain or capital loss you make from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset is disregarded if the asset was:

(a) an asset you held; or

(b) if you are a partner, an asset of the partnership; or

(c) if you are absolutely entitled to the asset as against the trustee of a trust (disregarding any legal disability), an asset of the trustee;

where the decline in value of the asset was worked out under Division 40 (including that Division as it applies under Division 355), or the deduction for the asset was calculated under Division 328, or would have been if the asset had been used.

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, except:

(a) land; or

(b) an item of trading stock; or

(c) an intangible asset, unless it is mentioned in subsection (2).

Subsection 40-30(2) of the ITAA 1997 states that these intangible assets are depreciating assets if they are not trading stock:

mining, quarrying or prospecting rights;

§ mining, quarrying or prospecting information;

§ geothermal exploration rights;

§ geothermal exploration information;

§ items of intellectual property;

§ in-house software;

§ IRUs;

§ spectrum licences;

§ datacasting transmitter licences;

§ telecommunications site access rights.

Section 995-1 of the ITAA 1997 states that an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as:

(a) the patentee, or a licensee, of a patent; or

(b) the owner, or a licensee, of a registered design; or

(c) the owner, or a licensee, of a copyright;

or of equivalent rights under a foreign law.

As the definition of intellectual property does not include a trade mark, it is excluded from being a depreciating asset by paragraph 40-30(1)(c) of the ITAA 1997 (ATO Interpretative Decision ATO ID 2004/858).

Similarly, as a domain name is not included in the definition of intellectual property, it too is not a depreciating asset.

Otherwise assessable

Section 118-20 of the ITAA 1997 states that a capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of this Part) includes an amount (for any income year) in:

a) your assessable income or exempt income; or

b) if you are a partner in a partnership, the assessable income or exempt income of the partnership.

As already established, the licence fees to be received under the licence agreement, relate to the right to the use and enjoyment of a CGT asset you own passing to another entity until such time as the licence agreement expires which is when title in the asset will pass to the other entity (CGT event B1).

Since the licence fees to be received are not considered 'royalties' under the ordinary meaning of the term they are not assessable under section 15-20 of the ITAA 1997. Further, as the licence fees are also not considered 'royalties' by reason of the extended definition of that term they are not assessable under section 6-5 of the ITAA 1997 as ordinary income.

Accordingly, as the licence fees received will not be included in your assessable or exempt income under any other provision, no reduction will need to be made to the capital gain you make from CGT event B1 and the capital gains tax provisions will continue to apply to the gain.