Edited version of your written advice

Authorisation Number: 1051258420515

Date of advice: 28 July 2017

Ruling

Subject: Deed of Settlement Amount

Question 1

Is the settlement amount received by you assessable ordinary income under section 6-5 of the ITAA 1997?

Answer

No.

Question 2

Is a portion of the settlement amount received by you assessable under capital gains tax provisions?

Answer

Yes.

Question 3

Is a portion of the settlement amount received by you assessable under the capital allowance regime under Division 40 of the ITAA 1997?

Answer

Yes

Question 4

Was the settlement amount paid to you pursuant to a Deed of Agreement consideration for a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) 1999?

Answer

Yes

This ruling applies for the following periods:

The year ended 30 June 201Z

The scheme commences on:

December 201Y

Relevant facts and circumstances

You work as a writer.

You are registered for GST.

In late 201X you entered a publishing agreement with the publishing entity to publish written materials. The written material was to be published as a hardcopy in Australia and an e-book internationally.

You expected to derive royalty income from the sale of the written materials under the publishing agreement.

You delivered the manuscript to the publisher and went through the editorial process. The written material was printed and a release scheduled.

The written material was not released and a deed of agreement was entered into with the publishing entity.

The deed of agreement had a settlement amount to be paid to you and contained additional terms;

● That the publishing agreement be terminated

● That the written materials would not be published

● That an agreed statement would be displayed on your website

● That all copies of the written materials, hard and electronic, be returned to the publisher

● That all legal, beneficial and intellectual property rights in the written materials be transferred from you to the publishing entity.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Subsection 40-25 of the Income Tax Assessment Act 1997

Subsection 40-30 of the Income Tax Assessment Act 1997

Subsection 40-295 of the Income Tax Assessment Act 1997

Subsection 102-5 of the Income Tax Assessment Act 1997

Subsection 102-20 of the Income Tax Assessment Act 1997

Subsection 104-25 of the Income Tax Assessment Act 1997

Subsection 116-40(1) of the Income Tax Assessment Act 1997

Subsection 118-24(1) of the Income Tax Assessment Act 1997

Subsection 995-1 of the Income Tax Assessment Act 1997

Section 9-5 of A New Tax System (Goods and Services Tax) 1999

Section 9-10 of A New Tax System (Goods and Services Tax) 1999

Reasons for decision

Question 1

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

● are earned

● are expected

● are relied upon

● have an element of periodicity, recurrence or regularity.

You received a lump sum settlement amount as compensation for the termination of your publishing agreement. The settlement was inclusive of the transfer of the copyright and other intellectual property rights in your written materials to the publishing entity. The settlement and resultant transfer of copyright did not come about as part of any profit making business plan you had undertaken. The lump sum settlement amount is therefore not considered income from rendering personal services, income from property or income from carrying on a business. The settlement amount is a one-off payment and thus does not have an element of recurrence or regularity. As such the settlement payment is not considered to be ordinary income.

Amounts that are not ordinary income, but are included in your assessable income by another provision, are called statutory income as per section 6-10 of the ITAA 1997.

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. The relevant provisions included in this list are section 102-5 of the ITAA 1997 (capital gains) and Division 40 of the ITAA 1997 (capital allowances).

Question 2

Section 102-20 of the ITAA 1997 provides that you make a capital gain or capital loss as a result of a Capital Gains Tax (CGT) event happening to an asset in which you have an ownership interest. Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property; or a legal or equitable right that is not property.

Taxation Ruling TR 95/35 discusses the treatment of compensation receipts and states that the particular asset in respect of which compensation has been received by the taxpayer may be in relation to:

1  an underlying asset;

2   a right to seek compensation; or

3   a notional asset

The right to seek compensation is an asset for CGT purposes. Subsection 104-25(2) of the ITAA 1997 indicates that the right to seek compensation is acquired at the time of occurrence of the breach of contract, personal injury or other compensable damage or injury. The right to seek compensation is disposed of when a court order is made or an out of court settlement is reached.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset (CGT event A1). In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation (paragraph 4 TR 95/35).

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. It is only in these cases that CGT event C2 would occur. Section 104-25 of the ITAA 1997 indicates that a CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends by the asset being redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expiring.

If the compensation relates directly to more than one asset, it is necessary to determine the most relevant assets and to apportion the compensation between those assets. Subsection 116-40(1) of the ITAA 1997 provides:

'If you receive a payment in connection with a transaction that relates to more than one CGT event, the capital proceeds from each event are so much of the payment as is reasonably attributable to that event.'

This provision requires the taxpayer to allocate receipts between the relevant assets. If the taxpayer allocates amounts between different assets on a reasonable basis we will generally accept that basis of allocation.

Given that a look through approach to the settlement amount has identified two assets, the right to seek compensation, which was created on cancellation of the publishing agreement, and the intellectual property asset in the form of copyright over the written materials, it is considered that the amount is not a straight A1 or C2 CGT event, but a combination of the two.

Question 3

Subsection 40-30(1) of the Income Tax Assessment Act 1997 (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.

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.

Paragraph 40-295(1)(a) of the ITAA 1997 provides that a balancing adjustment event occurs for a depreciating asset if you stop holding it.

The manuscript was delivered to and accepted by the publishers. Pre-printing of the written materials occurred and a release date was set. This indicates the written materials, and thus the copyright, in consideration as an asset was available and ready for use. Consequently a balancing adjustment event occurred when you transferred the copyright as part of the deed of settlement. The portion of the settlement amount relating to the transfer of the copyright is considered the termination value.

Please note that under subsection 118-24(1) of the ITAA 1997 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 an asset you held where the decline in value of the asset was worked out under Division 40.

Question 4

NOTE: In this part of the reasoning, unless otherwise stated, all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act).

Section 9-5 provides that you make a taxable supply if: 

(a) you make the supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with the indirect tax zone; and

(d) you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The GST-free and input tax provisions do not apply in your circumstances.

Supply

Paragraph 21 of Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements explains for there to be a supply for consideration, three criteria must be met:

● there must be a supply

● there must be a payment; and

● there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration

Paragraph 22 of GSTR 2001/4 explains that a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

Paragraph 43 of GSTR 2001/4 explains that a supply related to an out-of-court settlement may have occurred prior to the settlement (and in fact have been the subject of the dispute in the first place), or it may be created by the terms of the settlement itself.

Paragraphs 44 to 54 of GSTR 2001/4 identify three categories of supplies that relate to an out-of court settlement, these being an earlier supply, current supply; and discontinuance supply.

Paragraph 48 of GSTR 2001/4 explains that, a new supply may be created by the terms of the settlement; such a supply is referred to as a current supply.

Paragraph 49 of GSTR 2001/4 provides an example of a current supply.

49. A dispute arises over a claim by Beaut Enterprises Pty Ltd that Plagiariser Pty Ltd is using their trade name. Negotiations between the parties follow, resulting in Beaut entering into an agreement with Plagiariser that allows Plagiariser to use its trade name in the future. This would constitute the supply of a right under the agreement between Beaut and Plagiariser that amounts to a 'current' supply.

You entered into an agreement to deliver the written materials and granted the Publisher sole and exclusive rights of licence of the written materials. However the publishing entity objected to the written material's publication. To resolve the matter, you and the publishing entity entered into a Deed of Agreement. Terms included terminating the Publishing Agreement and transferring all legal, beneficial and intellectual property rights of the written materials and any previous versions, including assigning the entire copyright including future copyright throughout the world to the publishing entity. Your supply of rights, including the copyright, to an Entity was a current supply because it was a supply of rights created by the terms of the Deed of Agreement.

Payment

A sum was paid to you by the publishing entity.

Nexus between the supply and the payment

The payment from the publishing entity to you was for the supply of rights. The consideration related to your current supply and was consideration for that supply.

Your supply met the other requirements of a taxable supply. Further, the GST-free or input taxed provisions do not apply to you.

Therefore, the settlement amount paid by the publishing entity to you was consideration for your current taxable supply of rights.