Edited version of private advice

Authorisation Number: 1052132416512

Date of advice: 26 June 2023

Ruling

Subject: Capital proceeds - apportionment

Question

Will the 'apportionment rule: modification 2' set out in section 116-40 of the Income Tax Assessment Act 1997 apply to the capital proceeds received from the sale of the assets by Company S and Company C?

Answer

No, however the capital proceeds received under the contract should be apportioned on a reasonable basis between the parties and to each separate CGT event.

This ruling applies for the following period:

Year ended 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

At all relevant times, Company S and Company C have been controlled by their sole director.

In late 2018, Company C was contracted by Company M to design and create Applications.

Company S fully financed Company C's related business expenses by way of unsecured loans so that Company C could satisfy its contractual obligations to Company M.

In 2019, Company C acquired all intellectual property rights as they then existed in the Applications from Company M and from that date continued to improve and further develop the Applications by way of unsecured loans.

Just after Company C acquired the Applications from Company M, Company C and S agreed that, in return for Company S assuming the sole risk in financing Company C's acquisition and ongoing development of the Applications by way of unsecured loans, Company S would be granted and hold exclusive rights to market, sell and distribute licences for the Applications both domestically and abroad (the Exclusive Rights) and that the proceeds from Company S's exploitation of the Exclusive Rights would be distributed:

•         Initially as to X% but after the receipt of professional advice as to an arm's length percentage by Advisors Y% to Company C as a base rate royalty for creating and owning the Applications; and

•         Initially as to Z% and after receipt of the above professional advice X% to Company S as holder of the Exclusive Rights/as the unsecured financier of Company C's purchase and ongoing development of the Applications.

From 2019 until 2021:

•         Company C continued improving and further developing the Applications (financed by ongoing unsecured loans from Company S); and

•         Company S operated a business of the exploitation of its Exclusive Rights (the Business)

From 2020, the Business traded as 'Business name' and in respect of that business, Company S soley owned:

•         A domain name

•         All copyright and trademarks of the Business; and

•         The client list for the Business

All sale proceeds from Company S's exploitation of the Exclusive Rights were ultimately distributed:

•         As to X% to Company C

•         As to Y% to Company S

in accordance with agreement summarised in paragraph 3.4.

In or around June 2021 Company S (in its own capacity and on behalf of Company C) entered into negotiations to sell the Business and the Applications to Company D.

In the 2022 financial year, Company S, Company C, Company D and the Director entered into a Terms Sheet where:

•         All of the intellectual property in and associated with the Application including without limitation copyright in the source code, and trade mark rights in the relevant names and logos; and

•         All goodwill and knowhow associated with the application, domain names, client list and similar (owned by Company S).

for an upfront payment of $2,500,000 plus GST (the Upfront Payment) and for ongoing commissions based on future sales of the Applications (the Commissions) payable to Company S.

The Terms Sheet did not provide a breakdown as to how the Upfront Payment was apportioned between Company S's sale of the Business and Company C's sale of the Applications.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1997 subsection 116-40(1)

Reasons for decision

Capital gains tax (CGT)

When you sell an asset that is subject to CGT, it is called a CGT event. This is the point at which you make a capital gain or loss.

If there is a contract of sale, the CGT event happens when you enter into the contract. For example, if you sell a house, the CGT event happens on the date of the contract.

Capital proceeds

Subsection 116-20(1) of the Income Tax Assessment Act 1997 (ITAA 1997) explains that the capital proceeds from a CGT event are the total of:

a)    The money you have received, or are entitled to receive, in respect of the event happening; and

b)    The market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

Subsection 116-40(1) of the ITAA 1997 explains that:

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.

Example:

You sell a block of land and a boat for a total of $100,000. This transaction involves 2 CGT events.

The $100,000 must be divided among the 2 events. The capital proceeds from the disposal of the land are so much of the $100,000 as is reasonably attributable to it. The rest relates to the boat.

Application to your circumstances

In this case, both Company S and Company C were party to a single contract in which they each sold assets. These circumstances are different to what is considered in subsection 116-40(1) of the ITAA 1997 where a single entity executes a contract to dispose of 2 different assets.

However, we accept that in the circumstances a separate CGT event has occurred for Company S and Company C. Therefore, the capital proceeds received under the contract should be apportioned on a reasonable basis between the parties and to each CGT event.