Edited version of private advice

Authorisation Number: 1052274503516

Date of advice: 15 August 2024

Ruling

Subject: Assessable income - balancing adjustment event

Question 1

Did a balancing adjustment event under subsection 40-295(1) of the Income Tax Assessment Act 1997 (ITAA 1997) occur when the Producer acquired the Film rights?

Answer

Yes.

Question 2

Did capital gains tax (CGT) event A1 in section 104-10 of the ITAA 1997 happen when the Producer acquired the Film rights?

Answer

Yes. However, any capital gain you made will be disregarded.

This ruling applies for the following periods:

Year ended 30 June 2023

Year ended 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You carry on a business as an author.

You receive regular income in the form of royalties from your activities as an author.

You entered a publishing agreement with a Publisher in relation to an original work (Work) you wrote.

Later you, the Publisher and the Producer entered an Option (Option Agreement) and Deed of assignment (Rights Agreement).

This Option Agreement provides as background that:

•         you are the author of the Work which was published by the Publisher pursuant to a publishing agreement pursuant to which the Publisher has an exclusive licence over the Work, and

•         the Producer wishes to produce a film based on or incorporating the Work.

The terms of the Option Agreement provided that:

• you and the Publisher grant to the Producer an exclusive option (Film option) on the terms set out in the agreement to acquire the rights in the Work specified in the Rights Agreement
• concurrently with the execution of that Option Agreement, you, the Publisher and the Producer executed the Rights Agreement
• notwithstanding such execution, it was agreed that the Rights Agreement shall have no force or effect except that the Rights Agreement shall be binding and effective upon exercise of the Film option and the rights shall vest in the Producer as and from that date and the Producer is empowered to date the Rights Agreement accordingly.

The Producer exercised the Film option to acquire the Film rights and you received a lump sum payment.

The disposal of the rights to the Film is a final transaction and no further ongoing payments will be made to you in relation to the Film. That is, you will not receive any royalty payments when the Film is released.

You had final say on who the Film rights could be sold to and the Publisher could not sell the film rights without your approval.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 section 40-115

Income Tax Assessment Act 1997 section 40-285

Income Tax Assessment Act 1997 section 40-295

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 118-24

Reasons for decision

Summary

Copyright is a depreciating asset. A balancing adjustment event occurred when the Producer exercised the option and acquired the Film rights. The amount included in your assessable income is the difference between the termination value and adjustable value of the Film rights.

Copyright is also a CGT asset. CGT event A1 happened when you disposed of the Film rights. However, any capital gain you made from the CGT event happening is disregarded as the gain is included in your assessable income as a balancing adjustment.

Detailed reasoning

Depreciating assets

What a depreciating asset is

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 an intangible asset, unless it is mentioned in subsection 40-30(2) of the ITAA 1997 (subsection 40-30(1) of the ITAA 1997).

Items of intellectual property are depreciating assets if they are not trading stock (paragraph 40-30(2)(c) of the ITAA 1997).

Relevantly, an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as the owner, or a licensee, of a copyright (subsection 995-1(1) of the ITAA 1997).

Splitting a depreciating asset

If a depreciating asset you hold is split into 2 or more assets, Division 40 of the ITAA 1997 applies as if you had stopped holding the original asset and started holding the assets into which it is split (subsection 40-115(1) of the ITAA 1997).

A balancing adjustment event does not occur just because you split a depreciating asset (Note 2 to subsection 40-115(1) of the ITAA 1997).

If you stop holding part of a depreciating asset, Division 40 of the ITAA 1997 applies as if, just before you stopped holding that part, you had split the original asset into the part you stopped holding and the rest of the original asset. (The rest of the original asset is then taken to be a different asset from the original asset) (subsection 40-115(2) of the ITAA 1997).

If you grant or assign an interest in an item of intellectual property subsection 40-115(2) of the ITAA 1997 applies to you as if you had stopped holding part of the item (subsection 40-115(3) of the ITAA 1997.

Meaning of balancing adjustment event

A balancing adjustment event occurs for a depreciating asset if:

(a)  you stop holding the asset,

(b)  you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or having it installed ready for use again, or

(c)   you have not used it and:

(i)    if you have had it installed ready for use - you stop having it so installed, and

(ii)   you decide never to use it (subsection 40-295(1) of the ITAA 1997).

Balancing adjustments

An amount is included in your assessable income if:

(a)  a balancing adjustment event occurs for a depreciating asset you held and:

(i)    whose decline in value you worked out under Subdivision 40-B of the ITAA 1997, or

(ii)   whose decline in value you would have worked out under that Subdivision if you had used the asset, and

(b)  the asset's termination value is more than its adjustable value just before the event occurred.

The amount included is the difference between these amounts, and it is included for the income year in which the balancing adjustment occurred (subsection 40-285(1) of the ITAA 1997).

Meaning of termination value

The termination value of a depreciating asset is worked out as at the time when the balancing adjustment event occurs. It is:

(a)  if an item in the table in subsection 40-300(2) applies - the amount specified in that item, or

(b)  otherwise - the amount you are taken to have received under section 40-305 of the ITAA 1997 for the asset (subsection 40-300(1) of the ITAA 1997).

Relevantly, the amount you are taken to have received under a balancing adjustment event where you receive an amount, is the amount you received (Item 1 in the table in paragraph 40-305(1)(b) of the ITAA 1997).

Meaning of adjustable value

The adjustable value of a depreciating asset at a particular time is:

(a)  if you have not yet used it or had it installed ready for use for any purpose - its cost

(b)  for a time in the income year in which you first use it, or have it installed ready for use, for any purpose - its cost less its decline in value up to that time, or

(c)   for a time in a later income year - the sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time, less its decline in value for that year up to that time (subsection 40-85(1) of the ITAA 1997).

The opening adjustable value of a depreciating asset for an income year is its adjustable value to you at the end of the previous income year (subsection 40-85(2) of the ITAA 1997).

Cost

The cost of a depreciating asset you hold consist of 2 elements (section 40-175 of the ITAA 1997).

First element of cost

The first element is worked out as at the time when you began to hold the depreciating asset. Where a depreciating asset you hold is split into 2 or more assets, the cost is, for each asset into which it is split, the amount worked out under section 40-205 of the ITAA 1997 (subsection 40-180(1) and item 1 in the table in subsection 40-180(2) of the ITAA 1997).

Second element of cost

The second element is worked out after you start to hold the depreciating asset (subsection 40-190 of the ITAA 1997).

The second element is:

(a)  the amount you are taken to have paid under section 40-185 of the ITAA 1997 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since you started to hold the asset, and

(b)  expenditure you incur that is reasonably attributable to a balancing adjustment event occurring for the asset (subsection 40-190(2) of the ITAA 1997).

Division 40 of the ITAA 1997 applies to you as if you had paid, to hold a depreciating asset or for an economic benefit for such an asset, the greater of these amounts:

(a)  the sum of the amounts that the sum of the amounts that would have been included in your assessable income because you started to hold the asset or received the benefit, or because you gave something to start holding the asset or receive the benefit, if you ignored the value of anything you gave that reduced the amount actually included, or

(b)  the sum of the applicable amounts set out in the table in subsection 40-185(1) of the ITAA 19997 (if you pay an amount, the amount (item 1 in the table in subsection 40-185(2) of the ITAA 1997)) in relation to holding the asset or receiving the benefit (subsection 40-185(1) of the ITAA 1997).

Cost of a split depreciating asset

If you split a depreciating asset into separate assets as mentioned in section 40-115 of the ITAA 1997, the first element of the cost of each of the separate assets is a reasonable proportion of the sum of these amounts:

(a)  the adjustable value of the original asset just before it was split, and

(b)  the amount you are taken to have paid under section 40-185 of the ITAA 1997 for any economic benefit involved in splitting the original asset (section 40-205 of the ITAA 1997.

Adjustment: double deduction

Each element of the cost of a depreciating asset is reduced by any portion of that element of cost that you have deducted or can deduct, or that has been or will be taken into account in working out an amount you can deduct, other than under Division 40, Division 41 or Division 328 of the ITAA 1997 (section 40-215 of the ITAA 1997).

Capital gains tax

CGT assets

A CGT asset is any kind of property, or a legal or equitable right that is not property (subsection 108-5(1) of the ITAA 1997).

CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997).

You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law (subsection 104-10(2) of the ITAA 1997).

The time of the event is when you enter into the contract for the disposal, or if there is no contract, when the change of ownership occurs (subsection 104-10(3) of the ITAA 1997).

You make a capital gain if the capital proceeds from the disposal 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 (subsection 104-10(4) 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 of the ITAA 1997 (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 118-24(1) of the ITAA 1997).

Application to your circumstances

Copyright is a bundle of rights, and in the case of a literary work includes, amongst other rights, the right to publish the work and the right to make an adaptation (for example, a Film) based on the work. The creator of work in which copyright subsists is the owner of the work.

Copyright, being an item of intellectual property, is a depreciating asset. When the Producer exercised the Film option to acquire the Film rights the Rights Agreement came into force and your original depreciating asset was split into 2 (or more) separate depreciating assets.

Splitting the depreciating asset into 2 separate depreciating assets was a not a balancing adjustment event; however, when the Producer exercised the Film option and acquired the Film rights a balancing adjustment event occurred as you no longer held the Film rights (part of the depreciating asset).

The amount included in your assessable income as a result of the balancing adjustment event is the difference between the termination value and the adjustable value of the Film rights. The termination value is the amount you received for the disposal. The adjustable value will likely be negligible or even nil. This is because, as the creator of the Work you did not purchase it and most, if not all, the costs incurred in creating the Work are business expenses that are deductible under section 8-1 of the ITAA 1997.

Like most depreciating assets, copyright is also a CGT asset. When the Rights Agreement came into force you disposed of (and the Producer acquired) the Film rights at that time. CGT event A1 happened when this change in ownership occurred. However, any capital gain you made from the CGT event happening (that was also a balancing adjustment event) is disregarded under subsection 118-24(1) of the ITAA 1997.