ATO ID 2003/517: Capital gains: capital proceeds arising from the grant of a licence to use premises
Date of decision: 7 March 2003
Year of income: Year ended 30 June 2003
Business line: Private Groups and High Wealth Individuals

Issue
Is a licencee's undertaking to pay ongoing licence fees for the use of facilities included in the licensor's capital proceeds for CGT event D1 (section 104-35 of the Income Tax Assessment Act 1997 (ITAA 1997))?

Decision
No. A licencee's undertaking to pay on-going licence fees is not included in capital proceeds for CGT event D1 (section 104-35 of the ITAA 1997) because the undertaking is not received by the licensor 'in respect of the event happening' for the purposes of paragraph 116-20(1)(b) of the ITAA 1997.

Facts
A Licence Agreement was entered into between Company A and Company B after 20 September 1985. Under the Licence Agreement, Company A was granted a non-exclusive right to use port facilities by Company B in consideration for a Licence Fee. The Licence Fee is to be paid over the term of the Licence from income generated by the use of the port facilities. The amount of the Licence Fee is determined by the accounting profit or loss made by Company A from the use of the port facilities during the year. If Company A makes a profit, it has to pay an additional fee as well as an agreed Base Fee. If Company A makes a loss, then all or part of the Base Fee is either reduced or refunded. No amount is paid to Company A upon entering into the Licence Agreement. The Licence has an initial fixed term with three options to renew.

Reasons for decision
Summary: CGT event D1 happens if a taxpayer creates a contractual right or other legal or equitable right in another entity (subsection 104-35(1) of the ITAA 1997). In the present case, CGT event D1 happens when Company B enters into the Licence Agreement with Company A. Company B has created a right to use the port facilities in Company A. A capital gain will arise on CGT event D1 happening if the capital proceeds from creating the right are more than the incidental costs the taxpayer incurred that relate to the event. The taxpayer can make a capital loss if those capital proceeds are less (subsection 104-35(3) of the ITAA 1997). Generally, the capital proceeds from a CGT event are the total of: Company B does not receive, nor is it entitled to receive, any money as a result of CGT event D1 happening. As a result of granting Company A the right to use the port facilities, Company B is entitled to future income (the Licence Fee) for the term of the Licence. A right to income is generally assignable, and is therefore 'property' for the purposes of paragraph 116-20(1)(b) of the ITAA 1997. However, even though the right to payment is property, the issue in this case is whether this property is received in respect of the event happening. It is considered in the circumstances of this case that it is reasonable to conclude that Company A's undertaking to pay relates to the use of the port facilities, rather than the grant of the licence. The obligation of Company A to pay the Licence Fee is only a promise to pay for the use of the port facilities as and when use is permitted. Company A does not pay a premium for entering into the Licence Agreement, and the Licence Fee does not contain an embedded premium. Therefore, whilst the right to the Licence Fee is 'property' for the purposes of paragraph 116-20(1)(b) of the ITAA 1997, it is not property received 'in respect of the event happening', and is therefore not capital proceeds in accordance with subsection 116-20(1) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 104-35 subsection 104-35(3) subsection 116-20(1) paragraph 116-20(1)(b)
Subject references: Capital gains tax CGT capital proceeds CGT events D1 - D3 Bringing into existence a CGT asset