ATO ID 2004/982: Capital allowances: depreciating asset - copyright in computer program
Date of decision: 19 August 2004
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
For the purposes of working out a balancing adjustment amount under section 40-285 of the Income Tax Assessment Act 1997 (ITAA 1997), if a taxpayer develops a computer program by integrating purchased software and an algorithm that they have created and then sells the computer program, including all intellectual property rights subsisting in that program, is the depreciating asset for which the balancing adjustment event occurred the copyright in the last version of the program before it was sold?

Decision
Yes. The depreciating asset for which the balancing adjustment event occurred is the copyright in the last version of the computer program before it was sold.

Facts
The taxpayer integrated an interface software program which they had purchased with an algorithm that they had created, so as to develop a new computer program. Although the taxpayer had developed the new program to a prototype stage and had undertaken some external testing of it, the program had not been developed to the standard of a commercial product. The taxpayer intended to generate income from the copyright in the new program through licence fees received from others using the program, while the taxpayer owned the copyright. However, the taxpayer recognised that they did not have the financial resources or the technical skills to develop the computer program to operate as a commercially viable product. Another party purchased the program in its current state of development and all intellectual property rights subsisting in it so that the other party could derive licensing fees from the use of the copyright in such a fully commercial product.

Reasons for decision
Summary: To work out a balancing adjustment amount under section 40-285 of the ITAA 1997, a depreciating asset for which the balancing adjustment event occurred needs to be identified. As defined in the ITAA 1997, intellectual property includes rights that an entity has under a Commonwealth law as the owner, or a licensee of a copyright or of equivalent rights under a foreign law (section 995-1 of the ITAA 1997). The taxpayer created the algorithm and integrated it with the interface program to create the new computer program in which copyright subsists. The creation of the new program by the taxpayer entitled the taxpayer to the intellectual property rights as owner of the copyright in that new combined program. As an item of intellectual property, copyright (in a computer program) is a depreciating asset (paragraph 40-30 (2) (c) of the ITAA 1997.) If an item is made up of different components, it is necessary to determine whether the composite item is a single depreciating asset or whether the components are separate depreciating assets. This is a question of fact and degree which can only be determined in the light of all the circumstances of the particular case (subsection 40-30(4) of the ITAA 1997). The 'function' test can be used to identify any relevant depreciating asset. The relevant function can include actual, intended and possible uses of the items. Taxation Ruling TR 94/11 provides some guidelines to assist in making the determination. Some of the factors to be considered in applying the 'function' test include whether the item: Factors such as the mechanical independence of an item, physical separability and whether an item can be separately acquired also need to be considered in deciding whether an item may be a separate depreciating asset. The new computer program was developed by the taxpayer to be used and function in deriving assessable income by exploiting the copyright in the program so as to derive licences fees, and not to use the software in their own operations. If the new computer program could be said to be a separate item from the copyright in the program, the new computer program would not be a depreciating asset, as it is not 'in-house software', and is merely information. Broadly, 'in-house software' is computer software, or a right to use computer software, that a taxpayer acquires, develops or has another entity develop that is mainly for the taxpayer to use in performing the function for which the software was developed (section 995-1 of the ITAA 1997). If a depreciating asset has been sold, a balancing adjustment event has occurred, because the taxpayer stopped holding it (paragraph 40-295(1)(a) of the ITAA 1997). The relevant function in this situation was the use to which the computer program was designed to be put. As the computer program was solely created so as to be exploited to derive licence fees, a depreciating asset, copyright, was sold. For the purposes of working out the balancing adjustment amount under section 40-285 of the ITAA 1997, the depreciating asset for which the balancing adjustment event occurred is the copyright in the latest version of the computer program before it was sold.

Legislative references: Income Tax Assessment Act 1997 section 40-30 subsection 40-30(2) subsection 40-30(4) section 40-285 paragraph 40-295(1)(a) section 995-1
Related public rulings and determinations: Taxation Ruling TR 94/11
Subject references: Depreciating assets Uniform capital allowances system Capital allowances CoE