Private ruling: Business - deduction - licencing distributorship fee
Date of advice: 20 April 2017
Published: August 2017
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2013

Ruling: Q1: Is Y entitled to a deduction that amortises the cost of acquiring a licencing distributorship for the System? | A1: No.

Relevant facts and circumstances: Y paid W $XXX,XXX for the licencing distributorship for the System in Australia for a period of XX years. Y will use the licencing distributorship to earn income in Australia. W does not hold any patent, copyright, registered design or equivalent rights to the System under the law of the Country in which W is resident or any other foreign law.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 40-25 | Income Tax Assessment Act 1997 Subsection 40-30(1) | Income Tax Assessment Act 1997 Subsection 40-30(2) | Income Tax Assessment Act 1997 Section 40-880 | Income Tax Assessment Act 1997 paragraph 40-880(5)(f) | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Subsection 110-25(1) | Income Tax Assessment Act 1997 Subsection 110-25(2) | Income Tax Assessment Act 1997 paragraph 110-25(2)(a) | Income Tax Assessment Act 1997 Section 110-25

Reasons for decision: Summary: All legislative references below are to the Income Tax Assessment Act 1997 unless otherwise indicated. The payment of the Licencing Distributorship Fee is capital in nature as the payment secured an exclusive right to use the System in Australia. This right is an intangible asset but is not intellectual property. Consequently it is excluded from being a depreciating asset. However, it is a CGT asset under paragraph 108-5(1)(b). As the fee to secure the right forms part of the cost base of a CGT asset, the fee cannot be deducted under section 40-880. | Detailed Reasoning - Detailed reasoning: Capital expenses cannot be claimed under section 8-1. An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature ( British Insulated and Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155). Capital expenditure often produces an enduring benefit, that is, the structure of the advantage or asset. Revenue expenditure is often repetitious or recurring in nature and often does not produce assets or advantages of an enduring nature. In this case, the Licencing Distributorship Fee incurred by Y was to secure Y's position as the exclusive representative with an exclusive right to use the System in Australia. The System forms part of the structure of the business and is a capital asset. Accordingly, the Licencing Distributorship Fee is an outgoing of capital, or of a capital nature. | Detailed Reasoning - Depreciating assets: Division 40 discusses rules about deductibility of capital expenditure. Subsection 40-30(1) states 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: (a) land (b) an item of trading stock (c) an intangible asset, unless it is mentioned in subsection (2) Subsection 40-30(2) states the following intangible assets are depreciating assets if they are not trading stock: (a) mining, quarrying or prospecting rights (b) mining, quarrying or prospecting information (c) items of intellectual property (d) in-house software (e) IRUs (f) Spectrum licences (g) Data transmitter licences (h) Telecommunications site access rights. The definition of intellectual property is found within section 995-1. It includes the rights that an entity has under a Commonwealth law for a patent, registered design or copyright; or equivalent rights under a foreign law. In this case, we have been advised that W does not hold any patent, copyright, registered design or equivalent rights under W's country's law or any other foreign law for the System. Consequently, Y's right under the agreement to use the System does not meet the definition of intellectual property. As the right is an intangible asset that is not intellectual property, it is excluded from being a depreciating asset by section 40-30. Accordingly, a depreciation deduction is not available under section 40-25. | Detailed Reasoning - Capital Gains Tax: You make a capital gain or capital loss when a CGT event happens to a CGT asset. Section 108-5 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. A capital gain or capital loss in most cases is determined by reference to the proceeds received and the asset's cost base or reduced cost base. You can make a capital gain or loss only if a CGT event happens. Subsection 110-25(1) states the cost base of a CGT asset consists of 5 elements. Subsection 110-25(2) states the first element is the total of: (a) the money you paid, or are required to pay, in respect of acquiring it; and (b) the market value of any property you gave, or are required to give, in respect of acquiring it (worked out at the time of acquisition). The exclusive right that is acquired by Y under the agreement is a CGT asset under paragraph 108-5(1)(b). The Licencing Distributorship Fee paid in respect of acquiring this right is included in the first element of the cost base under paragraph 110-25(2)(a). | Detailed Reasoning - Section 40-880 - Business related costs: The object of subsection 40-880(1) is to make certain business capital expenditure deductible over 5 years if: a) the expenditure is not otherwise taken into account; and b) the deduction is not denied by some other provision; and c) the business is, was or is proposed to be carried on for a taxable purpose. There are however some limitations and exceptions to the deductibility of these costs. Subsection 40-880(5) states in part, you cannot deduct anything under this section for an amount of expenditure you incur to the extent that it could, apart from this section, be taken into account in working out an amount of a capital gain or capital loss from a CGT event. In this case, the Licencing Distributorship Fee forms part of the cost base of the right to use the System. Although a CGT event has yet to happen in relation to that right, when it does, the fee will be taken into account when working out the amount of the capital gain or capital loss. Accordingly a deduction is not allowable under section 40-880. | Detailed Reasoning - Conclusion: The Licencing Distributorship Fee incurred by Y is capital in nature. Y has secured an exclusive right to use the System in Australia. This right is an intangible asset but is not intellectual property. Accordingly a depreciation deduction is not allowable. However, the Licencing Distributorship Fee forms part of the first element of the cost base of the right for CGT purposes. As the fee will be taken into account for CGT purposes, it is not deductible under section 40-880.