Private ruling: CGT - Intellectual Property
Date of advice: 6 December 2024
Published: 13 January 2025
Ruling period: Year ended 30 June 20xx
Date scheme commenced: xx/xx/20xx

Ruling: Q1: Do 'the Assets' meet the definition of Intellectual Property (IP) in accordance with section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Is the IP a depreciating asset in accordance with section 40-30 of the ITAA 1997? | A2: Yes. | Q3: Does Division 40 of ITAA 1997 (Capital Allowances) apply to the IP? | A3: Yes. | Q4: Is the payment you received from the sale of the Assets assessable as ordinary income? | A4: No. | Q5: Is the payment you received from the sale of the Assets assessable as a capital gain? | A5: Yes. As there is no cost that has been identified under the Division 40 cost rules in section 40-175 of the ITAA 1997, the cost base is nil. | Q6: If the payment is a capital gain, does it qualify as a discount capital gain? | A6: Yes. | Q7: Is the payment received for the sale of the Assets included in your assessable income in the income year of receipt? | A7: Yes.

Relevant facts and circumstances: You were born in Country A and you took up residency in Australia on xx/xx/xx. Prior to this, you were living in Country A for the period xx to xx, and in Country B from xx to xx. On xx/xx/xx, you entered into the Original Agreement with the Company based in Country B. The purpose of engagement for the Original Agreement is that the engagement concerns performance of structural analyses, optimisation exercises and generation of general engineering documentation involving the Company's intellectual property. You will be paid at the rate of $X per hour. The title to, ownership of, copyright of and all other intellectual and industrial property rights, in all drawings, specifications, reports, computer programs and all other documents and materials you prepared, under and during the course of the Original Agreement, shall be exclusive property of the Company. Various items of intellectual property (IP) are collectively referred to as 'the Assets'. On xx/xx/xx you entered into an agreement with the Company headed the Amended Agreement. The terms of the Amended Agreement differed significantly from the Original Agreement with the most significant differences being that: • Under the Original Agreement the Assets which you would develop in carrying out your work was to belong to Safe Isolations, but under the Amended Agreement you owned the Assets. • Under the Original Agreement you were to be paid an hourly rate, but under the Amended Agreement your ' compensation ' was to be calculated by reference to the value of the Assets you developed using, among others, a formula taking into account the number of hours you spent on fulfilling your obligations to the Company and with it being made clear that you may not receive any compensation . You estimated the time for developing the Assets and negotiated periodically in retrospect, a few times a year. You did not complete any daily, weekly, or monthly time sheets with hours booked to activities which you gave to the Company, as the relationship you had with the Company was never one of employee-employer and if you were to eventually receive any payment from the Company (of which there was no guarantee) it was to be for what you produced and chose to sell, and not compensation for the time you had spent developing it. • While one dimension of the valuation of the valuation of the Assets was based on time (and this is the only dimension that was contractually defined), the other dimension was its ' criticality ' (i.e., its impact on manufacturing cost, commerciality and operational safety). During the retrospect valuation reviews and negotiations, both the creation time and the Assets' criticality were taken into account. • The sale price of the Assets also takes into consideration the total value of the deal the Company made with the buyer of technology. All three valuation dimensions (time formula, criticality, and total value of the Company's deal) were considered when negotiating the final Assets sale amount, with only the 'time formula' dimension contractually defined. The Amended Agreement was still in place when you moved to Australia and became an Australian resident for tax purposes on xx/xx/xx. On xx/xx/xx, you entered into an 'Asset Purchase Agreement' with the Company under which the Company will purchase copyrights and trade secrets in the form of computational models, finite element analyses, proprietary methods of ensuring product structural compliance, and other targeted structural analyses created and readied for use in 20xx and 20xx ('the Assets'). All of the owned Assets related to the Company as determined by a complete inventory as shown on the Exhibit A inventory of the Asset Purchase Agreement. The purchase price for the Assets is $x. You agree to assist the Company with furnishing of the Assets and waiver or affidavit as required to support the Company's ongoing endeavours to sell technology. On xx/xx/xx you and the Company entered into a 'Intellectual Property Assignment Agreement' (the IP Assignment Agreement) which formalised, for regulatory purposes, the sale of the IP under the Asset Purchase Agreement. The Company entered into an agreement to on-sell the IP you had developed and the purchaser of the IP insisted on the IP Assignment Agreement and had it prepared for the Company. If you had not signed the IP Assignment Agreement, the Company would not have been in a position to pay you for the IP. The purchase price was deposited into your bank account on xx/xx/xx (the Sale Proceeds). You confirm that the entire amount of the Sale Proceeds was for the copyright. You did not at any time prior to (or after) receiving the Sale Proceeds receive any renumeration or other payments from the Company, nor were you a shareholder in or had any ownership interest in the Company. As the amount to be paid to you under the Amended Agreement was to take into account the number of hours you had spent in fulfilling your obligations to the Company, you recorded the time spent on fulfilling your obligations and you worked out that approximately xx% of your time was spent before you became an Australian resident for tax purposes. Your time spent on developing the Assets consisted of conceptual design, basic design, and detailed design supported by engineering simulation capabilities. Time spent on these activities can be classified as computer work, manually building analytical/mathematical models, and developing optimization algorithms that ultimately gave an edge over the competitive technologies. To a lesser extent, your time spent on the development of the Assets included experimental testing in the Country B. The majority of the Assets that you created after arriving in Australia (and becoming a resident for tax purposes) were new, standalone assets. These were built on the lessons learned and within the constraints of the earlier development stages (which is a normal process when developing a novel technology) and undertaken prior to your Australian residency.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 40-30 | Income Tax Assessment Act 1997 section 40-175 | Income Tax Assessment Act 1997 section 40-285 | Income Tax Assessment Act 1997 section 40-290 | Income Tax Assessment Act 1997 section 40-295 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 104-240 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 115-20(1) | Income Tax Assessment Act 1997 subsection 115-25(1) | Income Tax Assessment Act 1997 section 855-45 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: All legislative provisions refer to ITAA 1997 unless otherwise specified. You created IP which is an intangible asset for CGT purposes. The relevant IP is a depreciating asset under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997). You confirm that the entire amount of the Sale Proceeds was for the copyright. You stopped holding the Assets, therefore a balancing adjustment event has occurred under section 40-295 for the depreciating asset that was the copyright. There is no cost that has been identified under the Division 40 cost rules in section 40-175 and therefore the cost base of the copyright is nil. As the requirements under subsection 115-20(1) and subsection 115-25(1) have been met, the capital gain was a discount capital gain. | Detailed Reasoning - Ordinary income: Section 6-5 provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources. Ordinary income is defined to mean income according to ordinary concepts. The legislation does not provide any specific guidance on what is meant by income according to ordinary concepts. However, case law has evolved to identify various factors that indicate whether an amount is income according to ordinary concepts. A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to employment or services rendered. Wages and business income are examples considered to be income according to ordinary concepts. The payment you received from the Company was for the Assets, on the terms and conditions set forth in the Asset Purchase Agreement and the IP Assignment Agreement. It was made clear that you may not receive any compensation under the Amended Agreement. The purpose of the Amended Agreement was for Safe Isolations to have the opportunity to purchase the IP from you which happened under the Asset Purchase Agreement. You assigned your interest in the IP to the Company in exchange for $x. The payment was not paid to you because of your employment relationship with Safe Isolations. There was no guarantee of any payment and if you had not signed the IP Assignment Agreement, Safe Isolations would not have needed the IP or been in a position to pay you for the IP. You had an intangible capital asset separate to your employment with the Safe Isolations. The payment is not considered to be ordinary income for the purposes of section 6-5. | Detailed Reasoning - Capital Gains Tax: Section 102-20 states that a capital gain or capital loss is made only if a CGT event happens. Section 108-5 defines a CGT asset as follows: 108-A CGT asset is: (a) any kind of property; or (b) a legal or equitable right that is not property. 108-5 (2) To avoid doubt, these are CGT assets: (a) part of, or an interest in, an asset referred to in subsection (1)... Section 995-1 of ITAA 1997 defines intellectual property as: An item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as: • The patentee, or a licensee, of a patent; or • The owner, or a licensee, of a registered design; or • The owner, or a licensee, of a copyright; Or of equivalent rights under a foreign law. Section 40-30 ITAA 1997 defines a depreciating asset as follows: • 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 2. • These intangible assets are depreciating assets if they are not trading stock and includes items of intellectual property. In your case, under the Amended Agreement you own the IP and payment for this IP was not guaranteed until Safe Isolations was able to on-sell your IP to a third party. You then entered into an Asset Purchase Agreement on xx/xx/xx. In consideration of your agreement to the Company to on-sell the IP you had developed and the purchase of the technology to third party, you assigned the Assets to the Company and have no remaining or residual intellectual property rights in the inventions. The Company successfully on-sold your IP to a third party as formalised by the IP Assignment Agreement on xx/xx/xx. On xx/xx/xx you received the proceed of your sale of the Asset. You created IP which is an intangible asset for CGT purposes. The relevant IP is a depreciating asset under Division 40 of the ITAA 1997. Under section 40-285 Balancing Adjustments, an amount is included in 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; 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. Section 40-295 provides that a balancing adjustment event occurs for a depreciating asset if you stop holding the asset, or you stop using it, or having it installed ready for us, for 'any' purpose and you expect never to use it, or have it installed ready for use, again. Because you stopped holding the Assets, a balancing adjustment event has occurred under section 40-295 for the depreciating asset that was the copyright. It is accepted that decline in value would have been worked out under Subdivision 40-D Balancing Adjustment if you had used the asset. Copyright is a depreciating asset which would be subject to Division 40 and having its decline in value calculated under that Division 40. It is a separate matter as to how much of the decline in value is deductible. The assessable amount is reduced under section 40-290, where the depreciating asset has been used for other than a taxable purpose. In this context that can be said to be solely for the purpose of sale, i.e, making a capital gain. Consequently, the assessable amount under Division 40 will be nil. CGT K7 event is a CGT event that occurs when a balancing adjustment event occurs for a depreciating asset that was held and used for a purpose other than a taxable purpose. In your case, section 104-240 applies to tax the amount received under the CGT provisions via CGT K7 event. The formula involved takes into account 'cost' as defined in Division 40, and not CGT cost base in the CGT rules. Accordingly, the market value 'cost base' rule in section 855-45 does not apply. Section 855-45 only defines CGT cost base for CGT purposes and there is a separate rule for depreciating assets. You have not provided any cost that has been identified under the Division 40 cost rules in section 40-175. Your personal time and labour are not considered as costs under Division 40. Therefore in your case the cost base is nil and the amount received is taken into account in working out the capital gain. Since the IP does not have a cost base, the entire payment will be assessable in the year it is received. The CGT discount rules provide in part: Subsection 115-20(1) To be a discount capital gain, the capital gain must have been worked out ... (b) for a capital gain that arose under CGT event K7 - using the cost of the depreciating asset concerned... Subsection 115-25(1) To be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event.... As the requirements as set out in subsection 115-20(1) and subsection 115-25(1) have been met, the capital gain was a discount capital gain.