Private ruling: Licensing of in-house software
Date of advice: 3 March 2016
Published: April 2016
Ruling period: Income year ended 30 June 2016

Ruling: Q1: Are the ERP Customisations held by Company A an 'in-house software' depreciating asset for the purposes of Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: (a) Will the balancing adjustment provisions in Subdivision 40-D of the ITAA 1997 apply to include an amount in Company B's assessable income as a consequence of granting the licences to Company C to the extent the Licence Fee is in respect of know-how? | A3: Yes. | Q3: If the answer to Question 2(b) is yes, and the cost of the new in-house software asset is the same amount as the existing adjustable value of the in-house software asset that is split, will the same amount as the existing adjustable value of the in-house software asset be depreciable under Division 40 of the ITAA 1997? | A4: Yes. | Q4: Will the Licence Fee received by Company B be assessable as ordinary income under section 6-5 of the ITAA 1997? | A5: No. | Q5: Will the Licence Fee received by Company B be assessable as a royalty within the ordinary meaning of "royalty" as a consequence of section 15-20 of the ITAA 1997? | A6: No. | Q6: Will the CGT provisions in Part 3-1 of the ITAA 1997 apply to give rise to a capital gain at the time that Company A grants the Licence to Company C? | A7: Yes.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Company B is an Australian proprietary company incorporated in 19XX. Company B is 100% owned by Company C. Company C is incorporated outside of Australia. Company B is the vehicle for all operations of Company C in Australia. Company B is the head company of the income tax consolidated group in Australia that has numerous subsidiaries, including Company A. The Business Unit was formed in 20XX. The Business Unit is an internal management reporting unit comprising its Australian and offshore trading entities. The Business Unit initially ran a disparate set of legacy information technology (IT) platforms with business processes that were different across Australia and its offshore and within companies in those jurisdictions. The core IT platforms used in the Business Unit were between X to XX years old and required replacement in order to sustain current performance. Project A The Business Transformation Unit was established in 20XX with the goal of implementing common business processes across the Business Unit. The transformation program was intended to deliver a unified operational structure for the Business Unit with standardised, simplified business processes and a single source of commercial information for decision making across the Business Unit. The Business Transformation Unit selected the latest version of an ERP software ("ERP software") as the technology solution for Company B and its business units in Australia and the offshore trading entities. ERP software is enterprise resource planning software developed by a foreign software company. Company C entered into standard licence agreements with the foreign software company to use the base ERP software and certain 'off the shelf' modules (ERP Licence). The ERP Licence confer rights upon Company C and its affiliates to use the base ERP software so long as any such use is within the terms of the ERP Licence. The ERP Licence states that the foreign software company retains legal title to the base code of the ERP software whilst Company C has ownership of any modifications and extensions to the software which do not alter the base source code of the ERP software. The implementation of ERP software in the Business Unit required the customisation of the standard ERP software 'off the shelf' modules to meet the business specific needs of the Business Unit. The outputs of this process included the system code, systems and user documentation, test scripts and training manuals. The modifications and extensions of the ERP software which did not alter the base source code of the ERP software are hereafter referred to as the ERP Customisations. The systems and user documentation, test scripts and training manuals are hereafter referred to as the Other Materials. It took less than five years to fully implement the latest version of ERP software and the ERP Customisations in the Business Unit. The cost of implementing the ERP software and the ERP Customisations in the Business Unit were treated as capital for tax purposes. The cost was not allocated to a software development pool and no amount was claimed as eligible research and development (R&D) expenditure under the R&D tax concession or R&D tax incentive. Company A owns all copyright in the ERP Customisations and Other Materials which arises under the Copyright Act 1968 . Project B In 20XX Company C decided to implement standardised systems, processes and data environment globally. The project to implement these changes was referred to as Project B. Project B includes the development and implementation of a global ERP template. Company C considered several approaches for the implementation of a global ERP template, including: • having a global ERP template but with multiple production instances and an overarching reporting solution; • a partial global ERP template and local instances; or • total local ERP instances. Company C determined that it needed to move toward the development and implementation of a single global instance of an ERP system. Company C decided that in order to fast track development of a single global instance of ERP it would build upon an existing ERP system within the group as opposed to starting afresh with a completely new instance. Company C decided that it would use the latest version of ERP and the ERP Customisations developed by Company A for use within the Business Unit. Company C will bear the costs of further developing the ERP Customisations as a global ERP template. In order to undertake Project B and develop a global ERP template Company A will grant Company C access and rights to: • system code (which is hosted on the systems). This is the software code of modifications and extensions to the base ERP software which is legally owned by Company A; and • documented knowledge and learnings from Project A, documented processes, user documentation, test scripts and training manuals developed and legally owned by Company A. On completion of Project B the ERP instance and further developed ERP Customisations created under Project B will operate independently and separately from the ERP instance and ERP Customisations created under Project A. Licence for Project A Instance Company A will grant Company C rights to the ERP Customisations and Other Materials by way of a perpetual licence. A draft licence agreement has been prepared to give effect to this decision (Licence Agreement). The Licence Agreement provides that Company A (as Licensor) will grant Company C (as Licensee) an exclusive licence to use the ERP Customisations and Other Materials in all jurisdictions with the exception of Australia where Company C will have a non-exclusive licence to use the ERP Customisations and Other Materials. The Licence Agreement contains the following relevant definitions: Use in respect of: (a) any component of the Project A IP which comprises software, means directly or indirectly load, execute, access, employ, exploit, utilise, store, display or sub-licence that software; (b) any other component of the Project A IP means access utilise, employ, store, exploit, and sub-licence, Project A IP means: (a) software (and all copyright in respect thereof) acquired by, owned or otherwise developed by, the Licensor in respect of the Project A (b) all know-how, trade secrets, Documents, Specifications, Confidential Information and Intellectual Property acquired by, or owned or otherwise developed by or on behalf of, the Licensor comprising, documenting or properly relating to the Project A; and (c) all Licensor's Improvements. Licence has the meaning given in the Agreement. Licence Fee is TBC , payable in the Agreed Currency. Licence Period means the period commencing on the Effective Date and continuing in perpetuity, subject always to earlier termination of the Agreement. The Licence Agreement states that the Licensor grants to the Licensee an exclusive licence to Use the Project A IP in all Overseas Jurisdictions, and a non-exclusive licence to Use the Project A IP in Australia (Licence). The Licence Agreement states that the Licensor retains both the legal and beneficial ownership of the Project A IP. The Licence Agreement states that the Licensor reserves the right to access, utilise, employ, store and exploit the Project A IP throughout Australia, including sub-licensing the Project A IP to members of the Group located in Australia (for their Use solely in Australia). The Licensor has no rights to Use the Project A IP in any Overseas Jurisdiction. The Licence Agreement states that on the Effective Date, the Licensor will deliver, or provide access, to the Licensee of copies of all Documents relating to the Project A IP. The Licence Agreement states that in consideration of the grant of the Licence, the Licensee agrees to pay the Licence Fee to the Licensor in one amount on the Effective Date in Immediately Available Funds. The Licence Agreement states that if required, the Licensor shall provide a Tax Invoice to the Licensee in respect of the Licence Fee. The Licence Agreement states that the Licence Fee is not refundable in any circumstances. A market value determination will be made to calculate the appropriate arm's length quantum of the Licence Fee. This valuation will be calculated by reference to the anticipated cost to replicate the Project A IP by Company C. The Licence Agreement states that save for Specified Purposes, the Licensee is prohibited from copying, modifying, adapting or decompiling any software which forms part of the Project A IP. The Licence Agreement states that the Licensee acknowledges that the Project A IP (and all Intellectual Property rights, including copyright, in the Project A IP) is and shall remain the sole property of the Licensor. The Licence Agreement states that on termination of the Licence, the Licensee's rights under the Licence shall immediately cease, but each party shall retain any rights it had against the other party in respect of any past breach of this document. The Licence Agreement states that on termination of the Licence, the Specifications and all Documents provided by the Licensor to the Licensee which relate to the Project A IP, at the option of the Licensor must be promptly returned, destroyed or permanently deleted.

Relevant legislative provisions: Copyright Act 1968 10 | Copyright Act 1968 13 | Copyright Act 1968 31 | Income Tax Assessment Act 1997 6-5(1) | Income Tax Assessment Act 1997 6-10(1) | Income Tax Assessment Act 1997 10-5 | Income Tax Assessment Act 1997 15-20 | Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Subdivision 40-D | Income Tax Assessment Act 1997 40-30 | Income Tax Assessment Act 1997 40-30(2) | Income Tax Assessment Act 1997 40-30(2)(c) | Income Tax Assessment Act 1997 40-30(4) | Income Tax Assessment Act 1997 40-85 | Income Tax Assessment Act 1997 40-115 | Income Tax Assessment Act 1997 40-115(1) | Income Tax Assessment Act 1997 40-115(2) | Income Tax Assessment Act 1997 40-115(3) | Income Tax Assessment Act 1997 40-205 | Income Tax Assessment Act 1997 40-285 | Income Tax Assessment Act 1997 40-285(1) | Income Tax Assessment Act 1997 40-285(2) | Income Tax Assessment Act 1997 40-295 | Income Tax Assessment Act 1997 40-295(1) | Income Tax Assessment Act 1997 40-295(1)(a) | Income Tax Assessment Act 1997 40-295(3) | Income Tax Assessment Act 1997 40-300 | Income Tax Assessment Act 1997 Division 46 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 102-25 | Income Tax Assessment Act 1997 104-35(1) | Income Tax Assessment Act 1997 104-35(2) | Income Tax Assessment Act 1997 104-35(3) | Income Tax Assessment Act 1997 110-35 | Income Tax Assessment Act 1997 116-20 | Income Tax Assessment Act 1997 118-20 | Income Tax Assessment Act 1997 118-20(1) | Income Tax Assessment Act 1997 995-1 and Taxation Laws Amendment (Software Depreciation) Bill 1999 | New Business Tax System (Capital Allowances) Bill 2001

Reasons for decision: Summary: Division 40 allows a deduction for the decline in value of a depreciating asset that is held for any time during a year of income. Section 40-30 specifies what is and is not an asset for the purposes of Division 40. Section 40-30 relevantly states: (1) 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; or (b) an item of * trading stock; or (c) an intangible asset, unless it is mentioned in subsection (2). (2) These 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) datacasting transmitter licences; (h) telecommunications site access rights. (3) … (4) Whether a particular composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree which can only be determined in the light of all the circumstances of the particular case. (5) … (6) …. The terms 'intellectual property' and 'in-house software' are both defined in section 995-1. Intellectual property Section 995-1 defines 'intellectual property' as: "intellectual property" : an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as: (d) the patentee, or a licensee, of a patent; or (e) the owner, or a licensee, of a registered design; or (f) the owner, or a licensee, of a copyright; or of equivalent rights under a foreign law. Section 10 of the Copyright Act 1968 defines a 'literary work' as including a computer program: "literary work" includes: (g) a table, or compilation, expressed in words, figures or symbols; and (h) a computer program or compilation of computer programs. Section 10 of the Copyright Act 1968 defines a 'computer program' as: "computer program " means a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result. Section 13 of the Copyright Act 1968 provides that the owner of a copyright has the exclusive right to authorise a person to do an act that is the exclusive right of the owner of the copyright. Section 31 of the Copyright Act 1968 provides that copyright in a literary or artistic work is, amongst other things, the exclusive right to reproduce it in a material form, to make an adaptation of the work and, in respect to a computer program, enter into a commercial rental arrangement in respect of it. In-house software Section 995-1 defines 'in-house software' as: "in-house software" is computer software, or a right to use computer software, that you acquire, develop or have another entity develop: (i) that is mainly for you to use in performing the functions for which the software was developed; and (j) for which you cannot deduct amounts under a provision of this Act outside Divisions 40 and 328. The Explanatory Memorandum (EM) that accompanied the New Business Tax System (Capital Allowances) Bill 2001 (NBTS CA Bill 2001) which introduced the current treatment of in-house software under Division 40 did not elaborate upon what was meant by the term 'computer software' in the definition of in-house software in section 995-1. However, at paragraph 1.18 of the EM it stated that the treatment of in-house software under Division 40 did not reflect an in-substance change to the way software was treated under the former Division 46. Former Division 46 allowed 'software' that was acquired, developed or commissioned to be treated as plant and depreciated. The EM which accompanied the Taxation Laws Amendment (Software Depreciation) Bill 1999 which introduced former Division 46 described 'software' in paragraph 13 as being: …computer programs consisting of encoded instructions designed to cause a computer to perform a particular task or to produce a particular result. The Macquarie Dictionary contains the following definitions of relevance: • Software: noun programs which enable a computer to perform a desired operation or series of operations (opposed to hardware ). • Program: Computers a set of instructions written in an artificial language which a computer can interpret and execute. Are the ERP Customisations an intangible depreciating asset that is in-house software? Project A resulted in the creation of the ERP Customisations and Other Materials. Copyright subsists in the ERP Customisations and in each item included in the Other Materials. Each copyright represents rights that Company A holds under the Copyright Act 1968 . Each copyright will therefore satisfy the definition of intellectual property in section 995-1 and will therefore be capable of being recognised as an intangible depreciating asset for the purposes of Division 40 due to paragraph 40-30(2)(c). Whether a number of assets which could each be viewed as a separate depreciating asset should be viewed as a composite item which is itself a depreciating asset is determined by subsection 40-30(4). The EM which accompanied the NBTS CA Bill 2001 which introduced subsection 40-30(4) stated at paragraph 1.15: Taxpayers will be required to exercise judgement in identifying the depreciating asset where the asset itself is made up of different parts and components. In doing this, the "functionality" test that is used as a basis of identifying a "unit of plant" in the existing plant depreciation rules can be used. (Specific reference to a "unit" or an "item" is not necessary to attract the test, as the definition of a depreciating asset is based on a life in effective use, and the depreciating asset must be identifiable as having its own life in such use.) ATO Interpretive Decision ATO ID 2011/2 Capital allowances: depreciating asset - segments of a fibre optic cable system (ATO ID 2011/2) considers paragraph 1.15 of the EM which accompanied the NBTS CA Bill 2001 and states: The paragraph states that judgement is required to be exercised in the objective identification of the depreciating asset where the asset in question is a composite item. The paragraph further suggests that the 'functionality test' that was used as a basis of identifying a unit of plant in the then existing plant depreciation rules can be used in the identification process in a modified manner taking into account the differences in the basis to the definitions of plant and depreciating asset. The purpose of such examination then, is not to test components of a composite asset as separate 'units' but to test the components for definable, separately identifiable and discrete function and then completeness in that function but not necessarily self-containment or isolation in that function. The function test has been applied in Ready Mixed Concrete (Vic) Pty Ltd v. FC of T 69 ATC 4038; (1969) 1 ATR 123, FC of T v. Tully Co-operative Sugar Milling Assoc Ltd 83 ATC 4495; (1983) 14 ATR 495, Monier Colourtile Pty Ltd v. FC of T 84 ATC 4846; (1984) 15 ATR 1256, Case S51 85 ATC 380; 28 CTBR (NS) Case 57 , and Case T33 86 ATC 293; 29 CTBR (NS) Case 35. Taxation Ruling TR 94/11 Income tax: general investment allowance - what is a unit of property? (TR 94/11) is instructive as it outlines what is considered to be an appropriate function test in the context of identifying a separate unit of property for the purpose of the now inoperative general investment allowance. TR 94/11 outlines that the function test is a factual examination of the function that an item serves in the particular taxpayer's income producing activity. TR 94/11 states at paragraph 3 that an item is generally identified as a single item if it has one or more of the following characteristics: 3. … (a) it is an entity entire in itself, capable of being separately identified or regarded and having a separate function (e.g. the transportable concrete mixer in Ready Mixed Concrete (Vic) Pty. Ltd. v FC of T 69 ATC 4038; (1969) 1 ATR 123). (b) the item is functionally complete in itself. However, the item need not be self contained or used in isolation. It is not necessary that the item function on its own. It should however, be capable of performing its intended discrete function ( FC of T v Tully Co-operative Sugar Milling Assoc. Ltd. 83 ATC 4495; (1983) 14 ATR 495). (c) the item when attached to another unit of property having its own independent function varies the performance of that unit (e.g. attachments for tractors such as rippers, post hole diggers, carry alls etc. ( Case M98 80 ATC 689; 24 CTBR(NS) Case 69)). (d) the item itself performs a definable, identifiable function (Monier Colourtile). TR 94/11 goes on to state at paragraph 4: 4. A unit of property need not necessarily be the smallest possible item which can be identified. A unit of property can be made up of a number of components. Several components or parts of an item of plant which work together with other components may be parts of a single functional item. It may be that this larger functional item, rather than the individual components, is the relevant 'unit of property'. The function of each component and the larger composite item should be considered when deciding which is the relevant 'unit of property'. For example, in Tully's case, it was the mixed juice pumping station (rather than its component parts such as starters, motors and pumps) which was the relevant 'unit of property'. The copyright in the ERP Customisations and the copyright in each of the items included in the Other Materials are each capable of being separately identified, being functionally complete in themselves and of separately performing a definable function. These factors would tend to indicate that each copyright is a separate depreciating asset for the purposes of Division 40. Nevertheless each copyright is an integral and interdependent part of the overall ability of Company B to use the computer software in its operations. If each copyright is considered in terms of the purpose and the use for which they were initially developed then they function as components of a single composite item under subsection 40-30(4). The copyright which subsists in the ERP Customisations is not recognised as a separate depreciating asset for the purposes of Division 40 of the ITAA 1997 as it is one component of a composite item for the purposes of subsection 40-30(4) of the ITAA 1997. However, the composite item, which consists of the copyright which subsists in the ERP Customisations and in each of the items included in the Other Materials, is computer software which in the circumstances will meet the definition of in-house software in section 995-1 of the ITAA 1997 and will therefore be an intangible depreciating asset for the purposes of Division 40 of the ITAA 1997. | Detailed Reasoning - Question 2(a) and Question 2(b): Subdivision 40-D provides for an amount to be either included in the assessable income of a taxpayer or deducted by a taxpayer when a balancing adjustment event occurs. Section 40-285 states: (1) 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; 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 those amounts, and it is included for the income year in which the balancing adjustment event occurred. (2) You can deduct an amount if: (k) 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 (l) the asset's termination value is less than its adjustable value just before the event occurred. Subsection 40-295(1) states: (1) A balancing adjustment event occurs for a depreciating asset if: (c) you stop holding the asset; or (d) you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again; or (e) 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. … (3) However, a balancing adjustment event does not occur for a * depreciating asset merely because you split it into 2 or more depreciating assets or you merge it with one or more other depreciating assets. (a) Know how Know-how is not considered to be either real or personal property. In Federal Commissioner of Taxation v United Aircraft Corporation (1943) 68 CLR 525 Latham CJ at page 534 stated: Knowledge is valuable, but knowledge is neither real nor personal property. Section 40-30 (reproduced above in question 1) specifies what assets can and cannot be depreciating assets for the purposes of Division 40. Section 40-30 does not allow knowledge or know-how itself to be recognised as an asset for the purposes of Division 40. (b) ERP Customisations As explained above in question 1, the copyright that subsists in the ERP Customisations satisfies the definition of intellectual property in section 995-1 and can be recognised as an intangible depreciating asset for the purposes of Division 40 due to paragraph 40-30(2)(c). However, the intangible depreciating asset is a component of a composite item for the purposes of subsection 40-30(4). The composite item is an in-house software depreciating asset for the purposes of Division 40. Section 40-115 addresses the consequences of splitting a depreciating asset or giving up part of a depreciating asset. Section 40-115 states: (1) If a depreciating asset you hold is split into 2 or more assets, this Division applies as if you had stopped holding the original asset and started holding the assets into which it is split. (2) If you stop holding part of a depreciating asset, this Division 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.) (3) If you grant or assign an interest in an item of intellectual property, subsection (2) applies to you as if you had stopped holding part of the item. Section 40-205 states: If you split a depreciating asset into separate assets as mentioned in section 40-115, the first element of the cost of each of the separate assets is a reasonable proportion of the sum of these amounts: (c) the adjustable value of the original asset just before it was split; and (d) the amount you are taken to have paid under section 40-185 for any economic benefit involved in splitting the original asset. The licences granted under the Licence Agreement will result in the copyright that subsists in the ERP Customisations and in each of the Other Materials being used other than mainly for performing the functions for which they were originally developed. The in-house software depreciating asset will be split into its constituent parts. The in-house software depreciating asset, which includes the copyright that subsists in the ERP Customisations and the copyright which subsists in each of the items included in the Other Materials, can be said to have commenced to be used as separate assets, being: • a new in-house software depreciating asset, which consists of the copyright which subsists in the ERP Customisations and the copyright which subsists in each of the items included in the Other Materials, that continues to be used in performing the functions for which the software was developed; and • separate intangible depreciating assets that are intellectual property, which consist of the copyright which subsists in the ERP Customisations and the copyright which subsists in each of the items included in the Other Materials that are exploited for the purposes of obtaining the Licence Fee from Company C (which is a purpose other than that for which it was originally developed). Subsection 40-115(1) will operate so that Company A will be treated as if it stopped holding the original asset, that was the in-house software depreciating asset, and started holding a new in-house software depreciating asset and the separate intellectual property depreciating assets into which it was split. The cost of the in-house software depreciating asset and the separate intellectual property depreciating assets that the taxpayer starts to hold after the original asset is split will be determined under section 40-205. Subsection 40-295(3) provides that no balancing adjustment event occurs for a depreciating asset merely because the asset is split into two or more depreciating assets. However, a balancing adjustment event may occur in relation to an asset that arises from the original asset that was split. Under the Licence Agreement Company A will grant an interest to Company C in various items of intellectual property, including the copyright which subsists in the ERP Customisations. Subsection 40-115(2) will apply due to the operation of subsection 40-115(3) so that, just before the grant of the licence, Company A will be treated as having split the intellectual property depreciating asset that consists of the copyright that subsists in the ERP Customisations into the part that it stopped holding (ERP Customisations Part) and the rest of the original intellectual property depreciating asset (ERP Customisations). The cost of the ERP Customisations Part and the ERP Customisations will be determined under section 40-205. On Company A stopping holding the ERP Customisations Part a balancing adjustment event will occur due to paragraph 40-295(1)(a). The adjustable value of the ERP Customisations Part will be determined under section 40-85. The termination value of the ERP Customisations Part will be determined under section 40-300. To the extent that the Licence Fee relates to the copyright that subsists in the ERP Customisations that amount will be the termination value of the ERP Customisations Part under section 40-300. The amount included under the balancing adjustment event will be determined under section 40-285 (being the difference between the termination value and the adjustable value). | Detailed Reasoning - Question 3: As explained above in Question 2, the licence granted under the Licence Agreement will result in the copyright that subsists in the ERP Customisations and in each of the Other Materials being used other than mainly for performing the functions for which they were originally developed. The in-house software depreciating asset will be split into its constituent parts. Subsection 40-115(1) will operate so that Company A will be treated as if it stopped holding the in-house software depreciating asset and started holding an in-house software depreciating asset and the separate intellectual property intangible depreciating assets into which it was split. The cost of the in-house software depreciating asset and the separate intellectual property depreciating assets will be determined under section 40-205. Section 40-205 states: If you split a depreciating asset into separate assets as mentioned in section 40-115, the first element of the cost of each of the separate assets is a reasonable proportion of the sum of these amounts: (e) the adjustable value of the original asset just before it was split; and (f) the amount you are taken to have paid under section 40-185 for any economic benefit involved in splitting the original asset. The cost as determined under section 40-205 will be used in calculating a deduction for an amount equal to the decline in value of the new in-house software depreciating asset under section 40-30. If the cost as determined under section 40-205 is the same as the adjustable value of the original in-house software depreciating asset before it was split, as calculated under section 40-85, then the same amount will be depreciable under Division 40. | Detailed Reasoning - Question 4: Subsection 6-5(1) states: Your assessable income includes income according to ordinary concepts, which is called ordinary income. Further, subsection 6-10(1) states: Your assessable income also includes some amounts that are not ordinary income. Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5. None of the provisions listed in section 10-5 are relevant in the present circumstances. Therefore the Licence Fee received by Company B will not be assessable income under section 6-10. The Licence Fee will only be included in the assessable income of Company B if it is assessable income under section 6-5. Section 6-5 provides that your assessable income includes income according to ordinary concepts which is called ordinary income. The classic definition of ordinary income in Australian law was given in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 by Jordan CJ: The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts. The leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). It was said in that case that: The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived" that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description. In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. It was further stated at page 138 that: To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business. Is the Licence Fee received on capital or revenue account? A threshold question is whether the Licence Fee is an amount received on capital or revenue account, as only an amount received on revenue account can be subject to section 6-5. Under the Licence Agreement Company A will grant Company C an exclusive licence to the use the ERP Customisations in all jurisdictions other than Australia and a non-exclusive licence to the use ERP Customisations in Australia. The exclusive and non-exclusive licences obtained by Company C under the Licence Agreement permit Company C to perform acts and do things that would normally infringe upon the rights of Company A as the owner of various copyrights under the Copyright Act 1968 . The nature of a payment for a licence has been the subject of some judicial consideration in the United Kingdom and Australia. Lord Denning provided a good description of how amounts received for the granting of a licence are generally viewed in Murray (Inspector of Taxes) v Imperial Chemical Industries Ltd [1967] 2 ALL ER 980 ( Imperial ). Lord Denning in Imperial at 982-983 stated in the context of an assignment of patent rights: I see no difference in this regard between an assignment of patent rights and the grant of an exclusive licence for the period of the patent. It is the disposal of a capital asset. But this does not determine the quality of the money received. A man may dispose of a capital asset outright for a lump sum, which is then a capital receipt. Or he may dispose of it in return for an annuity, in which case the annual payments are revenue receipts. Or he may dispose of it in part for one and in part for the other. Each case must depend on its own circumstances; but it seems to me fairly clear that if and in so far as a man disposes of patent rights outright (viz, by an assignment of his patent, or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If and in so far as he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during the period, then those also are revenue receipts (such as the payment of £2,500 a year over ten years in Inland Revenue Comrs v British Salmson Aero Engines Ltd , and, of course, the royalties of £10,000 a year in the present case). If and in so far as he disposes of the patent rights outright for a lump sum , which is arrived at by reference to some anticipated quantum of user , it will normally be income in the hands of the recipient (see the judgment of Lord Greene MR in Nethersole v Withers (Inspector of Taxes) ([1946] 1 All ER 711 at p 716; 28 Tax Cas, 501 at p 512.), approved by Viscount Simon in the House of Lords ([1948] 1 All ER 400 at p 403; 28 Tax Cas at p 518.)). If and in so far, however, as he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital (such as the payment of £25,000 in the British Salmson case ). It is different when a man does not dispose of his patent rights, but retains them and grants a non-exclusive licence. He does not then dispose of a capital asset. He retains the asset and he uses it to bring in money for him. A lump sum may in those cases be a revenue receipt (see Rustproof Metal Window Co Ltd v Inland Revenue Comrs , per Lord Greene MR ([1947] 2 All ER 454 at p 459; 29 Tax Cas 243 at p 270.), who emphasised that it was a non-exclusive licence there). Similarly a lump sum for "know-how" may be a revenue receipt. The capital asset remains with the owner. All he does is to put it to use. The observations of Lord Denning in Murray were referred to in Kwikspan Purlin System Pty Ltd v Commissioner of Taxation (Cth) (1984) 71 FLR 154 ( Kwikspan ) by Campbell J at 159. In Kwikspan it was determined that certain payments for the grant of exclusive licences to use a patented invention in different parts of Australia were received on capital account and, as the company in question was not in the business of dealing in patents, were not on income account. Under the Licence Agreement Company C will pay the Licence Fee in one single amount to Company A. Under the Licence Agreement Company C acknowledges that all intellectual property rights, including all copyright, is and shall remain the sole property of Company A. Under the Licence Agreement the licences are perpetual and will only be terminated on the insolvency of Company C under the Licence Agreement. The Licence Fee will be based upon a market value determination of an arm's length amount calculated by reference to the anticipated cost to replicate the Project A IP by Company C. Notably, the Licence Fee will not be calculated by reference to any use that is to be made by Company C of the Project A IP. Company A is the vehicle for all operations in Australia of a global business. Company A is not in the business of dealing in copyrights. On the basis of the above the Commissioner is of the view that the Licence Fee paid by Company C to Company A under the Licence Agreement for the exclusive and non-exclusive licences is received on capital account and will not be assessable as ordinary income under section 6-5. | Detailed Reasoning - Question 5: The Licence Fee paid by Company C to Company A is received on capital account and will therefore not be assessable as ordinary income under section 6-5. As the Licence Fee is not assessable as ordinary income under section 6-5 it may be assessable under section 15-20. Section 15-20 states: (1) Your assessable income includes an amount that you receive as or by way of royalty within the ordinary meaning of "royalty" (disregarding the definition of royalty in subsection 995-1(1)) if the amount is not assessable as ordinary income under section 6-5. (2) Subsection (1) does not apply to an amount of a payment to which section 15-22 or 15-23 applies. The High Court of Australia considered the essential characteristics of a royalty in Stanton v Federal Commissioner of Taxation (1995) 92 CLR 630 ( Stanton ). Dixon CJ, Williams, Webb, Fullagar and Kitto JJ stated in Stanton at 641: …the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken. The Commissioner summarises the key characteristics of a common law royalty in Taxation Ruling IT 2660 Income tax: Definition of royalties (IT 2660). The Commissioner in IT 2660 at paragraph 10: 10. The key characteristics of a common law royalty (i.e. a royalty within the ordinary meaning of the term) were outlined by R. H. Woellner, T.J. Vella and R.S. Chippendale in Australian Taxation Law, CCH Australia Ltd, 1989 at pages 272- 273. They identified that a common law royalty will normally have all of the following features: (a) It is a payment made in return for the right to exercise a beneficial privilege or right (e.g. to remove minerals or natural resources such as timber, to use a copyright, or to produce a play) - McCauley v. F.C. of T. (1944) 69 CLR 235; 7 ATD 427; F.C. of T. v. Sherritt Gordon Mines Ltd (1977) 137 CLR 612; 77 ATC 4365; 7 ATR 726. Amongst other things, copyright can cover music, literary and artistic works, various forms of mechanical, electronic and biological knowledge, equipment and processes. Where, for example, the copyright is licensed to someone to manufacture and sell records, compact discs, books, prints of art works, motor vehicle engines, packaged computer software etc., for an amount based on the number of units produced or sold, the amount paid would be a royalty. (b) The payment is made to the person who owns the right to confer that beneficial privilege or right - Barrett v. F.C. of T. (1968) 118 CLR 666; Sherritt Gordon Mines Ltd ; Case H9 76 ATC 39; 20 CTBR(NS) Case 64. However, the payment would still be a royalty if paid to another person or otherwise applied or dealt with at the direction of the owner. Moreover, payments for the use of the right that are made to a person who has been licensed or sub-licensed to deal with the right will also be regarded as royalty payments. (c) The consideration payable is determined on the basis of the amount of use made of the right acquired - McCauley ; Stanton ; Sherritt Gordon Mines ; Case H9 . (d) The consideration payable will usually be paid as and when the right acquired is exercised - McCauley ; Stanton ; Case H9 . However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired - I.R. Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272; Mills v. Jones (1929) 14 TC 769 ; Constantinesco v. R (1927) 11 TC 730. The exclusive and non-exclusive licences obtained by Company C under the Licence Agreement permit Company C to perform acts and do things that would normally infringe upon the rights of Company A as the owner of various copyrights under the Copyright Act 1968 . The licences are perpetual and will only be terminated in the event that Company C becomes insolvent and in accordance with the Licence Agreement. The timing of the Licence Fee and the amount of the Licence Fee is not determined by the extent of exploitation of the Project A IP. On this basis the Licence Fee will not be a royalty and accordingly cannot be assessable under section 15-20. | Detailed Reasoning - Question 6: Part 3-1 governs capital gains and capital losses. Section 102-25 states that if more than one CGT event happens then you choose the CGT event that is most specific to your situation; however, CGT event D1 is an exception to this rule. Subsection 104-35(1) states that CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. It is not necessary that the newly created asset be derived out of an existing asset. A 'right' is a form of incorporeal property which consists of a legal entitlement to property that which has no physical existence. Examples of incorporeal property are rights under contracts, a patent and goodwill. CGT event D1 happens whenever rights are created even if they are part of a larger agreement. In most circumstances the bundle of contractual rights would be considered to be a single right. However, each right arising from a contract may be considered separately and the capital gain or loss may be apportioned. Subsection 104-35(2) states that the time of CGT event D1 is when you enter into the contract or create the other right. Subsection 104-35(3) states that you make a capital gain from CGT event D1 if the capital proceeds from creating the right are more than the incidental costs you incurred in relation to the event and that you make a capital loss if the capital proceeds are less. Section 110-35 states how to work out the incidental costs in relation to a CGT event. Section 116-20 states that the capital proceeds from a CGT event are generally the money you received or are entitled to receive in respect of the event happening and the market value of any property you have received or are entitled to receive in respect of the event happening. Subsection 118-20(1) relevantly states that the capital gain you make from a CGT event is reduced if, because of the event, an amount is included in your assessable income or exempt income by a provision outside Part 3-1. CGT event D1 will occur when Company A grants the Licence to Company C under the terms of the Licence Agreement. The capital gain arising from CGT event D1 occurring will be reduced due to the application of section 118-20 to the extent that the Licence Fee is assessable income under the provisions of Subdivision 40-D.

(b) Will the balancing adjustment provisions in Subdivision 40-D of the ITAA 1997 apply to include an amount in Company B's assessable income as a consequence of granting the licences to Company C to the extent the Licence Fee is in respect of the ERP Customisations? | Reasons for decision: All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.