Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)CHANGE OF TITLE - TAX LAW IMPROVEMENT BILL (No. 1) 1998 - SENATE - Explanatory Memorandum.
Chapter 4 - Intellectual Property
Overview
This chapter covers the rules that are dealt with in Division 373 of Part 2-10 of the 1997 Act that allow deductions for intellectual property.
Part A summarises these rules.
Part B explains the changes to the 1936 Act.
Part C explains why some provisions of the 1936 Act have not been rewritten.
Part D explains the transitional provisions which set out how, and when, the new provisions apply.
Part E explains amendment that need to be made to the 1997 Act and the 1936 Act as a consequence of the rewritten 1936 Act.
A. Summary of the new law
Subdivision 373-A: Deduction for expenditure on registering items of intellectual property
It allows a deduction for capital expenditure incurred in obtaining or seeking to obtain the registration of an item of intellectual property. [section 373-1]
An amount can be deducted to the extent that the intellectual property is used to produce assessable income. [section 373-5]
Meaning of intellectual property
Intellectual property broadly means the rights held by an owner or licencee of a patent, copyright or registered design. [section 373-15]
Subdivision 373-B: Deduction for capital expenditure on intellectual property
It allows a deduction for capital expenditure to acquire an item of intellectual property.
The expenditure can be deducted in an income year if the item:
- •
- is owned by the taxpayer at the end of that year; and
- •
- has ever been used by the taxpayer to produce assessable income.
[section 373-10]
The deduction for a year is worked out by dividing the taxpayers unrecouped expenditure by the number of years remaining in the effective life of the intellectual property. [section 373-20]
Meaning of unrecouped expenditure
Unrecouped expenditure for an item of intellectual property is the taxpayers expenditure on the item reduced by the sum of:
- •
- any amounts the taxpayer has been allowed to deduct for it;
- •
- any consideration received by the taxpayer from its partial realisation ; and
- •
- any amount the taxpayer could not deduct because the taxpayer obtained a benefit from outside Australia that related to it.
Unrecouped expenditure may also be increased if the taxpayer who granted the licence pays an amount to have the licence surrendered to him or her. [section 373-25]
A taxpayers deductible expenditure on an item of intellectual property may be calculated differently depending on how they came to own it. [section 373-30]
A table is provided which sets this out for each type of owner.
Effective life of intellectual property
Effective life varies for different types of intellectual property. It is generally linked to the period for which the intellectual property rights subsist under the relevant Commonwealth law. [section 373-35]
Subdivision 373-C: Partial realisation of intellectual property
It specifies the consequences if an item of intellectual property is realised partially. [section 373-40]
Meaning of partial realisation of an item of intellectual property
A partial realisation happens if:
- •
- a part interest in the intellectual property is disposed of;
- •
- an interest in the patent, copyright or registered design is granted by licence;
- •
- an amount is received for the exploitation of the patent by the Commonwealth or a State or an authorised entity;
- •
- an amount is received for infringement of the patent, copyright or registered design.
[section 373-45]
Effect of a partial realisation of an item of intellectual property
A partial realisation of intellectual property can have three effects.
First, the unrecouped expenditure for the intellectual property is reduced by the amount obtained because of the partial realisation. [section 373-50]
Second, if the amount obtained from the partial realisation exceeds the unrecouped expenditure, the excess (subject to a limiting provision) is included in the taxpayers assessable income. [section 373-50]
Third, the part of the intellectual property remaining after the partial realisation is taken to be the same intellectual property as existed before the partial realisation.
[section 373-55]
Subdivision 373-D: Balancing adjustments
It determines how to calculate a balancing adjustment. [section 373-60]
Purpose of a balancing adjustment
It is a final accounting to ensure that total deductions correspond to actual loss.
When to calculate a balancing adjustment
A balancing adjustment is calculated when a balancing adjustment event occurs in an income year. [section 373-60]
Meaning of balancing adjustment event
A balancing adjustment event happens if an item of intellectual property:
- •
- is disposed of;
- •
- ceases to exist;
- •
- is subject to a partial change of ownership;
or, where the item of intellectual property is a licence, it is surrendered. [section 373-60]
Inclusion of an amount in assessable income
An amount is included in the taxpayers assessable income if the termination value of the item of intellectual property exceeds its written down value . The amount to be included is the lesser of:
- •
- the excess; and
- •
- the total deductions for the item less any amount previously included in assessable income due to its partial realisation.
[section 373-65]
Deduction of an additional amount
An additional amount is deducted if the termination value of the item of intellectual property is less than its written down value . The amount that can be deducted is the difference. [section 373-65]
Generally, the termination value of an item of intellectual property is its sale price (less expenses of sale). Other termination values apply if the intellectual property is disposed of other than by sale. [section 373-70]
The written down value of an item of intellectual property is the unrecouped expenditure on the item immediately before the balancing adjustment event. [section 373-75]
Subdivision 373-E: Application of the common rules
It explains that Common rules 1 and 2 (dealing respectively with roll-over relief for related entities and non-arm's length transactions) apply to this capital allowance. The common rules for capital allowances are contained in Division 41 of the 1997 Act. [section 373-80]
Common rule 1 is modified in certain respects for this capital allowance. The most important of these modifications make it clear that, as transmissions by operation of law or partial realisations are not balancing adjustment events, roll-over relief is not available. [section 373-85]
Subdivision 373-F: Adjustments affecting deductions under this Division
It states when a deduction is to be adjusted under this Division. It also sets out the circumstances in which unrecouped expenditure or expenditure on an item of intellectual property is adjusted.
A deduction is reduced if a benefit relating to the intellectual property is obtained from outside Australia.
[section 373-90]
Increasing unrecouped expenditure
Unrecouped expenditure for a licence may generally be increased by any amount incurred to obtain its surrender. A special rule applies if the taxpayer and the licencee are not dealing at arms length. [section 373-95]
Expenditure on an item of intellectual property is also adjusted in certain non-arm's length dealings.
[section 373-100]
If only a part of intellectual property is acquired from another entity, the expenditure may be adjusted.
[section 373-105]
B. Discussion of changes
The administrative discretions in Division 10B use the term an amount determined by the Commissioner. These are being replaced by objective tests based on reasonableness, eg. the inclusion of a reasonable amount.
The term unit of industrial property has been replaced by the more meaningful intellectual property. Other new terms and their equivalents under the 1936 Act are as follows:
| New Term | 1936 Act |
|---|---|
| acquire an item of intellectual property | new term for an existing concept in paragraph 124V(2)(b) |
| amount arising from a partial realisation of intellectual property | consideration receivable |
| unrecouped expenditure | residual value |
| expenditure | cost |
| partial realisation | part disposal |
| balancing adjustment event | new term for, broadly, disposal, in sections 124N and 124P |
| termination value | consideration receivable |
| written down value | new term, previously, residual value at the time of disposal |
Section 373-30 Meaning of expenditure
This section contains a table which sets out what expenditure on intellectual property qualifies for deduction purposes.
Provide that expenditure that gives rise to more than one item of intellectual property can only be written off once.
An invention may give rise to a patent in many countries if multiple registration is sought. Thus an inventor may acquire several items of intellectual property from one invention.
The 1936 Act does not prevent the expenditure in devising the invention from being deducted in relation to each of the items of intellectual property.
The change is consistent with the general policy that an amount can only be deducted once for income tax purposes.
Specify that market value applies in the non-arms length provisions.
The 1936 Act uses the term value . In line with the approach adopted generally in the 1997 Act as exemplified by Common rule 2, this rewrite uses market value as the appropriate term.
Section 373-35 Effective life of intellectual property
This section explains how to determine the effective life of items of intellectual property.
Extend the effective life of intellectual property in a standard patent to the end of the income year in which the 20th anniversary of the patent occurs.
The original Explanatory Memorandum for Division 10B states that the effective life of a patent is linked to the period for which it is granted under the relevant Commonwealth law. In1995 the Patents Act 1990 was amended to extend the term of a standard patent granted after 1 July 1995, from 16 to 20 years. This change aligns the 1997 Act with the general law.
Provide an effective life for petty patents that reflects their shorter duration.
Petty patents, introduced to Australia in 1979, are designed for gadgets and appliances with a relatively short commercial life. A petty patent is granted initially for a term of one year, but may be extended for a further five years.
The 1936 Act does not provide for petty patents and they are treated as having the same effective life as standard patents.
This change makes specific provision for them and establishes their effective life consistently with the Patents Act 1990.
Removal of a provision requiring the Commissioner of Taxation to determine the effective life of a work of joint authorship.
Calculating the effective life of a work of joint authorship under the 1936 Act reflects copyright law as it stood in 1956. Under the Copyright Act 1968 , the previous uncertainty in calculating effective life was removed.
The rewrite reflects the current copyright law. This enables the removal of a Commissioners discretion.
Section 373-45 Partial realisation of intellectual property
This section contains a table that explains how to determine the amount arising from the partial realisation of intellectual property.
Specify that market value applies in the non-arms length provisions.
The 1936 Act uses the term value . The rewrite specifies market value consistently with the use of that term in section 373-30.
Ensure that only one taxpayer obtains a deduction for the same expenditure in a non-arms length partial realisation of intellectual property for no consideration.
Broadly, the deduction allowable in realisations of this type is based on a calculation of what would have been payable as consideration in an arms length transaction. The rewrite guards against the unintended consequence of allowing both parties a deduction for the same expenditure by basing the amount of the deduction on the greater of market value and unrecouped expenditure.
Prevent double deductions in an arms length partial realisation of intellectual property for no consideration.
Generally, deductions for intellectual property on disposal and acquisition are based on what is paid for it. However, while the 1936 Act allows the acquirer to base a deduction on the items unrecouped expenditure, it also allows the disposer to calculate a deduction as if nothing had been received. The rewrite prevents an unintended consequence of allowing both parties a deduction for the same amount, by having both parties base their deduction on the unrecouped expenditure.
Section 373-70 Meaning of termination value
This section contains a table for calculating the termination value of intellectual property.
Clarify the existing non-arms length provision by specifying that market value applies.
The 1936 Act uses the term value . This rewrite specifies market value consistent with the use of that term in section 373-30.
Provide that in a non-arms length disposal of intellectual property for no consideration, the termination value is the greater of market and written down values.
Taking the termination value to be the market value can produce an inappropriate result - see example below. This result is avoided by taking the termination value to be the greater of market and written down values.
Example
X disposes of intellectual property to Y for no consideration in a non-arms length dealing. At that time the written down value of the intellectual property is $100 but the market value is $20. If value is taken as market value X would be entitled to a balancing deduction of $80 (ie. $100 written down value - $20 termination value).
Y's expenditure is equal to the written down value ($100). As Y is entitled to base a deduction on this amount, a double deduction would result.
Provide that in an arms length disposal of intellectual property for no consideration, the termination value is the written down value.
The 1936 Act does not provide a termination value in this case. This could result in double deductions for the same expenditure ie. with the same amount being deducted by a donor on disposal as is taken to be the donees expenditure . This is overcome by providing the termination value to be the written down value.
C. Provisions of the 1936 Act that have not been rewritten
Some provisions of the 1936 Act are redundant and have not been included in the 1997 Act. They are summarised in the following table:
| Provision | Subject | Reason for omission |
|---|---|---|
| 124K(1) | Definition of 'the owner'. | Unnecessary. |
| 124K(3) & (4) | Transmissions by operation of law. | Unnecessary. |
| 124S(3) | Residual value where intellectual property owned prior to 1 July 1956. | It has no current or ongoing application. |
| 124U(3) | Term of patent extended before acquisition. | Unnecessary. |
| 124U(4) | Copyright - Death of joint author. | It has no ongoing application. |
A review has recently been undertaken into Commonwealth assistance to the film industry.
The Government is presently considering the report on this review. Until a decision on it has been made by Government, these provisions will not be rewritten.
D. Transitional arrangements
The rewritten intellectual property provisions inserted by this Bill apply to assessments for the 1998-99 income year and later income years. [section 373-1]
When explaining how a specific provision of the rewritten law is to apply, the transitional provisions use the same section number as that provision.
The transitional provisions are explained in the following table:
| Transitional provision | About | What the amendment will do |
|---|---|---|
| 373-1 | Application of Division 373 of the 1997 Act | The general rule for applying the rewritten intellectual property provisions is that they will apply to assessments for the 1998-99 income year and later income years. [Schedule 4, item 1] |
| 373-10(1)-(3) | Applies to an item of intellectual property owned by a taxpayer before the 1998-99 year of income if the taxpayer continues to own the item. | This provision ensures an item which a taxpayer owned under the 1936 Act has an unrecouped expenditure and an effective life so that a deduction can be calculated under the rewrite. [Schedule 4, item 1] |
| 373-10(4) | Applies to an item of intellectual property owned by a taxpayer before the 1998-99 year of income if the taxpayer partially realises or ceases to be the owner of the item. | This provision ensures that where a taxpayer partially realises, or ceases to own, an item which was owned under the 1936 Act, the effects of the partial realisation or the balancing adjustment event takes into account amounts included in assessable income or amounts deducted or deductible under that Act. [Schedule 4, item 1] |
| 373-65 | Applies where there is a balancing adjustment event on an item on which there has been roll-over relief under the old law. | This provision ensures that in determining the amounts deductible and assessable to the transferor, amounts deductible and assessable to previous owners are included. [Schedule 4, item 1] |
| 373-100 | Applies to an item acquired in a non-arms length transaction, where the disposer of the item acquired it under the old law. | This provision ensures that where the disposer of the item acquired it under the 1936 Act, the items cost to the disposer will be considered in determining the expenditure of the acquirer. [Schedule 4, item 1] |
E. Consequential amendments
Amendment of the Income Tax Assessment Act 1997
Part 2 of Schedule 4 contains amendments to the 1997 Act. It inserts references to Division 373 into the checklist of core provisions.
| Section | Changes |
|---|---|
| Section 10-5 (List of provisions about assessable income) | Updates the item industrial property so that it only applies to copyright in an Australian film. Inserts intellectual property as an additional associated item. [Schedule 4, item 2] |
| Section 10-5 | Adds intellectual property to the list. [Schedule 4, item 3] |
| Section 12-5 (List of provisions about deductions) | Updates the item industrial property so that it only applies to copyright in an Australian film. Inserts intellectual property as an additional associated item. [Schedule 4, item 4] |
| Section 12-5 | Adds intellectual property to the list. [Schedule 4, item 5] |
| Section 20-5 (List of provisions that reverse the effect of deductions) | Adds to the list amounts arising from a partial realisation of an item of intellectual property. [Schedule 4, item 6] |
| Section 40-30 (Table of capital allowances) | Updates the item industrial property so that it only applies to copyright in an Australian film. Also adds intellectual property to the table. [Schedule 4, item 7] |
| Section 41-5 (Table showing application of common rules to some capital allowances) | Adds intellectual property to the table. Common rules 1 and 2 apply as modified by sections 373-80 and 373-85. [Schedule 4, item 8] |
| Section 41-10 | Removes the words in relation to the disposal of property. [Schedule 4, item 9] |
| Subsection 41-23(1) (Table of additional roll-over events for capital allowances) | Adds intellectual property to the table. [Schedule 4, item 10] |
| Paragraph 41-65(1)(a) | Substitutes entity for person. [Schedule 4, item 11] |
Amendment of the Income Tax Assessment Act 1936
Items 12 to 27 in Part 3 of Schedule 4 contains amendments to the 1936 Act. These amendments:
- •
- close off application of that part of Division 10B that has been rewritten; and
- •
- substitute references to Division 373 in corresponding provisions of the 1936 Act.
Closing off the application of the existing provisions
Item 22 of Part 3, Schedule 4 closes off that part of Division 10B that has been rewritten, so that it only applies to the 1997-98 and earlier income years. Part of Division 10B of the 1936 Act remains operative for units of industrial property that relate to copyright in an Australian film. [Schedule 4, item 22] This complements the transitional provisions which ensure that the rewritten provisions apply to the 1998-99 and later income years.
Inserting references to rewritten provisions
References in the 1936 Act to former provisions are updated with references to the new provisions or expressions. [Schedule 4, items 12 to 21 and 23 to 27]