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Edited version of your written advice
Authorisation Number: 1012726029114
Ruling
Subject: Deduction - Intellectual Property and Depreciating Assets
Question 1
Do customer contracts and customer relationships satisfy the definition of 'intellectual property' or 'depreciating asset' under the current tax legislation which may qualify them as depreciating assets for the purpose of claiming a depreciation deduction?
Answer
No.
Question 2
Is a tax deduction claimable for customer contracts under Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
No.
Question 3
Is a tax deduction claimable for customer relationships under Division 40 of the ITAA 1997?
Answer
No.
This ruling applies for the following periods:
1 January 2014 - 31 December 2014
The scheme commences on:
1 July 2013
Relevant facts and circumstances
Company A acquired the two entities for its IT division.
The entity was a division of Company whose ultimate parent is Foreign Company A.
The entity was carved out into a separate legal entity with Foreign Company B as the ultimate parent.
This was affected by a Local Asset Transfer Agreement, transferring all assets and liabilities in the division books including the customer contracts and relationship assets.
The division was globally acquired by Company B with Foreign Company B as the ultimate parent.
Customer Contracts
Software Maintenance contracts where customers renew and/or extend the maintenance period on an annual basis as long as the software packages are used. Many of the contracts have an auto renewal condition unless terminated with notice.
These software packages are:
• Asset maintenance software packages used mainly by the government departments nationally and internationally. Therefore by nature these software packages are not easily replaceable.
• General Evidence software. The software is used for presenting evidence of a case. The main customers of this software are law enforcement agencies.
The value of the contracts at the time of the transfer was estimated to be around $X million.
The estimated useful life of the contract was calculated using the Juglar theory of business cycle between 7 to 11 years. You consider 7 years to be more appropriate due to rapid changes in the computing world.
Customer Relationships
The relationships were valued through various contracts, such as services or software resales. Service contracts included implementation services and on-going support services. For the purpose of the valuation of this section, maintenance contracts have been excluded since disclosed in "customer contract" section to avoid double up. Although, undoubtedly maintenance contracts should contribute to customer relationship the same way as any other contracts.
The services here mentioned related to the services rendered to the same software packages as those in the customer contract section.
Relevant legislative provisions
Subsection 40-25(1) of the Income Tax Assessment Act 1997
Section 40-30 of the Income Tax Assessment Act 1997
Subsection 40-30(1) of the Income Tax Assessment Act 1997
Subsection 40-30(2) of the Income Tax Assessment Act 1997
Section 995-1 of the Income Tax Assessment Act 1997
Reasons for decision
Summary
The customer contracts and relationships are intangible assets that are not intellectual property and therefore as they do not fit into the exceptions listed in subsection 40-30(2) of the ITAA 1997, there is no deduction available under Division 40 in relation to these contracts.
Detailed reasoning
Subsection 40-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year.
The term 'depreciating asset' is defined in subsection 40-30(1) of the ITAA 1997 to mean:
an asset that has 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 mention in subsection (2)
Subsection 40-30(2) lists the following intangible assets as depreciating assets, provided they are not trading stock:
(a) mining, quarrying or prospecting rights;
(b) mining, quarrying or prospecting information;
(ba) geothermal exploration rights;
(bb) geothermal exploration information;
(c) items of intellectual property;
(d) in-house software;
(e) IRUs;
(f) Spectrum licences;
(g) Datacasting transmitter licences;
(h) Telecommunications site access rights.
Pursuant to section 995-1 of the ITAA 1997, intellectual property is an item consisting of the rights (including equitable rights) that an entity has under a Commonwealth law as including:
(a) The patentee, or a licensee, of a patent; or
(b) The owner, or a licensee, of a registered design; or
(c) The owner, or a licensee, of a copyright;
or of equivalent rights under a foreign law.
Customer contracts and customer relationships are intangible assets which provide the client with the right to use the software of the taxpayer as well as to receive services in relation to the ongoing maintenance of the software provided.
Although the software that the contracts relate to are intellectual property, the contracts that provide a client the use of the software and the provision of services to maintain the software is not intellectual property for the purposes of the taxation legislation.
The customer contracts and relationships are intangible assets that are not intellectual property and therefore as they do not fit into the exceptions listed in subsection 40-30(2) of the ITAA 1997, there is no deduction available under Division 40 in relation to these contracts.
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