Tax Implications of Structuring for Holding your Intellectual Property

When starting your business or embarking on your innovative journey your intellectual property may not be particularly valuable.  However, it has the propensity, as is no doubt desired, to become significantly more valuable.  Your intellectual property is also potentially taxable.  The more valuable it becomes, the greater the potential tax liability is, meaning it is important to consider these issues earlier rather than when too late.

CGT or Depreciating Assets?

An item of intellectual property is defined in the Income Tax Assessment Act 1997 (Tax Act) as consisting of the rights a person has under a law of the Commonwealth 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 copyright.

Notably trade marks are not included in this definition. Their tax treatment is, therefore, often different than for other intellectual property.

Intellectual property within the above definition will be a depreciating asset. Consequently, a trade mark is not a depreciating asset.  All intellectual property rights are CGT assets and each is a separate CGT asset.

Proposed Changes to Depreciation Regime

Certain intellectual property and other intangible assets are able to be depreciated and a non-cash deduction is available.  This includes standard patents, innovation patents, petty patents, registered designs and copyrights or the licences to copyrights, but also other licences including spectrum and datacasting transmitter licences, telecommunications site access rights and in-house software.  Of course, trade marks are not included since they are not a depreciating asset.

With tangible assets, a taxpayer can generally self-assess the taxable effective life of an asset; enabling better alignment with the actual number of years it is expected the asset will provide an economic benefit. However the number of years over which you can depreciate an intellectual property asset has in the past been fixed by the Tax Act.

Proposed changes to the Tax Act will from 1 July 2016[1] allow you to self-assess the taxable effective life of intellectual property in the same way tangible assets are able to be self-assessed.  That is, pursuant to the provisions in section 40-105 of the Tax Act, a taxpayer may estimate the period the asset can be used by any entity for one or more of the following purposes:

  • taxable purpose;
  • the purpose of producing exempt income or non‑assessable non‑exempt income; and/or
  • the purpose of conducting R&D activities, assuming that this is reasonably likely.

It will remain open to you, however, to continue to use the existing fixed statutory effective life to depreciate its intangible assets.

This will provide better flexibility for owners of these types of intellectual property and is a welcome change.

Allocation of Expenditure

At the early stages of creation of intellectual property, the question will often be asked: how is the expenditure to be treated, on revenue or capital account?  The answer to this question necessarily turns on the purpose of the expenditure.

Expenditure incurred in establishing, replacing or expanding your intellectual property is more likely to be of a capital nature[2] and should be able to form part of your cost (where your intellectual property is a depreciating asset) or cost base (where, or to the extent, your intellectual property is a CGT asset).  The cost of a depreciating asset is used to calculate the amount of depreciation allowable each year and is also used in calculating any assessable income or deduction on the eventual sale of that depreciating asset.  The cost base of a CGT asset is used in calculating any capital gain or loss upon a sale of that asset.

Where the expenditure incurred is in the form of a continual flow of working expenses[3] in the conduct of your operations, you would expect to be able to account for them as deductible under section 8-1 of the Tax Act in the income year in which they are incurred.  The types of expenses you might include here are those incurred in obtaining a short term licence or right to use intellectual property for income producing purposes.

Moving into the Right Structure

It can often be appropriate to hold your intellectual property in a separate entity from your trading entity to divide risk and ownership.  This can offer protection of your intellectual property in the event of a claim against the business, if claims can be limited to the trading entity.

While it is important to obtain appropriate advice and establish a structure to suit your business at the outset, there may be some avenues for relief if you later change your structure for holding intellectual property.

Tax Relief

For businesses whose intellectual property comprises a trade mark or marks it might be possible to access roll-over relief under the Tax Laws Amendment (Small Business Restructure Roll-over) Act 2016.  The small business roll-over relief can be used to allow small business entities[4] to restructure to incorporate a separate holding entity for intellectual property without incurring a capital gains tax liability.  Specifically, any capital gains tax liability upon the undertaking of a genuine restructure of an ongoing business will be disregarded provided that the transaction does not materially change the ultimate economic ownership of the assets of the business.  Roll-over relief will also be available for an intellectual property asset that is a depreciating asset and no income tax liability will arise where the conditions under these provisions are satisfied in relation to that asset.[5]

Where intellectual property is rolled-over by its transfer to a wholly-owned company in consideration for the issue of shares by the company to the original owner Division 122 and section 40-340 of the Tax Act should apply to allow the CGT event occurring on the transfer to be disregarded.  Under Division 122 the market value of the shares received must be substantially the same as the market value of the intellectual property that was transferred but this is not problematic with a newly formed company which, immediately after the transfer, only holds the intellectual property. In addition the original owner of the intellectual property must own all of the shares in the company immediately after the disposal of the intellectual property and the original owner and the company must be Australian residents.  This does create a problem for protection of the intellectual property asset as, in the example, the trading entity will hold all the shares in the company to which the intellectual property has been transferred, effectively leaving the intellectual property indirectly available to creditors of the trading entity.  Further action will be needed to prevent this.

There will be no Stamp Duty on a transfer of an intellectual property asset from one entity to another.

Unrelieved Tax Costs

If you do not qualify for relief you could have significant income tax obligations upon transferring intellectual property assets to be held by a different entity:

  1. For trade marks, there will be capital gains tax. Since there is often a minimal cost base for your trade mark, likely corresponding to its costs of registration, the capital gain could be significant if the trade mark has become considerably valuable as a result of its use.  If you have held the asset for more than 12 months and are an individual or the trustee of a trust, the general 50% discount is likely to be available, as may be further discounts under the small business CGT concessions.[6]
  2. These concessions are not available for other forms of intellectual property that are depreciating assets used wholly for taxable purposes and for which depreciation is claimed.[7] These will generally be subject to a balancing charge, the whole of which will be included in the assessable income of the transferor entity.[8]

Conclusion

In many situations it will be worthwhile incurring the costs to hold the intellectual property separately from other assets including those of ensuring that the ownership of any transferee entity is separated from the risks of a trading business.  Retention of access to valuable R&D concessions will be an important consideration in any such restructure.

Tax obligations incurred in restructuring can possibly reduce the tax obligations likely to be incurred on the eventual sale of intellectual property assets.  Incurring some tax now may reap a greater benefit in the future.  For example, where you are able to make a disposal of an entity which holds intellectual property you may be able to apply the CGT general 50% discount and possibly the small business CGT concessions to the interests in the entity, whereas this would not be available on a disposal of the intellectual property itself as a depreciating asset.

This opportunity is enhanced if access to any of the roll-over relief is available on restructuring the intellectual property holding.  Maybe the time is right for your businesses to strategise its intellectual property holding structure.


[1] It has been announced that the changes will apply from this time although they are yet to be passed.

[2]  Sun Newspapers Ltd & Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337;

[3]  ibid;

[4]  As defined in section 328-110 of the Tax Act, namely where the annual turnover is less than $10 million, assuming the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016, which increases this from $2 million, is passed;

[5] Item 8 of the table in section 40-340(1) of the Tax Act;

[6]  In Division 152 of the Tax Act;

[7] Under Division 40 or 328 of the Tax Act;

[8] Some exceptions exist for gains resulting from CGT event J2 or Subdivision 40-F or 40-G of the Tax Act;

For more information, please contact:
Amy Bishop

Amy Bishop
Senior Associate
p.  +61 8 8124 1827
e.  Email me

This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this report, or what it means for you, your business or your clients' businesses, please feel free to contact us.

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