Capital Allowances: balancing adjustment amount - whether patent used for a taxable purpose

Is the balancing adjustment amount from the sale of a patent, from which no licence royalties have been received and under which no items have been successfully manufactured, reduced under subsection 40-290(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The balancing adjustment amount is not reduced under subsection 40-290(1) of the ITAA 1997 as the patent had been used solely for a taxable purpose.

A self-employed inventor (the taxpayer) had embarked upon a business venture to exploit, by means of licensing patent rights for royalty income or manufacture of machines for sale, machine designs he had invented. He applied for and was granted a patent in regard of the design of the machine which showed the most potential for successful exploitation.

After failing to successfully secure any arrangements to exploit his patent and because of his advancing age, the taxpayer entered into an agreement for the sale of his patent, for a lump sum payment, to a company in which he held no interest. This agreement represented a real abandonment of the taxpayer's business in regard to the patent.

Prior to the sales agreement, the taxpayer had provided information to the same company about his machine design in an attempt to secure a licence agreement.

The rights the taxpayer held under the patent are a depreciating asset as defined in section 40-30 of the ITAA 1997 provided the patent is not trading stock. As the taxpayer was carrying on a business with the aim of commercially exploiting his invention by way of licensing patent rights for royalty income or manufacture of machines for sale, the patent was a capital asset of the taxpayer's business.

The sale of the patent results in a balancing adjustment event under paragraph 40-295(1)(a) of the ITAA 1997. The taxpayer is required to work out a balancing adjustment amount under section 40-285 of the ITAA 1997 as the decline in value of the patent was worked out or would have been worked out under Subdivision 40-B of the ITAA 1997.

Subsection 40-290(1) of the ITAA 1997 reduces the amount worked out under section 40-285 of the ITAA 1997 if deductions for the decline in value for the depreciating asset have been reduced under section 40-25 of the ITAA 1997. Subsection 40-25(2) of the ITAA 1997 reduces deductions for decline in value where a depreciating asset is used or installed ready for use for a purpose other than a taxable purpose.

The meaning of taxable purpose is set out in subsection 40-25(7) of the ITAA 1997 and includes the purpose of producing assessable income.

The taxpayer's activities in disclosing the details of his patented invention to outside parties in attempts to secure licence agreements for use of the patent, or to secure arrangements whereby machines could be manufactured subject to the patent, amount to commercial exploitation of the taxpayer's patent. As such, these activities are sufficient to constitute use of his patent for the ultimate purpose of producing assessable income.

Accordingly, subsection 40-25(2) of the ITAA 1997 does not apply to reduce the taxpayer's deductions for the decline in value of the patent.

It follows that the balancing adjustment amount arising from the sale of the patent is not reduced under subsection 40-290(1) of the ITAA 1997.