Capital Allowances: depreciating asset - rights to virtual land

Can a taxpayer claim a deduction under subsection 40-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the decline in value of rights to virtual land which they start to hold upon payment of a capital amount to the provider of an online role-playing game?

No. The taxpayer can not claim a deduction under subsection 40-25(1) of the ITAA 1997 for the decline in value of rights to virtual land which they start to hold upon payment of a capital amount to the provider of the online role-playing game because the rights they start to hold under that transaction do not satisfy the definition of a depreciating asset pursuant to subsection 40-30(1) of the ITAA 1997.

The taxpayer is one of numerous users of an online role-playing game (referred to by users of the website service as a virtual world). In order to gain online access to the virtual world the taxpayer agrees to the provider's terms and conditions that govern participation in the game. Upon acceptance of the terms and conditions the provider grants free access to tools for the computer generation of things (for example, digital representations of items of clothing or vehicles) in the virtual world. The tools provide user access to that part of the game's software that supports the creation of user-generated content. This access is accompanied by the provider's express permission for users to retain intellectual property rights with respect to the content they generate.

As provided for in the terms and conditions of the taxpayer's agreement with the provider, the taxpayer elects to pay a once-off capital amount to the provider to become the holder of rights to an aspect of the virtual world referred to by the provider as owning virtual land. The nature of the asset acquired by the taxpayer from this transaction is rights to a service pertaining to the management of a newly created section of the computer-generated landscape of the virtual world. The function of the computer-generated landscape is to simulate the land upon which user-generated content (for example digital representations of buildings) can be attached and contained within the virtual world. New sections of the virtual world's computer generated landscape are periodically created in the game by the provider in order to make fresh space available for additional user-generated content.

The newly created section of the computer-generated landscape the taxpayer manages is first devoid of user-generated content and the taxpayer does not subsequently create and attach content to it but licences its use to certain other game users in return for regular payments assessable to them as income pursuant to section 6-5 of the ITAA 1997. The licence granted by the taxpayer to other game users (referred to in the virtual world as the sale or rental of virtual land) enables those users to place in the virtual world, the content they wish to bring into play for their own social or commercial advantage.

(All legislative references are to the ITAA 1997).

In this case, the taxpayer has agreed to pay a capital fee to the provider of an online role-playing game service to become the holder of rights to an aspect of the provider's service (referred to as rights to virtual land). In order for the taxpayer to be entitled to a deduction under subsection 40-25(1) for the decline in value of the rights they start to hold under this transaction, the rights must first satisfy the definition of a depreciating asset pursuant to subsection 40-30(1).

A depreciating asset is defined in subsection 40-30(1) to be an asset that has a limited effective life and can reasonably be expected to decline in value over the time that it is used. The definition excludes land, trading stock and intangible assets, except for those intangible assets listed in subsection 40-30(2).

In the circumstances of this case, the taxpayer pays to hold rights to a service (referred to as rights to virtual land), additional to the service provided to users exclusive of paying a fee, that allow the taxpayer to deal with a brand new section of the landscape of an online game. The rights are not a tangible asset and are an intangible asset. Therefore, to be a depreciating asset, it needs to be an intangible asset listed in subsection 40-30(2).

The items listed in subsection 40-30(2) are: (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) *telecommunication site access rights *denotes a term defined in section 995-1.

The taxpayer's right clearly does not fall within the descriptions in paragraphs 40-30(2)(a), 40-30(2)(b) and 40-30(2)(e) to 40-30(2)(h) listed above. The possible application of paragraphs 40-30(2)(c) and 40-30(2)(d) requires further consideration.

Paragraph 40-30(2)(c) provides that items of intellectual property, are depreciating assets, if they are not trading stock. Intellectual property is defined in subsection 995-1(1). The definition states:

An item of intellectual property consists of the rights (including equitable rights) that an entity holds under a Commonwealth law as: (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.

The rights to virtual land, licensed by the taxpayer to certain users of the provider's online game facilitates, amongst other things, the users entitlement to copyright or other intellectual property rights with respect to content placed in the computer-generated landscape. In this case, the taxpayer does not become the holder of copyright or other intellectual property rights in respect of content placed in the computer-generated landscape. The section of the computer-generated landscape, in respect of which the taxpayer acquired rights, was first devoid of user-generated content and the taxpayer did not subsequently create and attach content to it. Accordingly, the rights to virtual land the taxpayer starts to hold upon payment of the once-off capital amount can not satisfy the definition of an item of intellectual property contained in subsection 995-1(1).

Paragraph 40-30(2)(d) provides that in-house software, is a depreciating asset. In-house software is defined in subsection 995-1(1) as computer software, or a right to use computer software, that you acquire, develop or have another entity develop that is mainly for you to use in performing the functions for which the software was developed.

Although the rights licensed by the taxpayer to certain users of the online game facilitates, amongst other things, the users access to the software necessary to generate content; the particular rights acquired by the taxpayer, upon payment of the capital fee, are not rights to use computer software. Rather they are rights to a service, additional to the service provided to users exclusive of paying a fee, which allows exploitation of the space available in a new section of the computer-generated landscape of the game. Further, the software, that enables the section of the computer-generated landscape exploited by the taxpayer to function, is not used primarily by the taxpayer in performing that software's functions. Rather it is the game users licensed by the taxpayer that primarily use the software to perform the functions for which that section of the computer-generated landscape was designed. Accordingly, the rights the taxpayer acquired upon payment of the once-off capital amount does not constitute in-house software as defined in subsection 995-1(1).

It follows that the rights the taxpayer starts to hold upon payment of the once-off capital amount is not included in any of the items listed in subsection 40-30(2).

As the rights the taxpayer starts to hold upon payment of the once-off capital amount is not listed in subsection 40-30(2), but is an intangible asset, it is excluded from being a depreciating asset, by paragraph 40-30(1)(c). Consequently, the taxpayer can not claim a deduction under subsection 40-25(1) for the decline in value of rights to virtual land they start to hold upon payment of the relevant capital amount to the provider of the online role-playing game. Note: In these circumstances, the right the taxpayer starts to hold is a legal or equitable right that falls within the meaning of a capital gains tax asset as defined in section 108-5.