1 Is the court awarded compensation distributed to you for the infringement of your copyrights (the Compensation Distributed) included in your assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 No. Question 2 Is the Compensation Distributed included in your assessable income as a balancing adjustment amount under Division 40 of the ITAA 1997? Answer 2 Yes. Question 3 Is any capital gain you made from the receipt of the Compensation Distributed included in your assessable income under Parts 3-1 and 3-3 of the ITAA 1997? Answer 3 No. This ruling applies for the following period : Year ended 30 June 20XX The scheme commenced on: July 20XX
You are a painter, illustrator and surface design artist. You publish artworks online, including artwork originals. You have licenced your designs. You are the owner of the federal copyright registrations that protect the creative content of your images and illustrations. 3 of your artworks include: • Artwork 1, published in May 20XX • Artwork 2, published in July 20XX, and • Artwork 3, published in April 20XX. You have been issued separate certificates of registration for each of the 3 abovementioned artworks, attesting a separate copyright registration has been made for each of the respective artworks. These certificates attest the artworks were first published in Australia, you were the author of the artworks, you are a citizen of Australia, you are the copyright claimant of the artworks and obtain the rights and permissions to the artworks.
Online copyright infringers traded upon your 3 copyrights, by selling and/or offering for sale products in connection with the respective artworks. In addition, the infringers sold unauthorised products that are based on and derived from the copyrighted subject matter of your images and illustrations. To illegally profit from the creative content of your artworks, the infringers created numerous internet stores and designed them to appear to be selling authorised products of yours. The infringers' internet stores shared unique identifiers, such as design elements and similarities of the unauthorised products offered for sale, establishing a logical relationship between them and suggesting their illegal operations arise out of the same transaction, occurrence or series of transactions or occurrences. The infringers attempted to avoid liability by going to great lengths to conceal both their identities and the full scope and interworking of their illegal operation. You consider your goodwill and reputation were irreparably damaged when your artworks were used as unauthorised goods.
You also consider you were further irreparably harmed by the unauthorised use of the copyrighted materials because infringers take away your ability to control the nature and quality of products bearing your artworks and derivative works. You further consider that you were irreparably damaged due to a loss of exclusivity. You sort injunctive and monetary relief. You filed an action to combat the infringers' unauthorised use of your artworks. You were represented by a representative who offered a no win no fee service. You were awarded $X in damages to March 20XX. You were awarded this amount in May 20XX. There were direct costs of $X, leaving a total amount for distribution of $X. X% of this amount was paid to your representative directly to account for expenses in relation to the case, while the remaining X%, being $X was forwarded to you as the Compensation Distributed.
Income Tax Assessment Act 1997 section 6-5 Income Tax Assessment Act 1997 section 6-10 Income Tax Assessment Act 1997 section 10-5 Income Tax Assessment Act 1997 Division 40 Income Tax Assessment Act 1997 section 40-30 Income Tax Assessment Act 1997 section 40-115 Income Tax Assessment Act 1997 section 40-285 Income Tax Assessment Act 1997 section 40-295 Income Tax Assessment Act 1997 section 102-5 Income Tax Assessment Act 1997 section 102-20 Income Tax Assessment Act 1997 section 104-25 Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 section 118-24
Summary The Compensation Distributed is a one-off payment and is not considered to be ordinary income. Copyright, being an item of intellectual property, is a statutory depreciating asset when it is not trading stock. A balancing adjustment event occurred when you received the Compensation Distributed. The amount included in your assessable income is the difference between the termination value and adjustable value of the 3 copyrights. Copyright is also a CGT asset. A CGT event happened when you received the Compensation Distributed; however, any capital gain you made from the CGT event happening is disregarded as the gain is included in your assessable income as a balancing adjustment. Detailed reasoning Ordinary income Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)). Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: • are earned
• are expected • are relied upon, and • have an element of periodicity, recurrence or regularity. Statutory income Amounts that are not ordinary income but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997). The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. Included in this list are sections 40-285 (balancing adjustments) and 102-5 (capital gains). Balancing adjustments An amount is included in your assessable income if: (a) a balancing adjustment event occurs for a depreciating asset you held and: (i) whose decline in value you worked out under Subdivision 40-B of the ITAA 1997, or (ii) whose decline in value you would have worked out under that Subdivision if you had used the asset, and (b) the asset's termination value is more than its adjustable value just before the event occurred. The amount included is the difference between these amounts, and it is included for the income year in which the balancing adjustment occurred (subsection 40-285(1) of the ITAA 1997).
Meaning of balancing adjustment event A balancing adjustment event occurs for a depreciating asset if: (a) you stop holding the asset, (b) you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or having it installed ready for use again, or (c) you have not used it and: (i) if you have had it installed ready for use - you stop having it so installed, and (ii) you decide never to use it (subsection 40-295(1) of the ITAA 1997). Depreciating assets A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, except an intangible asset, unless it is mentioned in subsection 40-30(2) of the ITAA 1997 (subsection 40-30(1) of the ITAA 1997). Items of intellectual property are depreciating assets if they are not trading stock (paragraph 40-30(2)(c) of the ITAA 1997).
Relevantly, an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as the owner, or a licensee, of a copyright, or of equivalent rights under a foreign law (subsection 995-1(1) of the ITAA 1997). Splitting a depreciating asset If a depreciating asset you hold is split into 2 or more assets, Division 40 of the ITAA 1997 applies as if you had stopped holding the original asset and started holding the assets into which it is split (subsection 40-115(1) of the ITAA 1997). A balancing adjustment event does not occur just because you split a depreciating asset (Note 2 to subsection 40-115(1) of the ITAA 1997). If you stop holding part of a depreciating asset, Division 40 of the ITAA 1997 applies as if, just before you stopped holding that part, you had split the original asset into the part you stopped holding and the rest of the original asset. (The rest of the original asset is then taken to be a different asset from the original asset) (subsection 40-115(2) of the ITAA 1997).
If you grant or assign an interest in an item of intellectual property subsection 40-115(2) of the ITAA 1997 applies to you as if you had stopped holding part of the item (subsection 40-115(3) of the ITAA 1997). Similarly, if an amount is received for infringement of copyright subsection 40-115(2) applies as if you had stopped holding part of the copyright. Meaning of termination value The termination value of a depreciating asset is worked out as at the time when the balancing adjustment event occurs. It is: (a) if an item in the table in subsection 40-300(2) applies - the amount specified in that item, or (b) otherwise - the amount you are taken to have received under section 40-305 of the ITAA 1997 for the asset (subsection 40-300(1) of the ITAA 1997). Relevantly, the amount you are taken to have received under a balancing adjustment event where you receive an amount, is the amount you received (Item 1 in the table in paragraph 40-305(1)(b) of the ITAA 1997). Meaning of adjustable value The adjustable value of a depreciating asset at a particular time is: (a) if you have not yet used it or had it installed ready for use for any purpose - its cost
(b) for a time in the income year in which you first use it, or have it installed ready for use, for any purpose - its cost less its decline in value up to that time, or (c) for a time in a later income year - the sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time, less its decline in value for that year up to that time (subsection 40-85(1) of the ITAA 1997). The opening adjustable value of a depreciating asset for an income year is its adjustable value to you at the end of the previous income year (subsection 40-85(2) of the ITAA 1997). Cost The cost of a depreciating asset you hold consist of 2 elements (section 40-175 of the ITAA 1997). First element of cost The first element is worked out as at the time when you began to hold the depreciating asset. Where a depreciating asset you hold is split into 2 or more assets, the cost is, for each asset into which it is split, the amount worked out under section 40-205 of the ITAA 1997 (subsection 40-180(1) and Item 1 in the table in subsection 40-180(2) of the ITAA 1997). Second element of cost
The second element is worked out after you start to hold the depreciating asset (subsection 40-190 of the ITAA 1997). The second element is: (a) the amount you are taken to have paid under section 40-185 of the ITAA 1997 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since you started to hold the asset, and (b) expenditure you incur that is reasonably attributable to a balancing adjustment event occurring for the asset (subsection 40-190(2) of the ITAA 1997). Division 40 of the ITAA 1997 applies to you as if you had paid, to hold a depreciating asset or for an economic benefit for such an asset, the greater of these amounts: (a) the sum of the amounts that the sum of the amounts that would have been included in your assessable income because you started to hold the asset or received the benefit, or because you gave something to start holding the asset or receive the benefit, if you ignored the value of anything you gave that reduced the amount actually included, or
(b) the sum of the applicable amounts set out in the table in subsection 40-185(1) of the ITAA 19997 (if you pay an amount, the amount (Item 1 in the table in subsection 40-185(2) of the ITAA 1997)) in relation to holding the asset or receiving the benefit (subsection 40-185(1) of the ITAA 1997). Cost of a split depreciating asset If you split a depreciating asset into separate assets as mentioned in section 40-115 of the ITAA 1997, the first element of the cost of each of the separate assets is a reasonable proportion of the sum of these amounts: (a) the adjustable value of the original asset just before it was split, and (b) the amount you are taken to have paid under section 40-185 of the ITAA 1997 for any economic benefit involved in splitting the original asset (section 40-205 of the ITAA 1997. Adjustment: double deduction
Each element of the cost of a depreciating asset is reduced by any portion of that element of cost that you have deducted or can deduct, or that has been or will be taken into account in working out an amount you can deduct, other than under Division 40, Division 41 or Division 328 of the ITAA 1997 (section 40-215 of the ITAA 1997). Capital gains tax A CGT asset is any kind of property, or a legal or equitable right that is not property (subsection 108-5(1) of the ITAA 1997). Copyright is an intangible CGT asset. A CGT event is a type of transaction which occurs in relation to a CGT asset. This type of transaction results in a capital gain or capital loss. You make a capital gain from the CGT event if the capital proceeds are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-10(4) of the ITAA 1997).
A capital gain or capital loss you make from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset is disregarded if the asset was an asset you held where the decline in value of the asset was worked out under Division 40 of the ITAA 1997 (including that Division as it applies under Division 355), or the deduction for the asset was calculated under Division 328, or would have been if the asset had been used (subsection 118-24(1) of the ITAA 1997). Application to your circumstances Ordinary income The Compensation Distributed was not earned by you as it does not directly relate to any services performed. Rather, the Compensation Distributed relates to the infringement of your 3 copyrights. The Compensation Distributed is a one-off payment and therefore does not have any elements of recurrence or regularity. Although the Compensation Distributed can be said to be expected, and perhaps relied upon, this expectation arises from the legal action, rather than from any relationship with personal services performed. As such, the Compensation Distributed is not considered to be ordinary income under section 6-5 of the ITAA 1997. Balancing adjustment
Copyright is a bundle of rights, and in the case of an artwork includes, amongst other rights, the right to sell or offer for sale products in connection with the artwork. The creator of the artworks in which the 3 copyrights subsist is the owner of the artworks. Copyright, being an item of intellectual property, is a depreciating asset. When you received the Compensation Distributed, it was in relation to only part of the economic value of the 3 copyrights, not the 3 copyrights themselves. The Compensation Distributed is effectively a substitution for a part of the 3 copyrights, meaning the original depreciating assets were split into 2 or more separate depreciating assets. Splitting the depreciating asset into 2 separate depreciating assets was not a balancing adjustment event; however, when you received the Compensation Distributed a balancing adjustment event occurred.
The amount included in your assessable income because of the balancing adjustment event is the difference between the asset's termination value and adjustable value. The termination value is the Compensation Distributed, being $X. This is because compensation is considered a substitute for proceeds from the disposal of an asset, as it relates to the loss or impairment of the asset. The adjustable value will likely be negligible or even nil. This is because, as the creator of the artworks you did not purchase them and most, if not all, the costs incurred in creating the artworks are business expenses that are deductible under section 8-1 of the ITAA 1997. Capital gains tax As noted above, like most depreciating assets, copyright is also a CGT asset. While a CGT event happened when you received the Compensation Distributed, any capital gain you made from the CGT event happening is disregarded as the gain is included in your assessable income as a balancing adjustment.