Tax issues in the sale of a business there are structural issues to consider in relation to the sale of IP whether or not it is part of a business sale.
Depreciating Assets – Not CGT-able
While a depreciating asset can qualify as an active asset, the sale of depreciating assets does not give rise to assessable capital gains. Instead, a gain arising on a sale of a depreciating asset is taxed as a revenue amount under Division 40 of the ITAA 1997 (“the 1997 Act”). As such, the various small business concessions under Division 152 will be unavailable on the sale of depreciating assets. Importantly, gains on many items of intellectual property, such as patents and copyright, are now taxed under Division 40, so the concessions will be unavailable.
IP is not CGT-able
Trademarks, patents, brand names, software, knowhow, designs, copyright, confidential information and other intellectual property (“IP”) are becoming increasingly important and valuable assets of a business and consequently the tax issues are becoming more important. When it comes to selling a business, the true characterisation and value of the business needs to be dissected. It is important to separate goodwill from other intangibles. There was a big shift in the tax position when on and from 1 July 2001, IP (as defined in the CGT provisions) was removed from the CGT net and became part of the ordinary income UCA regimeunder Division 40. Suddenly, the opportunity was gone for some taxpayers to just use the 50% CGT discount to cap tax on the sale of IP at 23.25% or, if the CGT small business concessions apply, maybe pay no tax at all.
Disposal of IP that is a “depreciating asset”
For IP that is a “depreciating asset” subdivision 40-D will apply when the holder disposes of the IP. When the holder ceases to hold the depreciating asset there is a balancing adjustment. If the proceeds from the disposal of the asset (called thetermination value) exceed the adjustable value then the difference is assessable. If the proceeds are less, the difference is deductible. As a result of section 118-24, in many cases where the IP disposed of is a “depreciating asset” the CGT regime will not need to be considered.
Disposal of IP that is not a “depreciating asset”
For IP that is not a “depreciating asset”, such as a trademark (whether registered or unregistered) and confidential information, subdivision 40-D will have no application. Neither are they a CGT asset. In respect of such IP and other intangibles that are neither CGT assets nor depreciating assets (e.g.: know-how and business processes), the taxation outcomes in the hands of the vendor and purchaser are relevant.
The ATO takes the view that the “essential character” of the transaction is cogent in determining the relevant taxation outcome, both for vendor and purchaser. In Taxation Determination TD 2005/1, the Commissioner considers the conveyance of a patient list as part of a business sale, as the supply of information, which is neither a service nor a disposal of a copyright. This could be highly advantageous for the purchaser, by virtue of the black hole expenditure provisions, as to which see section 40-880 of the 1997 Act which began operation on 6 April 2006.
Sale structuring options to consider
In the typical sale or purchase of a business, we used to only worry about what was split between goodwill and plant and equipment, with nominal value attributed to the IP behind goodwill. Generally it was copyright. Now, the ATO is particularly keen to see all of the intangibles and a basis of allocation between them. And don’t assume you can say “it’s all part of goodwill so it gets taxed under the CGT rules”. You won’t be able to say “Don’t worry, it’s all goodwill” because since Murry’s case (1998) and the ATO’s view expressed in TR 1999/16, it is necessary to identify and value any IP intangibles. Goodwill attached to a business sits over the bundle of intangibles but is separate from it.
An analysis of the above issues gives rise to a number of business structure possibilities.
Importance of differentiating goodwill from IP
Similarly, the balancing charge on the sale of most IP makes it imperative when selling the assets of a business to differentiate goodwill, which is a capital asset, from IP.