Issue 263 | 20 December 2007 |
Article by Teresa Dyson, Partner and Tim Rowe, Lawyer, Blake Dawson Waldron
Intellectual property in all its forms, has become an ever-increasingly valuable commodity in the 21st century. The communications revolution, globalisation and the digital age have all played a large part; in particular, the ability to leverage IP on a worldwide scale. This value is not merely economic — it can serve socially and culturally desirable ends. However, as an essentially speculative endeavour, the development of IP is underscored by myriad risk exposure and capital outlay, often with no return until late in the piece.
In Report 262, we considered some of the taxation issues associated with the development of IP. Part II considers the exploitation and realisation of IP, including discussion of recent developments and the impact of GST, and touches on certain international taxation aspects of the process.
IP may be exploited in many ways, including by sale/assignment and by licensing. We discuss below the taxation treatment of licensing and assignment. However, determining whether IP has, in fact, been either licensed or assigned, can sometimes be unclear. In respect of the assignment of copyright, the Commissioner, on 27 June 2007, released for public comment Draft Taxation Ruling TR 2007/D5 (draft ruling).
The draft ruling contains the Commissioner's view on the circumstances in which consideration for an assignment of copyright will be treated as a royalty and, in particular, focuses on so-called “partial assignments”.
Royalty payments are generally subject to withholding tax under Div 11A, Pt III of the Income Tax Assessment Act 1936 (ITAA 1936). The standard rate of withholding tax is 30%, but is reduced under most double tax agreements.
The Commissioner states that he has issued the draft ruling because he is aware of:
“arrangements which suggest that some non-resident copyright owners may be seeking to structure copyright transactions as assignments. The underlying rationale for this approach is the contention that payments made in respect of such assignments of copyright are not royalties and therefore would not attract royalty withholding tax.”
While royalties are generally subject to withholding tax, ordinary income is not. Accordingly, if a non-resident is protected by a double tax agreement and does not have a permanent establishment in Australia, any Australian-sourced income it earns that is not classified as royalty income is unlikely to be taxed in Australia. Even if the non-resident is not protected by a treaty, Australia would only be able to tax the non-resident by way of assessment and recovery rather than withholding — a much less effective method of tax collection.
For income tax purposes, “royalty” has two definitions: the common law definition and the statutory definition. These definitions are discussed in an earlier taxation ruling, ie IT 2660. At para 10 of IT 2660, the Commissioner discusses the common law meaning of “royalty”, identifying the following four key features:
1. the payment is in return for the right to exercise a beneficial privilege or right
2. the payment is made to the person who owns the right
3. the amount payable is determined on the basis of the amount of use made of the right
4. the consideration is usually paid as and when the right is acquired (but an amount paid that is a pre- or post-estimate referable to the amount of use will nevertheless be a royalty).
The statutory definition effectively extends the definition. Paragraph 12 of IT 2660 notes that s 6(1) of the ITAA 1936 defines “royalty” as, inter alia:
“...amounts paid or credited for:
(a) the use of or right to use, any copyright, patent design or model, plan, secret formula, process, trademark or other like property or right;”
In this context, the Commissioner states in the draft ruling (at para 23):
“From a taxation perspective, any amount or amounts paid or credited as consideration for all forms of the copyright short of an outright sale of the copyright is a royalty or are royalties under the extended definition provided in subsection 6(1) of ITAA 1936. Such payments are regarded for tax purposes as given for the ‘use of, or the right to use’ copyright by the assignee.”
Conversely, any amount paid for an outright sale is not a “royalty”, and no withholding tax will be payable, unless the amounts, for whatever reason, fall within the definition of that term in s 6(1) of ITAA 1936 or the common law meaning of royalty.
Somewhat predictably, the Commissioner states (at para 25) that to determine whether payments are royalties in respect of the sale of copyright, “it is necessary to consider all the relevant facts and circumstances surrounding the transaction including the substance of the agreement between the parties”.
Assignments of copyright may be limited in a number of ways, such as by:
• the right to only perform certain acts with respect to the subject matter
• the geographical region in which the rights may be exercised, or
• the period of time or number of times during which the rights may be exercised.
The Commissioner rules that payment for an assignment limited in one or more of these manners is likely to be a royalty, as it is a payment for the “use of, or right to use copyright”, with the subsisting copyright remaining with the assignor.
The Commissioner uses several examples to explain the application of the draft ruling. A lump sum payment for an assignment of the right to publish an article for a period of six months will be a royalty, as will a lump sum for a right to publish the article three times. However, a lump sum payment for an assignment of all rights to a book in Australia, including the right to modify the subject matter and license it to third parties in Australia, will be regarded as an outright sale, not a royalty. Where copyright in a film is assigned for (the first) six months, notwithstanding that the value of the residual copyright is substantially diminished when the rights revert to the assignor, the payment will be a royalty because there is still some value remaining in the copyright.
The Commissioner also notes that, where consideration for an assignment is given partly by royalty and partly by something else, the part of the consideration that comprises a royalty will be subject (proportionally) to withholding tax.
The capital/revenue distinction permeates the analysis of the taxation treatment of IP. As discussed above, a licence fee is generally regarded as a royalty. Royalty is broadly defined in the tax legislation as:
1. the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trade mark, or other like property or right
2. the use of, or the right to use, any industrial, commercial or scientific equipment
3. the supply of scientific, technical, industrial or commercial knowledge or information
4. the supply of any assistance that is ancillary and subsidiary to the above
5. the reception of, or the right to receive, visual images or sounds or both, transmitted to the public by satellite or cable, optic fibre or similar technology and the use of, or right to use, visual images and/or sounds in connection with television or radio broadcasting transmitted by this technology
6. the use of or right to use motion picture films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, and
7. payment made for an undertaking that rights to use the property etc will not be granted to anyone else.
These receipts will be taxed as ordinary income if they are received on revenue account, and will be assessed under the capital gains tax (CGT) provisions if they are received on capital account.
Receipts will generally be characterised as income if they are receipts in the ordinary course of carrying on a business, or they result from a transaction entered into with a profit-making intention or purpose (see generally the discussion in FC of T v Myer Emporium Ltd 87 ATC 4363 as to what constitutes a profit-making intention or purpose). The receipt will be characterised “in the recipient's hands”; it will not necessarily correlate to the nature of the expenditure by the counter-party (ie what may constitute capital expenditure for the licensee may be a revenue receipt for the licensor).
The recipient is required to account for all receipts on revenue account in the income tax year in which they are received.
If the receipt is on capital account and is in relation to a depreciating asset, the granting of a licence will cause the licensor to be deemed to have stopped holding the asset and to have commenced holding a new asset referable to the remaining rights. This receipt may trigger a balancing adjustment, a mechanism which reconciles the written-down value with any premium on the disposal. CGT event K7 will occur if a balancing adjustment event has happened to a depreciating asset (ie the grant of a licence), which may trigger a capital gain or loss.
CGT event D1 will occur on the creation of contractual or other rights that are not depreciable. The licensor will have a taxable capital gain to the extent that the capital proceeds received from the licensee for creating the licence exceed the incidental costs of creating it. On the other hand, a capital loss will arise if the incidental costs of creating the right exceed the capital proceeds. Note that a licensor will only receive capital proceeds if payment for the licence is partly or wholly of a capital nature.
The R & D recapture rules apply to amounts received in respect of a licence of any IP derived from R& D activities for which the licensor was eligible to claim a deduction under the R& D rules, treating them as assessable income.
A payment of a royalty by an Australian resident licensee (or a non-resident operating through an Australian permanent establishment) to a non-resident licensor (or a resident operating through an overseas permanent establishment) may be subject to Australian royalty withholding tax. The licensee is required to withhold and remit an amount in respect of that liability to the Tax Office.
Royalties derived from non-Australian sources by an Australian resident may be subject to royalty withholding tax of the source country. The licensor remains assessable for Australian tax on the gross amount of royalties received, but may be entitled to a foreign tax credit for any foreign withholding tax paid.
The normal rate of Australian royalty withholding tax is 30%. This is subject to any applicable bilateral tax treaties, which generally limit the rate to 10% (or 5% under the US and UK agreements).
Any deemed financing element of payments under an agreement which provides for an effective purchase of IP (ie an instalment sale, hire purchase agreement or lease/licence for life) will attract interest withholding tax at a rate of 10%.
The consequences for a licensee will also depend on whether the payments are classified as capital or income. A similar characterisation process as was discussed in respect of expenditure incurred to create IP rights applies.
To the extent that the licensee acquires the licence of the relevant item of IP for use in conducting eligible R& D activities, the licensee may be entitled to apply the R& D tax concessions.
Royalties payable by an Australian licensee to a non-resident may be subject to withholding tax. There are also transfer pricing rules which apply where parties are not dealing at arm's length.
The grant of a licence to use IP may also give rise to a liability for stamp duty at a state level. In South Australia and the Northern Territory, duty is charged on a conveyance or transfer of property. In Western Australia, it is charged on a transfer of business assets. Whether a licence creates a proprietary right or a personal right will ultimately depend on the terms of the licence. Generally, an exclusive licence is considered to create a proprietary right to exploit the underlying IP and will be dutiable in these jurisdictions.
A licence will only be dutiable in a jurisdiction that imposes duty to the extent it has a relevant “nexus” with that jurisdiction (ie if the instrument is executed in the jurisdiction, it relates to property located in that jurisdiction, or it relates to any activity done in that jurisdiction). Where there is a relevant “nexus” with more than one state, the duty will generally be apportioned by the amount of use of the IP in each state.
Note that the grant of a licence of IP would generally not result in a liability for duty in New South Wales, Victoria, the Australian Capital Territory, Queensland or Tasmania.
Again, the capital/revenue distinction is the first characterisation that must be made.
If the IP is on revenue account, the proceeds of sale are income and the recipient is liable to tax on those amounts in the year in which they are earned.
If the IP is on capital account and the item is a depreciating asset, a balancing adjustment will occur and CGT event K7 will trigger either a capital gain or loss in respect of the proceeds less the written down-value of the asset. If the item is not a depreciating asset, CGT event A1 will occur and will trigger a capital gain or loss based on the proceeds less the cost base (which includes expenditure incurred to acquire and hold the asset).
The CGT rules will not apply if the R& D concessions have been claimed in respect of expenditure incurred in developing the IP. In this case, generally speaking, the proceeds of sale of the IP are treated as assessable income.
The income tax consequences for a transferee are broadly similar to the consequences for a licensee. If the acquisition is on revenue account, the expenditure will be deductible upfront; if on capital account, the expenditure either will form part of the cost base on a subsequent disposal of the asset or, if the asset is depreciable, may be depreciated in accordance with the existing depreciation schedule.
The transfer of IP might give rise to a liability for stamp duty in each Australian jurisdiction except Victoria and the ACT.
The transfer of IP will only be dutiable in New South Wales and Tasmania if the IP has been used or exploited in the relevant state in the previous 12 months, and the transfer also involves a transfer of goodwill of a business that has traded in the relevant state in the previous 12 months (to the extent it has been used in those respective states). Likewise, Western Australia and Queensland only impose duty in respect of IP transferred with business assets, however the Western Australian definition of “IP” is extremely broad.
Transfer duty will be payable in the Northern Territory and South Australia on a transfer of most recognised forms of IP. The rate in the Northern Territory is 5.4% and in South Australia is 5.5% of the higher of the market value and the consideration paid.
Those dealing with IP must be aware of the impact of GST on their activities. GST is a tax that requires a supplier to remit 1/11th of consideration received to the Tax Office. Practically, suppliers usually pass on the burden of GST to a recipient by way of increasing the consideration payable, however consideration is presumed to be GST-inclusive unless otherwise agreed.
In general terms, GST is payable where a supplier makes a supply connected with Australia for consideration in the course or furtherance of an enterprise, and that supplier is registered or required to be registered for GST.
Any acquisitions made by a person for the purpose of developing IP are likely to carry a GST component. Broadly, if the IP is going to later be sold or licensed, the acquirer will be entitled to credits for the GST it pays on acquiring things.
A later sale or licence of any IP developed may also need to carry a GST component if the sale or licence is connected with Australia. However, if the supply is to a non-resident and the IP is to be used outside Australia, no GST will be payable.
Ultimately, as with most endeavours, earnings (less expenses) from IP are brought to tax in a way that is, for the most part, commensurate with the tax burden borne by others. There are concessions built into the tax system to encourage culturally and economically beneficial development of IP. However, the balance must be struck to ensure a substantial degree of horizontal fiscal equity, in light of the capital outlays of people developing IP.
In the following decision, the Federal Court determined that the importation and sale of unbranded goods in packaging bearing a trade mark that was not applied by the trade mark owner, amounted to trade mark infringement. This was the case even though the goods were genuine.
Brother Industries, Ltd, a Japanese company (“Brother Japan”), has conducted an international business of producing, marketing, and selling a variety of products, including printers. Its wholly owned subsidiary, Brother International (Aust) Pty Ltd (“Brother Australia”), one of the applicants in the proceedings, has carried on the Australian arm of the business with the licence and authority of Brother Japan, and has used several of Brother Japan's Australian trade marks relating to the word “BROTHER”.
Brother Japan has produced a printer drum unit (referred to in the judgement as the “BROTHER DR-200 unit”) which is embossed with the BROTHER brand. The unit is wrapped in distinctive packaging, comprising a box made of cardboard which bears the BROTHER trade mark.
Brother Japan also makes an unbranded unit which is similar but not identical to a BROTHER DR-200. These unbranded units are not embossed with the BROTHER trade mark and are sold exclusively to one purchasing company (“Company X”) who then sells or distributes the units under a brand name unrelated to Brother or with no brand name at all.
The respondent had sourced Brother printer drum units from a US supplier (“Discover Group”) who were unrelated to the Brother companies. Discover Group is a wholesaler of computer “consumables” and sold the unbranded, generic units to the respondent at a substantially lower price, than the respondent would have paid if the units were purchased from Brother Australia or its authorised distributors. The evidence indicated that these units were wrapped in counterfeit packaging which prominently displayed the Brother name and trade mark and sold to customers in Australia.
Brother became aware in 2004 that the respondent was selling these unbranded products in what appeared to be counterfeit BROTHER DR-200 packaging. Brother alleged that the units were the unbranded products produced by Brother Japan for Company X.
Brother sought injunctive relief to restrain the respondent from infringing its trade marks, from contravening s 52 and 53 of the Trade Practices Act 1974 and passing off the unbranded products as Brother products.
Brother had asserted that use of the BROTHER trade marks on packaging and on business stationery such as invoices, amounted to use of the trade mark in relation to those goods by the respondent pursuant to s 17 of the Trade Marks Act 1995.
The respondent had countered however, that it has not used the BROTHER trade marks in a manner that would contravene the Act because Brother's right of exclusive use (conferred by s 20 of the Act), only operates to prevent the sale in Australia of goods which are not Brother's products but which bear its trade mark. It was further argued that the BROTHER name and trade mark as applied, still indicated that the origin of the units was Brother. It was therefore Brother itself who was the user of the BROTHER name and trade mark.
The court decided however that Brother could not be described as having used its trade mark on the products sold by the respondent. Brother had taken steps to dissociate itself from the unbranded products it sold to Company X by removing any trade mark. It could not therefore be said to have used a false copy of its trade mark which, without permission was applied to its product by some disassociated entity in the distribution chain.
Further, where a retailer imports for sale, goods which are in packaging bearing a counterfeit trade mark, that importation will be an infringing use of the mark. It was immaterial that the respondent received counterfeit-packaged printer drums and not goods which themselves bore a counterfeit mark.
Section 7(4) of the Trade Marks Act supports this conclusion, defining use of a trade mark not only as the application of the mark to the product itself, but also the application of the mark to other items relating to the product, such as packaging, invoices, correspondence and advertisements. Section 9 of the Act provides that a trade mark used on an invoice attached to either the packaging in which the product is stored or transported, is to be taken as being applied in relation to the goods.
The respondent had asserted that the application of Brother's Australian marks was done with the licence or authority of Brother Japan (the owner of the infringed marks). It argued that the evidence established that on the balance of probabilities, the units it imported were sourced originally by Discover Group from Brother America. Brother America must have sourced these products from Brother Japan or Brother International which had erroneously sent Brother America rather than Company X the unbranded units.
However, the court determined that the respondent had not established the chain of supply of the unbranded units and their packaging back to Brother America, let alone Brother Japan. The court also noted that it would not suffice for the respondent to merely demonstrate that it had the consent of an entity related to the registered owner of the trade marks.
In any case, the court found that the respondent would not be able to argue that it had Brother's consent because it still had not established that the registered owner of the infringed marks, Brother Japan, expressly or impliedly consented to the application of its mark to or in relation to, the goods. The unbranded units were not branded by Brother Japan with its mark, and the packaging was counterfeit. No consent, whether express or implied, was given by Brother Japan to any person or entity to apply its mark to the products. Indeed, Brother Japan had distanced itself from these products, manufacturing them only as unbranded products and selling them only through a confidential arrangement with Company X.
The respondent had argued that when selling the products, it did no more than communicate what was represented by Brother without adopting or endorsing these representations. In other words, it was a mere conduit in the distribution process.
However, the court determined that the respondent's conduct was likely to mislead members of the public into believing that the unbranded products were in some way promoted or distributed by Brother or with its consent. The packaging and invoices identified the products as genuine Brother DR-200 units, when they were not.
Citation: Brother Industries, Ltd v Dynamic Supplies Pty Ltd (2007) AIPC 92-262.
The following cases have also been included in the Service:
• Lockwood Security Products Pty Ltd v Doric Products Pty Ltd [No. 2] (2007) AIPC 92-261, a High Court decision on whether a patent for a lock device lacked an inventive step
• KD Kanopy Australasia Pty Ltd v Insta Image Pty Ltd (2007) AIPC 92-258, a Federal Court decision concerning infringement of a patent for a collapsible canopy
• Macquarie Bank Limited v Great Southern Loan (SP) Pty Ltd (2007) AIPC 92-260, a Trade Marks Office decision concerning the registrability of the trade mark “Thinking Forward”. The registration application was refused because the applied for mark was deceptively similar to the mark “FORWARD THINKING”
• Fendi Adele SRL v Fox-Wizel Ltd (2007) AIPC 92-259, a further Trade Marks Office decision concerning opposition to the registration of a trade mark on s 44 and 60 grounds.
Under the current legal deposit scheme as stipulated in s 201 of the Copyright Act 1968, publishers of “library material” (which is essentially paper-based publications) are required to deposit a copy of all printed material published in Australia with the National Library of Australia.
The Commonwealth government has released a discussion paper on the possibility of extending the scheme to include audiovisual and electronic material.
For further information, visit the Department of Communications, Information Technology and the Arts’ website at www.dcita.gov.au.
The Patents Regulations 1991 have recently been amended by the Patents Amendment Regulations 2007 (No. 1).
Importantly, the amending Regulations substantially remove the compliance burden relating to the obligation on applicants and patentees to inform the Commissioner of Patents of the results of certain foreign patent office searches.
However, any results that were to be filed before 22 October 2007 must still be lodged with the Patent Office.
The Patents Regulations in the Service will be updated in the next report to reflect the amendments.
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